GS1 Flashcards
What were 2 RQs in Wisdon of Crowds?
1) Do peer opinions contain value-relevant info?
2) Do some users intentionally spread disinformation?
What were 2 channels to voice their opinions in Wisdom of Crowds?
1) Comments
2) Articles
Methodology of Wisdom of crowds - what variables were run?
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
What were the results of first regression in Wisdom of Crowds?
That both negative comments and articles predict negative abnormal returns
What interpretations did authors of Wisdom of crowds consider for the fact that negative words predict negative abnormal returns?
1) Predictability channel
2) Clout channel
To test 2 channels, what did authors of Wisdom of Crowds do, and what did they find?
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
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?
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)
What 2 findings do Wisdom of Crowds have?
1) Peer advice has value for investments
2) Social media allows direct user interactuon and produce valuable content
Dooes ERP (equity return puzzle) hold for long-term bonds as well as for short-term? Discuss
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
What are the explanations behind ERP? Discuss
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
What is the future of ERP and what are the reasons and implications?
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
List 3 reasons why stronger p-value is needed when trying to find a new factor affecting stock prices.
1) Less chances to discover a true factor
2) Cost of data mining has decreased
3) There is limited amount of data
What is multiple testing?
Increase in type-1 error when testing multiple hypotheses simultaneously
What 2 measures are used to assess type-1 error severity in research?
1) Family-wise error rate (chance of a single false discovery)
2) False Discovery Rate (what % of findings is false)
What 5 factors survive the 3 adjustments done by the authors of “And the cross-section of expected results”?
1) Momentum
2) Market beta
3) Book-to-market
4) Short-term volatility
5) Durable consumption goods
What is the conclusion of “the cross section”?
Much higher p-value is needed, ~p=0.27
What are the 2 pillars of asset pricing?
1) Efficient capital markets
2) Correct asset pricing models
Name 2 types of asset pricing models:
1) Equilibrium
2) Empirical
What tests of market efficiency did Fama do and what did he find and what
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)
Why there are no bubbles? Argue
1) No price decline is ever predictable
2) Bubble “stocks” forecast real activity well
What can be sources of value or size premium in 3-factor model?
1) It can be extension of ICAPM model
2) Overreactipn hypothesis
3) Investor preferences and tastes
What are the 2 tasks by behavioral economics?
To describe optimal behaviour and to discuss how people actually act
What are the 3 traits of Econs?
1) Infitite cognition and willpower
2) Self-interest
3) Well-defined preferences
What are the 3 most important concepts in behavioral economics?
1) Overconfidence
2) Loss aversion
3) Self-control
What are the arguments of behaviorists why behavioral economics matter?
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
2 dangers of belief in EMH?
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?
Describe 3 aspects of prospect theory and describe aspects of intertemporal choice! What do behaviorists say about behavioral beliefs of humans?
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.
Name 2 conditions which can lead to LOP violation:
1) Agents falsely believe that 2 similar assets are different
2) Arbitrageurs are constrained
List cases of LOP violation:
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)
What prevents arbitrageurs from enforcing LOP?
1) Noise trader risk
2) Short-selling constraits (legal or can’t find enough stocks to borrow)
Name 5 cases of forensic finance:
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
What are the benefits of derivatives?
1) Cheaper than replication
2) Better risk allocation
3) Hedging
4) Improved liquidity (market efficiency for underlying illiquid assets like bonds)
Who are the users of derivatives and why they use them?
1) Non-financial firms - lower stock volatility, i/r and exchange rate exposure
2) Financial firms - mostly for trading
3) Individuals - very limited use
What are the risks of derivative?
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
