Market Efficiency and Behavioral Finance

Question 1

abnormal return

Answer 1

The difference between an investment’s actual return and its expected return. (Chapter 9)

Question 2

alpha

Answer 2

An investment’s abnormal return, equal to the difference between its actual return and its expected return. (Chapter 9)

Question 3

anchoring

Answer 3

A phenomenon in which individuals place too much weight on information that they have at hand, even when that information is not particularly relevant. (Chapter 9)

Question 4

arbitrage

Answer 4

A phenomenon in which individuals place too much weight on information that they have at hand, even when that information is not particularly relevant. (Chapter 9)

Question 5

arbitrage

Answer 5

A transaction in which an investor simultaneously buys and sells identical assets at different prices to earn an instant, risk-free profit. (Chapter 9)

Question 6

behavioral finance

Answer 6

The body of research into the role that emotions and other subjective factors play in investment decisions. (Chapter 9)

Question 7

belief perseverance

Answer 7

The tendency to ignore or discount evidence contrary to one’s existing beliefs. (Chapter 9)

Question 8

charting

Answer 8

The activity of charting price behavior and other market information and then using the patterns these charts form to make investment decisions. (Chapter 9)

Question 9

confidence index

Answer 9

A ratio of the average yield on high-grade corporate bonds to the average yield on average-or intermediate-grade corporate bonds; a technical indicator based on the theory that market trends usually appear in the bond market before they do in the stock market. (Chapter 9)

Question 10

efficient market

Answer 10

A market in which securities reflect all possible information quickly and accurately. (Chapter 9)

Question 11

efficient markets hypothesis (EMH)

Answer 11

Basic theory of the behavior of efficient markets, in which there are a large number of knowledgeable investors who react quickly to new information, causing securities prices to adjust quickly and accurately. (Chapter 9)

Question 12

familiarity bias

Answer 12

The tendency to invest in securities simply because they are familiar to the investor. (Chapter 9)

Question 13

loss aversion

Answer 13

A situation in which the desire to avoid losses is so great that investors who are otherwise risk-averse will exhibit risk-seeking behavior in an attempt to avoid a loss. (Chapter 9)

Question 14

market anomalies

Answer 14

Irregularities or deviations from the behavior one would expect in an efficient market. (Chapter 9)

Question 15

market technicians

Answer 15

Analysts who believe it is chiefly (or solely) supply and demand that drive stock prices. (Chapter 9)

Question 16

moving average (MA)

Answer 16

A mathematical procedure that computes and records the average values of a series of prices, or other data, over time; results in a stream of average values that will act to smooth out a series of data. (Chapter 9)

Question 17

narrow framing

Answer 17

Analyzing an investment problem in isolation or in a particularly narrow context rather than looking at all aspects of the problem. (Chapter 9)

Question 18

overconfidence

Answer 18

The tendency to overestimate one’s ability to perform a particular task. (Chapter 9)

Question 19

random walk hypothesis

Answer 19

The theory that stock price movements are unpredictable, so there’s no way to know where prices are headed. (Chapter 9)

Question 20

representativeness

Answer 20

Cognitive biases that occur because people have difficulty thinking about randomness in outcomes. (Chapter 9)

Question 21

self-attribution bias

Answer 21

The tendency to overestimate the role that one’s intelligence or skill plays in bringing about a favorable investment result and to underestimate the role of chance in that result. (Chapter 9)

Question 22

semi-strong form (EMH)

Answer 22

Form of the EMH holding that abnormally large profits cannot be consistently earned using publicly available information. (Chapter 9)

Question 23

short interest

Answer 23

The number of stocks sold short in the market at any given time; a technical indicator believed to indicate future market demand. (Chapter 9)

Question 24

strong form (EMH)

Answer 24

Form of the EMH that holds that there is no information, public or private, that allows investors to consistently earn abnormal profits. (Chapter 9)

Question 25

technical analysis

Answer 25

The study of the various forces at work in the marketplace and their effect on stock prices. (Chapter 9)

Question 26

theory of contrary opinion

Answer 26

A technical indicator that uses the amount and type of odd-lot trading as an indicator of the current state of the market and pending changes. (Chapter 9)

Question 27

Small-firm effect

(size effect)

Answer 27

Small firms can earn positive abnormal returns of as much as 5% to 6% per year.

Question 28

Relative Strength Index

RSI

Answer 28

measures the strength of advances and declines over short time periods. High RSI values indicate a stock is overbought, and low values indicate a possible oversold security.

common technical measures of momentum