Lecture 1-introduction

Question 1

What does traditional finance suggest?

Answer 1

People make rational decisions.

People are unbiased in their predictions about the future.

People are risk averse. They will only take risk if the expected rewards are sufficient.

Question 2

What is behavioural finance?

Answer 2

People make irrational decisions

Psychology affects people as they make investment decisions

Investment decisions are affected by cognitive errors, psychological biases and emotions

Question 3

Homo Economicus- Economic man assumptions

Answer 3

Fully comprehends all their consequences

Has unbounded cognitive capacity

Can handle large volumes of information

The value he attaches to different outcomes is not affected by emotions/past experience

-Unbiased forecasts

Question 4

What is utility?

Answer 4

Utility is a term in economics that refers to the total satisfaction received from consuming a good or service.

Economic theories based on rational choice usually assume that consumers will strive to maximize their utility

Question 5

What is the expected utility formula?

Answer 5

E[u] = ∑pi * u(xi)

Outcomes and probabilities

Question 6

What is subjective expected utility

Answer 6

-When outcome probabilities are unknown and subjectively estimated