1. Behavioral Finance
Unit II

2. Unit II Course objectives: To understand the cognitive psychology
To understand arbitrageur
To understand the fundamental of risk
To understand Expected utility
To understand theories based on expected utility
Course Outcome
Building block of Behavioural Finance,
Demand by arbitrageurs
Transaction costs and short-selling costs
Professional arbitrage
Destabilizing informed trading

3. Cognitive psychology 
Cognitive psychology is the study of mental processes such as "attention, language use, memory, perception, problem solving, creativity, and thinking."

4. Attention
The psychological definition of attention is "A state of focused awareness on a subset of the available perceptual information".
The key function of attention is to discriminate between irrelevant data and filter it out, enabling the desired data to be distributed to the other mental processes.

5. Perception
Perception involves both the physical senses (sight, smell, hearing, taste, touch) as well as the cognitive processes involved in interpreting those senses. Essentially, it is how people come to understand the world around them through interpretation of stimuli.

6. Language
Cognitive psychologists study how language use is involved in mood,or numerous other related areas.

7. Metacognition
Metcognition, in a broad sense, is the thoughts that a person has about their own thoughts.
More specifically, it includes things like:
How effective a person is at monitoring their own performance on a given task (self-regulation).
A person's understanding of their capabilities on particular mental tasks.
The ability to apply cognitive strategies.

8. Definition of 'Arbitrageura
A type of investor who attempts to profit from price inefficiencies in the market by making simultaneous trades that offset each other and capturing risk-free profits.

9. The limits to arbitrage
Misvaluations of financial assets are common, but it is not easy to reliably make abnormal This is called The limits to arbitrage

10. Transaction Cost
In economics and related disciplines, a transaction cost is a cost incurred in making an economic exchange

11. Short Selling Cost
In finance, short selling (also known as shorting or going short) is the practice of selling securities or other financial instruments that are not currently owned, and subsequently repurchasing them ("covering"). losses, and any

12. Definition of 'Noise Trader Risk'
A form of market risk associated with the investment decisions of noise traders. The higher the volatility in market price for a particular security, the greater the associated noise trader risk

13. DEFINITION OF 'EXPECTED UTILITY'
An economic term summarizing the utility that an entity or aggregate economy is expected to reach under any number of circumstances.

14. expected utility hypothesis
Expected utility is based on the expected utility hypothesis. This hypothesis is related with the people’s preference with regard to their choice that have uncertain outcomes This hypothesis states that if certain axioms are satisfied, the subjective value associated with a gamble by an individual is the statistical expectation of that individual's valuations of the outcomes of that gamble.

15. Expected utility models
Expected utility of income and initial wealth model
Expected utility of income model
Expected utility of terminal wealth model

16. Expected utility of income and initial wealth model
This model assumes that gains are ordered pairs of amounts of initial wealth and income.

17. Expected utility of income model
This model assumes that gains are amount of income.

18. Expected utility of terminal wealth model
This model assumes that gains are amount of terminal wealth

19. Decision making process
Formulation of objective
Identifying the criteria for decision making
Identifying alternatives
Comparing various available alternatives
Making final decision

20. Expected utility as a basis of decision making
Expected utility theory states that at the time of decision making, the decision maker choose among various risky or uncertain option by comparing their expected utilities with respect to their needs.

21. Criticism
Expected Utility Theory is a normative theory about how to make optimal decisions under risk. It does not say anything about how people actually take decisions in practice.
A related idea, the Expected Utility Hypothesis, states that people do in fact behave as rational agents and this is controversial within behavioral science.
Like any mathematical model, expected utility theory is an abstraction and simplification of reality. The mathematical correctness of expected utility theory do not guarantee that expected utility theory is a reliable guide to human behavior or optimal practice.

22. Fundamental Risk
Exposure to loss from a situation affecting a large group of people or firms, and caused by (a) natural phenomenon such as earthquake, flood, or (b) social phenomenon, such as inflation, unemployment, war. Fundamental risks may or may not be insurable.

23. Professional Arbitrage
In stack markets, larger volume involving arbitrage transactions are performed by a relatively small number of professionally trained investors (wealth managers), who take larger positions with their client’s money.

24. Informed Trading
Trading when based on certain information is known as “Informed trading”
Informed Traders are those who trade on the basis of some information available or provided to them.

25. Types of Informed Traders
(1) Fundamental Traders:Those who believe that market will react to the events in acertain ways which can predict the future market prices based on these events.

26. (2) Technical traders
Those who use various types of charts, trends and other trading information like prices and trading volumes for analysis.

27. (3) High Frequency Traders
Those who use and analyse complex alogrithms to execute orders in stock markets.

28. Destabilizing Informed trading
Some activities can be attributed to destablising of informed trading as follows:
(1) Trading in future:

29. Positive feedback
Positive feedback investors buy stock when