1. Introduction Flashcards
Why Experiments in Finance?
For identification and causal inference
Explain Identification & causal inference
Isolation of true causes
Randomized trials
Replicability: Would the experiment give the same results overtime
Goal of Behavioral Finance ?
Explain behaviors in the dynamics of the stock market using insights from psychology, sociology and neuroscience.
The 3 spheres adding realism to the finance theory?
- Realistic assumptions about individual beliefs (expectations of the future)
- Individual preferences (Non-rational preferences)
- Cognitive limitations
Explain the Weak form of the EMH
Past performance has nothing to do with future prices.
- NO technical analysis
- NO beating the market
Explain the Semi-Strong form of the EMH
Stock Price reflect both the market and non-market public info (present)
Explain the Strong form of the EMH
All availalble and non-available (inside) information is priced in
What are the assumptions to the EMH
- No transaction costs
- Information is costless
- investors have homogenous expectations
- investors are rational
Empirical facts: What are the 4 facts about private households
- Low rates of stock market participation
- under-diversification
- poor trading performance (overtrading)
- prefer actively managed funds that are costly
What are the implications of the EMH
- No free lunch
- instant price adjustment to new information
- supports passive investing
Empirical facts: Explain the difference between long-term reversal and momentum (return predictability)
- Long-term reversal: stock returns over the past 3-5 years usually reverse.
- Momentum: A stock return over the past six months - 1 year predicts the signs in the cross-section.
Empirical facts: Explain the equity premium puzzle
Stocks (equities) give much higher returns than “safe” bonds over time—way more than experts think they should.
Why is this a mystery ? Because stocks are riskier, but not this much riskier (based on models).
Empirical facts: What is the definition of a bubble?
Episode in which an asset becomes substantially “overvalued” meaning that the price exceeds its intrinsic value.
Arbitrage: Limits to arbitrage
- Fundamental: adverse news against the asset’s fundamentals
- Execution risk: needs to act fast
- Costs: trading costs, research costs
- Noise trader risk: the mispricing persist for longer as more irrationality comes into play.
