Behavioral Finance Economics 437

Second Mid-Term Thursday, Apr 6 Lectures through today Readings: Kahneman: Thinking: Fast and Slow Lewis: The Undoing Project Burton-Shah: Chapters 9 and 11 Fama-French “Cross Section” article on Collab

Value Investing What Is Value Investing? Measuring Value Buying something that is “out of favor” with the vast majority of investors What does that really mean? Measuring Value Low Price/Earnings Ratio High Book/Market Ratio Value vs Growth What is a “growth” stock? What is a “value” stock?

DeBondt-Thaler 1984 “Over-Reaction” Hypothesis Suggests that: After a period of “over-reaction,” markets “revert” back and go the other way. Stocks that have done well in the past, do poorly in the future Stocks that done poorly in the past, do well in the future Their article is designed to test whether or not “mean reversion” is true.

Data NYSE data Begin with three year lookback in Dec 1932 Jan 1926 through December 1982 Monthly return data Begin with three year lookback in Dec 1932 Monthly data from Jan 1930 through Dec 1932 36 months or three years data Form portfolios of L(osers) and W(inners) Then see how they do for the next three years

Interesting facts Most of the excess returns are in January Loser effect more pronounced: Losers earned 19.6 % more than the market Winners earn 5.0 % less than the market Loser portfolio minus Winner portfolio return = 24.6 %!!!!! Most of the return difference is during 2nd and 3rd year Larger loses become larger winners; larger winners become larger losers

The End