5. Using the saving example in the text (Wendy Chan), calculate the income replacement ratio based o

  

5. Using the saving example in the text (Wendy Chan), calculate the income replacement ratio based on a deferral rate of 10% and an investment return on retirement savings of 3.5%. (All other assumed values remain the same.) The example starts on page 299 in the textbook attached.
textbook.pdf

Unformatted Attachment Preview

Don't use plagiarized sources. Get Your Custom Essay on
5. Using the saving example in the text (Wendy Chan), calculate the income replacement ratio based o
Just from $13/Page
Order Essay

B EHAVIORAL F INANCE
Psychology, Decision-Making, and Markets
This page intentionally left blank
B EHAVIORAL F INANCE
Psychology, Decision-Making, and Markets
Lucy F. Ackert
Michael J. Coles College of Business
Kennesaw State University
Richard Deaves
DeGroote School of Business
McMaster University
Australia • Brazil • Japan • Korea • Mexico • Singapore • Spain • United Kingdom • United States
Behavioral Finance: Psychology,
Decision-Making and Markets
Lucy F. Ackert, Richard Deaves
Vice President of Editorial, Business:
Jack W. Calhoun
Publisher: Joe Sabatino
© 2010 South-Western, Cengage Learning
ALL RIGHTS RESERVED. No part of this work covered by the
copyright hereon may be reproduced or used in any form or by any
means—graphic, electronic, or mechanical, including photocopying,
recording, taping, Web distribution, information storage and
retrieval systems, or in any other manner—except as may be
permitted by the license terms herein.
Executive Editor: Mike Reynolds
Sr. Developmental Editor:
Laura Bofinger Ansara
For product information and technology assistance, contact us at
Cengage Learning Customer & Sales Support, 1-800-354-9706
Marketing Manager: Nathan Anderson
For permission to use material from this text or product, submit all
requests online at www.cengage.com/permissions
Sr. Content Project Manager:
Tamborah Moore
Production Technology Analyst: Jeff Weaver
Further permissions questions can be emailed to
permissionrequest@cengage.com
Media Editor: Scott Fidler
Sr. Frontlist Buyer, Manufacturing: Kevin Kluck
Library of Congress Control Number: 2009932742
Production Service: Cadmus
ISBN-13: 978-0-324-66117-0
ISBN-10: 0-324-66117-7
Compositor: Cadmus/KGL
Sr. Rights Acquisitions Manager/Text:
Margaret Chamberlain-Gaston
Sr. Permissions Acquisitions Manager/Images:
Dean Dauphinais
South-Western Cengage Learning
5191 Natorp Boulevard
Mason, OH 45040
USA
Sr. Editorial Assistant: Adele Scholtz
Sr. Art Director: Michelle Kunkler
Internal Designer: Juli Cook
Cover Designer: Rokusek Design
Cover Image: © Loke Yek Mang / Shutterstock
1 2 3 4 5 6 7 13 12 11 10 09
Cengage Learning products are represented in Canada by Nelson
Education, Ltd.
For your course and learning solutions, visit www.cengage.com
Purchase any of our products at your local college store or at our
preferred online store www.ichapters.com
To Bryan, Moira, William, and Rory
—Lucy Ackert
To Karen and André
—Richard Deaves
This page intentionally left blank
BRIEF CONTENTS
P REFACE
A BOUT
xx
THE
A UTHORS
I NTRODUCTION
PART I
xxiv
xxvi
CONVENTIONAL FINANCE, PROSPECT THEORY,
AND
MARKET EFFICIENCY
CHAPTER
1
Foundations of Finance I: Expected Utility Theory
CHAPTER
2
Foundations of Finance II: Asset Pricing, Market Efficiency,
and Agency Relationships 19
CHAPTER
3
Prospect Theory, Framing, and Mental Accounting
CHAPTER
4
Challenges to Market Efficiency
PART II
5
Heuristics and Biases
CHAPTER
6
Overconfidence
CHAPTER
7
Emotional Foundations
PART III
CHAPTER
8
3
37
60
BEHAVIORAL SCIENCE FOUNDATIONS
CHAPTER
1
81
83
106
INVESTOR BEHAVIOR
120
135
Implications of Heuristics and Biases for Financial Decision-Making
137
vii
viii
BRIEF CONTENTS
CHAPTER
CHAPTER
9
10
PART IV
Implications of Overconfidence for Financial Decision-Making
Individual Investors and the Force of Emotion
SOCIAL FORCES
168
183
CHAPTER
11
Social Forces: Selfishness or Altruism?
CHAPTER
12
Social Forces at Work: The Collapse of an American Corporation
PART V
MARKET OUTCOMES
185
13
Behavioral Explanations for Anomalies
CHAPTER
14
Do Behavioral Factors Explain Stock Market Puzzles?
219
237
263
CORPORATE FINANCE
CHAPTER
15
Rational Managers and Irrational Investors
CHAPTER
16
Behavioral Corporate Finance and Managerial Decision-Making
PART VII
202
217
CHAPTER
PART VI
151
265
RETIREMENT, PENSIONS, EDUCATION, DEBIASING,
MANAGEMENT 293
AND
279
CLIENT
CHAPTER
17
Understanding Retirement Saving Behavior and Improving DC Pensions
CHAPTER
18
Debiasing, Education, and Client Management
PART VIII
MONEY MANAGEMENT
333
CHAPTER
19
Behavioral Investing
CHAPTER
20
Neurofinance and the Trader’s Brain
G LOSSARY 359
R EFERENCES 367
I NDEX 383
335
351
319
295
CONTENTS
P REFACE xx
A BOUT THE A UTHORS xxiv
I NTRODUCTION xxvi
PART I
CHAPTER
1
CONVENTIONAL FINANCE, PROSPECT THEORY,
EFFICIENCY 1
AND
MARKET
Foundations of Finance I: Expected Utility Theory 3
Introduction 3
Neoclassical Economics
Rational Preferences 4
Utility Maximization 4
Relevant Information 6
4
Expected Utility Theory 6
Risk Attitude 8
Allais Paradox 11
Framing 14
Looking Forward 14
Chapter Highlights 14
Discussion Questions and Problems
15
ix
x
CONTENTS
Appendix: More on Expected Utility Theory
Definitions 16
Axioms Required to Derive Expected Utility
Sketch of a Proof 17
Characteristics of Utility Functions 18
Endnotes
CHAPTER
2
16
17
18
Foundations of Finance II: Asset Pricing, Market Efficiency,
and Agency Relationships 19
Introduction 19
The Pricing of Risk
20
Risk and Return for Individual Assets 20
Risk and Return for Portfolios of Assets 21
The Optimal Portfolio 22
Capital Asset Pricing Model 26
Operationalizing the CAPM 27
28
Efficiency and Information 28
What Does Market Efficiency Imply? 29
Misconceptions about Market Efficiency 30
Joint Hypothesis Problem 30
Market Efficiency
Agency Theory 31
From Rationality to Psychology 33
Chapter Highlights 33
Discussion Questions and Problems 34
Endnotes 35
CHAPTER
3
Prospect Theory, Framing, and Mental Accounting 37
Introduction 37
Prospect Theory 38
Key Aspects of Observed Behavior 38
Value Function 40
Lottery Tickets and Insurance 41
Weighting Function 42
Hypothetical Value and Weighting Functions
Some Examples 45
Other Issues 45
Riskless Loss Aversion 45
Origins of Prospect Theory 46
Prospect Theory and Psychology 47
Competing Alternative Theories 47
44
CONTENTS
47
Does Prospect Theory Work with Nonmonetary Outcomes? 48
Integration vs. Segregation 48
Mental Accounting 50
Opening and Closing Accounts 50
Evaluating Accounts and Choosing When to Close Them 51
Closure, Integration, and Segregation 52
Framing
From Theory to Practice 52
Chapter Highlights 53
Discussion Questions and Problems 53
Appendix: Conditions Required for the Prospect Theory Weighting
Function 55
Conditions
Endnotes
CHAPTER
4
55
56
Challenges to Market Efficiency 60
Introduction 60
Some Key Anomalies
61
Lagged Reactions to Earnings Announcements
Small-Firm Effect 62
Value vs. Growth 63
Momentum and Reversal 65
61
67
Theoretical Requirements for Market Efficiency 67
Support 1: All Investors Are Always Rational 67
Support 2: Investor Errors Are Uncorrelated 68
Shiller’s Model 68
Support 3: There are no Limits to Arbitrage 71
What Limits Arbitrage? 72
Fundamental Risk 72
Noise-Trader Risk 72
Implementation Costs 73
Looking Forward 75
Noise-Trading and Limits to Arbitrage
Chapter Highlights 75
Discussion Questions and Problems 76
Appendix: Proofs for Shiller Model 77
Endnotes 78
xi
xii
CONTENTS
PART II
CHAPTER
5
BEHAVIORAL SCIENCE FOUNDATIONS
81
Heuristics and Biases 83
Introduction 83
Perception, Memory, and Heuristics
84
Perception 84
Memory 84
Framing Effects 85
Ease of Processing and Information Overload
Heuristics 86
Examples of Heuristics 87
86
87
Familiarity 87
Ambiguity Aversion 88
Diversification Heuristic 89
Status Quo Bias and Endowment Effect 89
Heuristics and Biases, Prospect Theory, and Emotion
Representativeness and Related Biases 90
Conjunction Fallacy 91
Base Rate Neglect 91
Bayesian updating 92
Hot Hand Phenomenon 93
Gambler’s Fallacy vs. Hot Hand 95
Overestimating Predictability 95
Availability, Recency, and Salience 96
Familiarity and Related Heuristics
97
What Explains Anchoring? 98
Anchoring vs. Representativeness
90
Anchoring
99
99
Fast and Frugal Heuristics 99
Response to Critique 100
Looking Ahead 100
Heuristics and Biases and Financial Decision-Making
Do Heuristic-Induced Errors Cancel Out? 101
Chapter Highlights 101
Irrationality and Adaptation
Discussion Questions and Problems
Endnotes 103
CHAPTER
6
Overconfidence 106
Introduction 106
Miscalibration 106
What Is It? 106
Example of a Calibration Test
107
102
100
CONTENTS
110
Better-Than-Average Effect 110
Illusion of Control 111
Excessive Optimism 111
Being Overconfident in More than One Sense 112
Are People Equally Overconfident? 112
Are People Consistently Overconfident? 113
Factors Impeding Correction 114
Biases Interfering with Learning 114
Is Overconfidence an Unmitigated Flaw? 114
Other Strains of Overconfidence
Looking Ahead to Financial Applications 115
Chapter Highlights 116
Discussion Questions and Problems 116
Endnotes 117
CHAPTER
7
Emotional Foundations 120
Introduction 120
The Substance of Emotion 120
A Short History of Emotion Theory 122
Evolutionary Theory 124
The Brain 126
Emotion and Reasoning 128
Our Minds, Bodies, and Emotion 130
Looking Ahead 130
Chapter Highlights 132
Discussion Questions and Problems 132
Endnotes 133
PART III
CHAPTER
8
INVESTOR BEHAVIOR
135
Implications of Heuristics and Biases for
Financial Decision-Making 137
Introduction 137
Financial Behaviors Stemming from Familiarity
138
Home Bias 138
Distance, Culture and Language 139
Local Investing and Informational Advantages 140
Investing in Your Employer or Brands that You Know 141
Financial Behaviors Stemming from Representativeness
Good Companies vs. Good Investments
142
141
xiii
xiv
CONTENTS
Chasing Winners 143
Availability and Attention-Grabbing
145
145
An Experimental Study of Real Estate Appraisals
Anchoring vs. Herding and Analysts 147
Anchoring to Available Economic Cues
Chapter Highlights 147
Discussion Questions and Problems
Endnotes 148
CHAPTER
9
145
148
Implications of Overconfidence for Financial Decision-Making 151
Introduction 151
Overconfidence and Excessive Trading
151
Overconfident Traders: A Simple Model 152
Evidence from the Field 157
Evidence from Surveys and the Lab 159
161
Gender and Overconfidence in the Financial Realm 161
Dynamics of Overconfidence among Market Practitioners
Demographics and Dynamics
Underdiversification and Excessive Risk Taking
Excessive Optimism and Analysts 163
Chapter Highlights 164
Discussion Questions and Problems 164
Endnotes 165
CHAPTER
10
161
162
Individual Investors and the Force of Emotion 168
Introduction 168
Is the Mood of the Investor the Mood of the Market?
Pride and Regret 170
The Disposition Effect 171
169
Empirical Evidence 171
Prospect Theory as an Explanation for the Disposition Effect
Another Possible Explanation 174
Experimental Evidence 174
175
Evidence of a House Money Effect on a Large Scale
Prospect Theory and Sequential Decisions 176
House Money
Affect 177
Chapter Highlights 178
Discussion Questions and Problems
Endnotes 179
179
175
172
CONTENTS
PART IV
CHAPTER
11
SOCIAL FORCES
183
Social Forces: Selfishness or Altruism? 185
Introduction 185
Homo Economicus 186
Fairness, Reciprocity, and Trust
186
Ultimatum and Dictator Games 187
The Trust Game 189
Who Is More Fair? 191
Social Influences Matter 192
Competition in Markets 193
Incentives and Contract Design 194
196
Testing Conformity 196
Obedience to Authority 197
Conformity
Social Behavior and Emotion 198
Social Behavior and Evolution 198
Chapter Highlights 199
Discussion Questions and Problems 199
Endnotes 200
CHAPTER
12
Social Forces at Work: The Collapse of an American
Corporation 202
Introduction 202
Corporate Boards 203
Benefits of a Corporate Board 203
Outside Directors 204
It’s a Small World 205
Directors, Compensation, and Self-Interest
Directors and Loyalty 206
206
What Do Professional Security Analysts Do?
The Performance of Security Analysts 207
Do Analysts Herd? 208
205
Analysts
207
209
The Performance and Business of Enron 209
The Directors 211
The Analysts 212
Other Players in Enron’s Downfall 213
Organizational Culture and Personal Identity 213
Enron
xv
xvi
CONTENTS
Chapter Highlights 214
Discussion Questions and Problems
Endnotes 215
PART V
CHAPTER
13
MARKET OUTCOMES
214
217
Behavioral Explanations for Anomalies 219
Introduction 219
Earnings Announcements and Value vs. Growth
220
What is Behind Lagged Reactions to Earnings Announcements? 219
What Is Behind the Value Advantage? 220
What is Behind Momentum and Reversal? 221
Daniel-Hirshleifer-Subrahmanyam Model and Explaining Reversal 222
Grinblatt-Han Model and Explaining Momentum 224
Barberis-Shleifer-Vishny Model and Explaining Momentum and Reversal
230
Inappropriate Risk Adjustment 230
Fama-French Three-Factor Model 232
Explaining Momentum 232
Temporary Deviations from Efficiency and the Adaptive Markets
Hypothesis 233
Rational Explanations
Chapter Highlights 233
Discussion Questions and Problems
Endnotes 234
CHAPTER
14
234
Do Behavioral Factors Explain Stock Market Puzzles? 237
Introduction 237
The Equity Premium Puzzle
238
The Equity Premium 238
Why Is the Equity Premium a Puzzle?
What Can Explain This Puzzle? 240
243
Tulip Mania 244
The Tech/Internet Bubble
238
Real-World Bubbles
245
247
Design of Bubbles Markets 248
What Can We Learn From These Experiments?
Experimental Bubbles Markets
Behavioral Finance and Market Valuations
Excessive Volatility 251
Do Prices Move Too Much? 251
Demonstrating Excessive Volatility
252
249
251
227
xvii
CONTENTS
Explaining Excessive Volatility 253
Volatility Forecasts and the Spike of 2008
Markets in 2008 254
Chapter Highlights 258
Discussion Questions and Problems
Endnotes 259
PART VI
CHAPTER
15
CORPORATE FINANCE
253
259
263
Rational Managers and Irrational Investors 265
Introduction 265
Mispricing and the Goals of Managers
A Simple Heuristic Model 266
First Order Conditions 267
266
Examples of Managerial Actions Taking Advantage of Mispricing
Company Name Changes 268
Explaining Dividend Patterns 269
Share Issues and Repurchases 272
Mergers and Acquisitions 272
Irrational Managers or Irrational Investors?
Chapter Highlights 275
Discussion Questions and Problems 275
Endnotes 276
CHAPTER
16
268
274
Behavioral Corporate Finance and Managerial
Decision-Making 279
Introduction 279
Capital Budgeting: Ease of Processing, Loss Aversion, and Affect
Payback and Ease of Processing 280
Allowing Sunk Costs to Influence the Abandonment Decision
Allowing Affect to Influence Choices 280
Managerial Overconfidence 282
Investment and Overconfidence 282
Overinvestment 282
Investment Sensitivity to Cash Flows
Mergers and Acquisitions 284
Start-ups 285
283
Can Managerial Overconfidence Have a Positive Side?
Chapter Highlights 288
Discussion Questions and Problems 289
Endnotes 289
288
280
279
xviii
CONTENTS
PART VII
CHAPTER
17
RETIREMENT, PENSIONS, EDUCATION, DEBIASING,
AND CLIENT MANAGEMENT 293
Understanding Retirement Saving Behavior and
Improving DC Pensions 295
Introduction 295
The World-Wide Move to DC Pensions and its Consequences
DBs vs. DCs 296
Problems Faced by Employee-Investors
298
Saving with Limited Self-Control and Procrastination
How Much Needs to be Saved? 298
Limited Self-Control 300
Exponential and Hyperbolic Discount Functions
Procrastination 302
Evidence on Retirement Preparedness 303
Asset Allocation Confusion
Documenting the Problem
Are There “Correct” Asset
Moving toward a Solution
Is Education the Answer?
303
303
Allocations?
306
307
296
298
301
305
307
Automatic Enrollment 308
Scheduled Deferral Increase Programs 310
Asset Allocation Funds 311
Moving toward the Ideal 401(k) 313
Chapter Highlights 313
Improvements in DC Pension Design
Discussion Questions and Problems
Endnotes 315
CHAPTER
18
314
Debiasing, Education, and Client Management 319
Introduction 319
Can Bias be Eliminated?
319
Steps Required to Eliminate Bias 319
Strategies for Helping Those Affected by Bias 321
Debiasing Through Education 322
Psychographic Profiling, Personality Types, and Money Attitudes
Optimizing Education 325
Client Management Using Behavioral Finance 326
Traditional Process of Asset Allocation Determination 326
Using Behavioral Finance to Refine Process 328
Chapter Highlights 330
Discussion Questions and Problems
Endnotes 331
330
323
CONTENTS
PART VIII
CHAPTER
19
MONEY MANAGEMENT
333
Behavioral Investing 335
Introduction 335
Anomaly Attenuation, Style Peer Groups, and Style Investing
Refining Anomaly Capture 337
Refining Value Investing Using Accounting Data 337
Refining Momentum-Investing Using Volume 337
Momentum and Reversal 339
Momentum and Value 341
Multivariate Approaches 342
Style Rotation 345
Is it Possible to Enhance Portfolio Performance Using
Behavioral Finance? 346
Early Evidence 346
What is Behavioral Investing?
Chapter Highlights 348
347
Discussion Questions and Problems
Endnotes 348
CHAPTER
20
348
Neurofinance and the Trader’s Brain 351
Introduction 351
Expertise and Implicit Learning 351
Neurofinance 353
Insights from Neurofinance 354
Expertise and Emotion 355
Chapter Highlights 356
Discussion Questions and Problems 356
Endnotes 357
G LOSSARY 359
R EFERENCES 367
I NDEX 383
335
xix
PREFACE
Writing an overview of a burgeoning field is a daunting task. When we started our
project, existing research in behavioral finance was already abundant. Since then,
new work has appeared virtually daily. The only reasonable approach was to be
selective. While we hope this book is a comprehensive treatment of the more important contributions in the field of behavioral finance, worthy research has certainly been excluded.
In writing this book, the students we have taught and the professional audiences we have addressed were a driving force. It is our hope that the material covered in this book will allow readers to consider financial decision-making in a new
light. While a number of useful books that cover topics in behavioral finance are
available to the interested reader, our goal was to write a book that would provide
an accessible overview of the field, while at the same time illustrating how behavioral finance can be applied in real-world settings. With this in mind, the level of
rigor has been kept low and theory has been kept to a minimum.
It is our belief that this book is suitable for undergraduate and graduate students in business and economics, as well as interested practitioners. The book can
be used for a dedicated elective course or as a supplement to a more traditional
corporate or managerial finance course.
To support the instructor and promote student learning an Instructor’s Manual (IM) accompanies this book. The IM includes three parts: Solutions to Discussion Questions and Problems; Teaching Exercises; and Lecture Slides. Each of the
20 chapters in the book contains a number of Discussion Questions and Problems
and the first part of the IM provides suggested solutions to each exercise. The second part of this manual presents Teaching Exercises that are designed to promote
hands-on learning including experiments, cases and other items, running the gamut
from Trading Simulators to Star Trek, from a price prediction game to a dice
game, from a risk-taking survey to the Super Bowl, from Barings Bank to Royal
xx
PREFACE
xxi
Dutch Shell, and so on. Finally, to give the instructor a head-start in the classroom,
we have assembled a series of Lecture Slides.
ACKNOWLEDGEMENTS
We are particularly indebted to those early researchers who provided a path for
the growing numbers of scholars who have built upon their work, including
Werner De Bondt, Robert Dreman, Daniel Kahneman, Robert Shiller, Hersh
Shefrin, Andrei Shleifer, Vernon Smith, Meir Statman, Richard Thaler, and Amos
Tversky.
Though we are certainly forgetting numerous names, some of the researchers
whose work has been influential and who appear prominently in these pages are:
Maurice Allais, Marc Alpert, Solomon Asch, Clifford Asness, Malcolm Baker,
Nardin Baker, Guido Baltussen, Brad …
Purchase answer to see full
attachment

  
Basic features
  • Free title page and bibliography
  • Unlimited revisions
  • Plagiarism-free guarantee
  • Money-back guarantee
  • 24/7 support
On-demand options
  • Writer’s samples
  • Part-by-part delivery
  • Overnight delivery
  • Copies of used sources
  • Expert Proofreading
Paper format
  • 275 words per page
  • 12 pt Arial/Times New Roman
  • Double line spacing
  • Any citation style (APA, MLA, Chicago/Turabian, Harvard)

Our guarantees

Delivering a high-quality product at a reasonable price is not enough anymore.
That’s why we have developed 5 beneficial guarantees that will make your experience with our service enjoyable, easy, and safe.

Money-back guarantee

You have to be 100% sure of the quality of your product to give a money-back guarantee. This describes us perfectly. Make sure that this guarantee is totally transparent.

Read more

Zero-plagiarism guarantee

Each paper is composed from scratch, according to your instructions. It is then checked by our plagiarism-detection software. There is no gap where plagiarism could squeeze in.

Read more

Free-revision policy

Thanks to our free revisions, there is no way for you to be unsatisfied. We will work on your paper until you are completely happy with the result.

Read more

Privacy policy

Your email is safe, as we store it according to international data protection rules. Your bank details are secure, as we use only reliable payment systems.

Read more

Fair-cooperation guarantee

By sending us your money, you buy the service we provide. Check out our terms and conditions if you prefer business talks to be laid out in official language.

Read more