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Question 1

What were 2 RQs in Wisdon of Crowds?

Answer 1

1) Do peer opinions contain value-relevant info?

2) Do some users intentionally spread disinformation?

Question 2

What were 2 channels to voice their opinions in Wisdom of Crowds?

Answer 2

1) Comments

2) Articles

Question 3

Methodology of Wisdom of crowds - what variables were run?

Answer 3

X1 - average fraction of negative words in comments about some stock
X2 - average fraction of negative words in articles about some stock
Y - abnornal returns of company

Question 4

What were the results of first regression in Wisdom of Crowds?

Answer 4

That both negative comments and articles predict negative abnormal returns

Question 5

What interpretations did authors of Wisdom of crowds consider for the fact that negative words predict negative abnormal returns?

Answer 5

1) Predictability channel

2) Clout channel

Question 6

To test 2 channels, what did authors of Wisdom of Crowds do, and what did they find?

Answer 6

Run negative words regression on Earning Surprises (actual earnings minus analysts forecast) and found out that only predictability channel matters because both comments and articles predict negative earning surprises

Question 7

What 4 mechanisms behind predictability of returns by comments did authors of Wisdom of Crowds discuss and which 2 did they test and what they found?

Answer 7

Discussed:

1) Recognition
2) Money
3) Correct bad advice, peer feedback
4) Driving price to fundamental value

Tested:

2) Money (found that consistent authors get read more)
3) Feedback (found that if article is bad, comments predict performance better than article)

Question 8

What 2 findings do Wisdom of Crowds have?

Answer 8

1) Peer advice has value for investments

2) Social media allows direct user interactuon and produce valuable content

Question 9

Dooes ERP (equity return puzzle) hold for long-term bonds as well as for short-term? Discuss

Answer 9

Yes, if you invested in 20th century in short-term bonds, you would outperform stocks only in 9% cases, and if you invested in long-term, you would outperform in 2% cases

Question 10

What are the explanations behind ERP? Discuss

Answer 10

1) Expected utility theory - agents are loss averse. Problem - to justify ERP, one has to value 1 lost dollar as much as 170 earned.
2) Risk aversion and investor myopia - “if investors would be able to see that long-term stocks are superior, they would invest in them. They just can’t”.
3) Investor Heterogeneity and TC - first, not all population can trade at all, second - for many people their implicit portfolio is correlated with stocks already, don’t want more equity exposure
4) Long-tail risk
5) Misperception of risk in 20th century

Question 11

What is the future of ERP and what are the reasons and implications?

Answer 11

Will persist, but on a lower scale. Me
Because:
1) Faded memory of Great Depression
2) Pension plans invested in stocks
3) Index fund rise

Implications - designing financial tools that would include more population in equity trading would enhance welfare

Question 12

List 3 reasons why stronger p-value is needed when trying to find a new factor affecting stock prices.

Answer 12

1) Less chances to discover a true factor
2) Cost of data mining has decreased
3) There is limited amount of data

Question 13

What is multiple testing?

Answer 13

Increase in type-1 error when testing multiple hypotheses simultaneously

Question 14

What 2 measures are used to assess type-1 error severity in research?

Answer 14

1) Family-wise error rate (chance of a single false discovery)
2) False Discovery Rate (what % of findings is false)

Question 15

What 5 factors survive the 3 adjustments done by the authors of “And the cross-section of expected results”?

Answer 15

1) Momentum
2) Market beta
3) Book-to-market
4) Short-term volatility
5) Durable consumption goods

Question 16

What is the conclusion of “the cross section”?

Answer 16

Much higher p-value is needed, ~p=0.27

Question 17

What are the 2 pillars of asset pricing?

Answer 17

1) Efficient capital markets

2) Correct asset pricing models

Question 18

Name 2 types of asset pricing models:

Answer 18

1) Equilibrium

2) Empirical

Question 19

What tests of market efficiency did Fama do and what did he find and what

Answer 19

1) Event studies (stock splits) - announcements were impounded in price before the announcement itself
2) Time-varied returns (there is no irrational price swings, investor preferences change over time)
3) Inflation predictive regressions (real estate and traded bond prices do incorporate best inflation expectations, but with stocks results are perverse - higher inflation leads to lower returns - and JHP is back, should it be like this or assumptions are wrong)

Question 20

Why there are no bubbles? Argue

Answer 20

1) No price decline is ever predictable

2) Bubble “stocks” forecast real activity well

Question 21

What can be sources of value or size premium in 3-factor model?

Answer 21

1) It can be extension of ICAPM model
2) Overreactipn hypothesis
3) Investor preferences and tastes

Question 22

What are the 2 tasks by behavioral economics?

Answer 22

To describe optimal behaviour and to discuss how people actually act

Question 23

What are the 3 traits of Econs?

Answer 23

1) Infitite cognition and willpower
2) Self-interest
3) Well-defined preferences

Question 24

What are the 3 most important concepts in behavioral economics?

Answer 24

1) Overconfidence
2) Loss aversion
3) Self-control

Question 25

What are the arguments of behaviorists why behavioral economics matter?

Answer 25

1) Classic models don’t predict how actual, non-expert people act (deny existence of air)
2) People don’t have many opportunities to learn on high-stake decisions
3) Markets will cater to biases, not eradicate them
4) Means of errors are not standartly distributed by systematically biased

Question 26

2 dangers of belief in EMH?

Answer 26

1) Policymakers might not take measures to dampen the bubbles
2) If even financial markets can be off for a factor of 2, what about less efficient markets like labour one?

Question 27

Describe 3 aspects of prospect theory and describe aspects of intertemporal choice! What do behaviorists say about behavioral beliefs of humans?

Answer 27

1) Kink at losses
2) Utility derived from changes in wealth
3) Decision weights are functions of probabilities

Intertemporal:

1) Myopia (now and later vs later and very later)
2) Models to explain - “2-self”, “beta-delta

Behavior: humans are less selfish than Econs.

Question 28

Name 2 conditions which can lead to LOP violation:

Answer 28

1) Agents falsely believe that 2 similar assets are different
2) Arbitrageurs are constrained

Question 29

List cases of LOP violation:

Answer 29

1) Country mutual funds (Taiwan and Germany - legal constraints thi)
2) ADRs - legal constraints
3) Twin shares (S&P500 tho)
4) Dual-class shares (Molex shares)
5) Corporate spinoff (hard to short tho, only 1% is hold by institutional investors)

Question 30

What prevents arbitrageurs from enforcing LOP?

Answer 30

1) Noise trader risk

2) Short-selling constraits (legal or can’t find enough stocks to borrow)

Question 31

Name 5 cases of forensic finance:

Answer 31

1) NASDAQ even-eight collusion of brokers
2) Late-trading of mutual funds who let hedge funds to exploit the price stale after 4pm
3) Stock option backdating and spring loading (problems - shareholder dilution, goal - to channel money to managers, to reduce taxable income, to make employees accept lower wages)
4) IPO spinning
5) Re-writing of market recommendations

Question 32

What are the benefits of derivatives?

Answer 32

1) Cheaper than replication
2) Better risk allocation
3) Hedging
4) Improved liquidity (market efficiency for underlying illiquid assets like bonds)

Question 33

Who are the users of derivatives and why they use them?

Answer 33

1) Non-financial firms - lower stock volatility, i/r and exchange rate exposure
2) Financial firms - mostly for trading
3) Individuals - very limited use

Question 34

What are the risks of derivative?

Answer 34

1) Valuation issues - BMS assumption violations, complex OTC securities
2) Some contracts might be illiquid and hard to exit
3) Perverse incentives (not risk-adjusted profits)
4) Systemic risks