Implications Of Biases On DM

Question 1

What is the rational explanation of home bias?

Answer 1

Institutional barrier:different trading costs and tax rates, and capital movement restrictions)

Question 2

What are the problems with the rational explanation of home via? French and poterba (1991) 3

Answer 2

• there are no more capital movement restrictions
• differential trading costs:if costs in one country are lower then investors should trade in it, but we don’t see that
• differential tax rates:there is little difference between domestic and foreign tax rates for most investors

Question 3

What is the familiarity bias?

Answer 3

• tendency towards companies with the same language/culture as the investor
• tendency to invest in your own employer or brands you know

Question 4

What is representativeness?

Answer 4

-People often think that a good company is representative of a good investment (firms that have a positive image)

Recency: investors tend to invest in companies based on performance in the past

Question 5

What are the views of Jegadeesh and Titman (1993)? Momentum effect

Answer 5

• holding period abnormal returns arise because of delayed overreaction to info that pushes the price of winner above their long term value
• then when the stock prices of the winners and losers revert to their fundamental values, the returns of losers should exceed the returns of winners

Question 6

Which stocks have the biggest momentum effect?

Answer 6

Stocks with the most information asymmetry enjoy the biggest momentum effect (small stocks and stocks having few analysts to follow)

Short term momentum risk: risk adjusted returns are positively correlated for 3-12 months return intervals

Question 7

What are debondt and Thaler’s (1985) views on long term reversals?

Answer 7

Stocks that do poorly in the past perform better in the next 3-5 years

-because investors overreact to both good and bad news. Overly optimistic about recent winners and overly pessimistic about recent losers:so past losers become underpriced and past winners become overpriced (but much larger for losers than winners)

Question 8

What are Barber and Odeon’s (2008) 3 biases?

Answer 8

• availability:investors tend to buy stocks that are in the news (stocks where info is freely available)
• Attention grabbing:negative news is ignored and positive news may attract purchases. institutional investors are less likely to be affected by this bias
• anchoring and herding:prices are anchored to list prices. Analysts may heard if they are influenced by the recommendations of other analysts

Question 9

What are they implications of overconfidence?

Answer 9

Overconfident investors are more certain of their value estimates so they trade excessively (greater trading activity and higher levels of volume in the market)

Analysts tend to be excessively optimistic about the prospect of the companies overconfident investors are following (would recommend buyers bit sellers)

Question 10

What is home bias?

Answer 10

• Domestic investors mainly hold domestic securities
• Investors are optimistic about their market relative to the foreign market
• people tend to favour that which is familiar(have access to private info)