1. Behavioral Finance
Economics 437

2. Exam on Tuesday, Feb 12, 2019 9:30 AM in Nau 101
Don’t bring anything to the exam:
No calculators
No writing paper
No books
Nothing
All answers are written directly on the exam

3. Decifering Shleifer Chapter 2
The assets
The players
Their behavior
Equilibrium
Profitability of the players

4. The Main Issues What happens in equilbrium
Undetermined
Some forces make pt > 1, some forces push pt < 1, result is indeterminant
Who makes more profit, arbitrageurs or noise traders?
Depends
But, it is perfectly possible for arbitrageurs to make more!
Survival?

5. The Key Pricing Equation

6. When Do Noise Traders Profit More Than Arbitrageurs?
Noise traders can earn more than arbitrageurs when ρ* is positive. (Meaning when noise traders are systematically too optimistic)
Why?
Because they relatively more of the risky asset than the arbitrageurs
But, if ρ* is too large, noise traders will not earn more than arbitrageurs
The more risk averse everyone is (higher λ in the utility function, the wider the range of values of ρ for which noise traders do better than arbitrageurs

7. What Does Shleifer Accomplish?
Given two assets that are “fundamentally” identical, he shows a logic where the market fails to price them identically
Assumes “systematic” noise trader activity
Shows conditions that lead to noise traders actually profiting from their noise trading
Shows why arbitrageurs could have trouble (even when there is no fundamental risk)

8. The End