Chpt. 9 Behavioral Finance+Technical Analysis

Models of financial markets that emphasize potential implications of psychological factors affecting investor behavior. (Assumes ppl don't always make rational decisions)

• 1) stock prices in 1990s didnt match "fundamentals" (high P/E ratios)
• 2) Evidence of refusal to sell losers
• 3)Economics discipline is exploring behavioral aspects of decision making

• -using info from one context to influence decision making in another unreached context
• -may lead to unsustainably high P/E ratios

• -some ppl are overconfident in their ability to pick stocks or have exaggerated belief that "risk" will hurt the other person but not them.
• -They bid stock prices too high
• -common among investors

• -many ppl become "anchored" to their ideas and will not update their expecatations when new info arrives
• -leads to momentum in stock returns

• -decisions are affected by how choices are posed. 
• -ppl view gains and losses differecntly (loss aversion, regret avoidance which leads to disposition effect)

• -specific form of framing in which ppl segregate certain decisions.
• -when cash is needed investors may spend dividends, but refuse to sell a small portion of stock to raise money
• -may lead to a preference for stocks that pay larger dividends even though tax liability may be higher

• -ppl blame themselves more for unconventional choices that turn out badly so they avoid regret by making conventional decisions
• -regret from losses> joy from gains
• -regret reduced with "shared pain"

investors refuse to sell loser stocks (hard to admit when your wrong)

mechanism for "correcting" prices

• 1)info costs
• 2)trading costs
• 3)other restrictions (short selling)

• 1)Fundamental risk-changes in fundamentals can wipe out any arbitrage profits, making it risky
• 2)Implementation costs-short sale constraints make it difficult to arbitrage overpriced securities
• 3)Model Risk- using faulty model to value security

assumption prices react to infro gradually over time (rather than instantly)

• 1)Dow Theory
• 2)Moving Average
• 3)Breadth
• 4)Relative Strength
• 5)Point and Figure Charts

Looks at movements in S-T moving averages (and price) relative to L-T moving averages

extent to which movements in broad market indexes are reflected widely in movements of individual stock prices

Recent performance of a given stock or industry compared to that of a broader market index

• 1)Trin Statistic
• 2)Confidence Index
• 3)Short Interest
• 4)Put/Call Ratio

ratio of average volume in declining issues to average volume in advancing issues

• -spread between rates of return on highest grade bonds + lower grade bonds (higher is bearish)
• -ratio of yield of top rated corp. bonds to yield on intermediate grade bonds

total number of shares currently sold-short in the market

ratio of put options to call options outstanding on a stock

S-T moving average crosses L-T moving average from below

S-T moving average crosses L-T moving average from above (S-T line has neg. slope)