R07: The Behavioural Finance Perspective

Question 1

What are the differences between traditional finance and behavioural finance?

Answer 1

Traditional:

• Rational
• Risk averse
• Access to perfect information
• Utility theory
• Bayes formula

Behavioural:

• May not be risk averse
• Bounded rationality
• Prospect theory

Question 2

What are the three forms of the EMH?

Answer 2

• Weak (technical analysis useless)
• Semi-strong (technical and fundamental analysis useless)
• Strong (even insider info useless)

Question 3

What are the anomalies with EMH?

Answer 3

• Fundamental (value vs growth)
• Technical (technical analysis)
• Calendar (January effect)

Question 4

What are the three types of utility function of wealth?

Answer 4

• Risk-averse: concave (diminishing marginal utility of wealth)
• Risk-neutral: linear (constant)
• Risk-seeking: convex (increasing)

Question 5

What are the four behavioural finance perspectives?

Answer 5

1. Consumption/saving
2. Behavioural asset pricing
3. Behavioural portfolio theory
4. Adaptive markets hypothesis

Question 6

Is the sentiment premium higher for value or growth stocks?

Answer 6

Value