Behavioral Finance 2 Flashcards
If there are extrapolators in the market, to what opportunities does that lead?
Arbitrage opportunities where the market price is not equal to intrinsic value
What is noise-trader risk?
Risk that irrational investors in the market grow in number or intensify incorrect beliefs, pushing prices further away from the actual value –> GameStop
Since managers are compensated based on performance, how do they react to arbitrage opportunities in the light of behavioral finance?
They are scared towards arbitrage opportunities because he cannot know when the prices will correct and it will cost him his compensation.
What is synchronization risk?
Managers could correct the price errors in the market but they should do it coordinated and that is very difficult in a fragmented market.
Why don’t the irrational investors disappear?
Noise traders scare away arbitrageurs so irrational investors don’t lose that much money on wrong prices.
Also, there seems to be imperfect transgenerational transmission of information.
What does momentum mean in behavioral finance?
Extreme winners consistently beat extreme losers in the following period
Firms with extreme asset growth consistently underperform compared to small asset growth. Why?
Because of extrapolation in the market. Irrational investors may confuse growth in assets with growth in dividends and therefore push the price up and when it corrects, it will underpeform.
