1. Behavioral Finance Introduction January 21, 2016 Behavioral Finance Economics 437

2. Behavioral Finance Introduction January 21, 2016 Course Information Three Books Andre Shleifer – “Inefficient Markets” Daniel Kahneman – “Thinking: Fast and Slow (should have already read) Edwin Burton – Sunit Shah – “Behavioral Finance” Richard Thaler -- Misbehaving Online Reading at Toolkit Reading is difficult I-Clickers - required Lectures Exams Two mid terms Mch 3 and April 14 Final May 9: 2PM Office Hours 11-12: Tues Thur at VNB office (not on grounds)

3. Behavioral Finance Introduction January 21, 2016 Course Topics Review of MPT & EMH Limits to Arbitrage Anomalies Serial Correlation in Stock Returns

4. Behavioral Finance Introduction January 21, 2016 Immediate Reading (today, Jan 21) Malkiel (online) Shiller (online) Shleifer (book, Ch 1) Fama (online)

5. Behavioral Finance Introduction January 21, 2016 Reading (starting Jan 28) “Noise Trading” – Limits to Arbitrage Black on Toolkit Shliefer on Toolkit Burton & Shah, pp 1-51

6. Behavioral Finance Introduction January 21, 2016 The Efficient Market Hypothesis (EMH) Price captures all relevant information Modern version based upon “No Arbitrage” assumption Why do we care? Implications Only new information effects prices Publicly known information has no value Investors should “index” Allocation efficiency

7. Behavioral Finance Introduction January 21, 2016 The Milton Friedman argument for market efficiency in the presence of “noise traders” If noise traders are truly “random,” then their effects will “cancel out.” (Kind of a law of large numbers result) Noise traders are “systematic,” then arbitrage traders will “trade against them” and take all of their money Thus prices will be efficient in either case

8. Behavioral Finance Introduction January 21, 2016 But, then October 19, 1987 1992, Article by Eugene Fama and Ken French The Tech Bubble The Rise of Hedge Funds

9. Behavioral Finance Introduction January 21, 2016 1987 - The “Rip Van Winkle” Year July 2700 Jan 2200 October 2300 2200 1700 Dec 2200

10. Behavioral Finance Introduction January 21, 2016 Fama and French Both authors are staunch supporters of EMH 1992 Article gave a simple formula to pick stocks that “beat the market” consistently This lead “respectability” to a growing literature that simple formulae could “beat the market”

11. Behavioral Finance Introduction January 21, 2016 The Tech Bubble 1999 Nasdaq up 100 percent for the year Priceline: Came public at 20, rose to 200, fell to under 1 No news of substance Nasdaq peaked at 5000 in March 2000 Fell to 1800 by 2002

12. Behavioral Finance Introduction January 21, 2016 Hedge Funds Industry grew from cottage industry to massive industry Charges very, very high fees to customers Idea: they can outperform the market; thus they deserve the big fees Used by Harvard and Yale endowments (UVA as well)

13. Behavioral Finance Introduction January 21, 2016 And There Things Stood In 1970

14. Behavioral Finance Introduction January 21, 2016 The End