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Chapter 12 - Behavioral Finance and Technical Analysis
Chapter 12 Behavioral Finance and Technical Analysis Answer Key
Multiple Choice Questions
1. Conventional theories presume that investors ____________ and behavioral finance
presumes that they ____________.
A. are irrational; are irrational
B. are rational; may not be rational
C. are rational; are rational
D. may not be rational; may not be rational
E. may not be rational; are rational
Conventional theories presume that investors are rational and behavioral finance presumes
that they may not be rational.
AACSB: Analytic
Bloom's: Remember
Difficulty: Basic
Topic: Behavioral Critique
12-18
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Chapter 12 - Behavioral Finance and Technical Analysis
2. The premise of behavioral finance is that
A. conventional financial theory ignores how real people make decisions and that people
make a difference.
B. conventional financial theory considers how emotional people make decisions but the
market is driven by rational utility maximizing investors.
C. conventional financial theory should ignore how the average person makes decisions
because the market is driven by investors that are much more sophisticated than the average
person.
D. conventional financial theory considers how emotional people make decisions but the
market is driven by rational utility maximizing investors, and conventional financial theory
should ignore how the average person makes decisions because the market is driven by
investors that are much more sophisticated than the average person
E. None of these is correct.
The premise of behavioral finance is that conventional financial theory ignores how real
people make decisions and that people make a difference.
AACSB: Analytic
Bloom's: Remember
Difficulty: Basic
Topic: Behavioral Critique
12-19
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Chapter 12 - Behavioral Finance and Technical Analysis
3. Some economists believe that the anomalies literature is consistent with investors'
____________ and ____________.
A. ability to always process information correctly and therefore they infer correct probability
distributions about future rates of return; given a probability distribution of returns, they
always make consistent and optimal decisions
B. inability to always process information correctly and therefore they infer incorrect
probability distributions about future rates of return; given a probability distribution of
returns, they always make consistent and optimal decisions
C. ability to always process information correctly and therefore they infer correct probability
distributions about future rates of return; given a probability distribution of returns, they often
make inconsistent or suboptimal decisions
D. inability to always process information correctly and therefore they infer incorrect
probability distributions about future rates of return; given a probability distribution of
returns, they often make inconsistent or suboptimal decisions
E. None of these is correct.
Some economists believe that the anomalies literature is consistent with investors inability to
always process information correctly and therefore they infer incorrect probability
distributions about future rates of return and given a probability distribution of returns, they
often make inconsistent or suboptimal decisions.
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Behavioral Critique
12-20
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Chapter 12 - Behavioral Finance and Technical Analysis
4. Information processing errors consist of
I) forecasting errors
II) overconfidence
III) conservatism
IV) framing
A. I and II
B. I and III
C. III and IV
D. IV only
E. I, II and III
Information processing errors consist of forecasting errors, overconfidence, and conservatism.
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Behavioral Critique
5. Forecasting errors are potentially important because
A. research suggests that people underweight recent information.
B. research suggests that people overweight recent information.
C. research suggests that people correctly weight recent information.
D. research suggests that people either underweight recent information or overweight recent
information depending on whether the information was good or bad.
E. None of these is correct.
Forecasting errors are potentially important because research suggests that people overweight
recent information.
AACSB: Analytic
Bloom's: Understand
Difficulty: Intermediate
Topic: Behavioral Critique
12-21
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Chapter 12 - Behavioral Finance and Technical Analysis
6. DeBondt and Thaler believe that high P/E result from investors'
A. earnings expectations that are too extreme.
B. earnings expectations that are not extreme enough.
C. stock price expectations that are too extreme.
D. stock price expectations that are not extreme enough.
E. None of these is correct.
DeBondt and Thaler believe that high P/E result from investors earnings expectations that are
too extreme.
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Behavioral Critique
7. If a person gives too much weight to recent information compared to prior beliefs, they
would make ________ errors.
A. framing
B. selection bias
C. overconfidence
D. conservatism
E. forecasting
If a person gives too much weight to recent information compared to prior beliefs, they would
make forecasting errors.
AACSB: Analytic
Bloom's: Understand
Difficulty: Intermediate
Topic: Behavioral Critique
12-22
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Chapter 12 - Behavioral Finance and Technical Analysis
8. Single men trade far more often than women. This is due to greater ________ among men.
A. framing
B. regret avoidance
C. overconfidence
D. conservatism
E. None of these is correct.
Single men trade far more often than women. This is due to greater overconfidence among
men.
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Behavioral Critique
9. ____________ may be responsible for the prevalence of active versus passive investments
management.
A. Forecasting errors
B. Overconfidence
C. Mental accounting
D. Conservatism
E. Regret avoidance
Overconfidence may be responsible for the prevalence of active versus passive investments
management.
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Behavioral Critique
12-23
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Chapter 12 - Behavioral Finance and Technical Analysis
10. Barber and Odean (2000) ranked portfolios by turnover and report that the difference in
return between the highest and lowest turnover portfolios is 7% per year. They attribute this
to
A. overconfidence
B. framing
C. regret avoidance
D. sample neglect
E. overconfidence, framing, regret avoidance, and sample neglect
They attribute this to overconfidence.
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Behavioral Critique
11. ________ bias means that investors are too slow in updating their beliefs in response to
evidence.
A. Framing
B. Regret avoidance
C. Overconfidence
D. Conservatism
E. None of these is correct.
Conservatism bias means that investors are too slow in updating their beliefs in response to
evidence.
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Behavioral Critique
12-24
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Chapter 12 - Behavioral Finance and Technical Analysis
12. Psychologists have found that people who make decisions that turn out badly blame
themselves more when that decision was unconventional. The name for this phenomenon is
A. regret avoidance
B. framing
C. mental accounting
D. overconfidence
E. obnoxicity
An investments example given in the text is buying the stock of a start-up firm that shows
subsequent poor performance, versus buying blue chip stocks that perform poorly. Investors
tend to have more regret if they chose the less conventional start-up stock. DeBondt and
Thaler say that such regret theory is consistent with the size effect and the book-to-market
effect.
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Behavioral Critique
13. An example of ________ is that a person may reject an investment when it is posed in
terms of risk surrounding potential gains but may accept the same investment if it is posed in
terms of risk surrounding potential losses.
A. framing
B. regret avoidance
C. overconfidence
D. conservatism
E. None of these is correct.
An example of framing is that a person may reject an investment when it is posed in terms of
risk surrounding potential gains but may accept the same investment if it is posed in terms of
risk surrounding potential losses.
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Behavioral Critique
12-25
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Chapter 12 - Behavioral Finance and Technical Analysis
14. Statman (1977) argues that ________ is consistent with some investors' irrational
preference for stocks with high cash dividends and with a tendency to hold losing positions
too long.
A. mental accounting
B. regret avoidance
C. overconfidence
D. conservatism
E. None of these is correct.
Statman (1977) argues that mental accounting is consistent with some investors' irrational
preference for stocks with high cash dividends and with a tendency to hold losing positions
too long.
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Behavioral Critique
15. An example of ________ is that it is not as painful to have purchased a blue-chip stock
that decreases in value, as it is to lose money on an unknown start-up firm.
A. mental accounting
B. regret avoidance
C. overconfidence
D. conservatism
E. None of these is correct.
An example of regret avoidance is that it is not as painful to have purchased a blue-chip stock
that decreases in value, as it is to lose money on an unknown start-up firm.
AACSB: Analytic
Bloom's: Understand
Difficulty: Intermediate
Topic: Behavioral Critique
12-26
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Chapter 12 - Behavioral Finance and Technical Analysis
16. Arbitrageurs may be unable to exploit behavioral biases due to ____________.
I) fundamental risk
II) implementation costs
III) model risk
IV) conservatism
V) regret avoidance
A. I and II only
B. I, II, and III
C. I, II, III, and V
D. II, III, and IV
E. IV and V
Arbitrageurs may be unable to exploit behavioral biases due to fundamental risk,
implementation costs, and model risk.
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Limits to Arbitrage
17. ____________ are good examples of the limits to arbitrage because they show that the
law of one price is violated.
I) Siamese Twin Companies
II) Unit trusts
III) Closed end funds
IV) Open end funds
V) Equity carve outs
A. I and II
B. I, II, and III
C. I, III, and V
D. IV and V
E. V
Siamese Twin Companies, closed end funds, and equity carve outs are good examples of the
limits to arbitrage because they show that the law of one price is violated.
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Limits to Arbitrage
12-27
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Chapter 12 - Behavioral Finance and Technical Analysis
18. __________ was the grandfather of technical analysis.
A. Harry Markowitz
B. William Sharpe
C. Charles Dow
D. Benjamin Graham
E. None of these is correct.
Charles Dow, the originator of the Dow Theory, was the grandfather of technical analysis.
Benjamin Graham might be considered the grandfather of fundamental analysis. Harry
Markowitz and William Sharpe might be considered the grandfathers of modern portfolio
theory.
AACSB: Analytic
Bloom's: Remember
Difficulty: Basic
Topic: Technical Analysis and Behavioral Finance
19. The goal of the Dow theory is to
A. identify head and shoulder patterns.
B. identify breakaway points.
C. identify resistance levels.
D. identify support levels.
E. identify long-term trends.
The Dow theory uses the Dow Jones Industrial Average as an indicator of long-term trends in
market prices.
AACSB: Analytic
Bloom's: Remember
Difficulty: Basic
Topic: Technical Analysis and Behavioral Finance
12-28
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Chapter 12 - Behavioral Finance and Technical Analysis
20. A long-term movement of prices, lasting from several months to years is called
_________.
A. a minor trend
B. a primary trend
C. an intermediate trend
D. trend analysis
E. both a primary trend and trend analysis
Minor trends are merely day-to-day price movements; intermediate trends are "corrections",
or offsetting movements in one direction after longer-term movements in another direction;
trends lasting for the period described above are primary trends.
AACSB: Analytic
Bloom's: Remember
Difficulty: Basic
Topic: Technical Analysis and Behavioral Finance
21. A daily fluctuation of little importance is called ____________.
A. a minor trend
B. a primary trend
C. an intermediate trend
D. a market trend
E. None of these is correct.
A daily fluctuation of little importance is called a minor trend.
AACSB: Analytic
Bloom's: Remember
Difficulty: Basic
Topic: Technical Analysis and Behavioral Finance
12-29
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Chapter 12 - Behavioral Finance and Technical Analysis
22. Price movements that are caused by short-term deviations of prices from the underlying
trend line are called
A. primary trends.
B. secondary trends.
C. tertiary trends.
D. Dow trends.
E. contrary trends.
The secondary trend is caused by these deviations, which are eliminated by corrections that
bring the prices back to the trend lines.
AACSB: Analytic
Bloom's: Remember
Difficulty: Basic
Topic: Technical Analysis and Behavioral Finance
23. The Dow theory posits that the three forces that simultaneously affect stock prices are
____________.
I) primary trend
II) intermediate trend
III) momentum trend
IV) minor trend
V) contrarian trend
A. I, II, and III
B. II, III, and IV
C. III, IV and V
D. I, II, and IV
E. I, III, and V
The Dow theory posits that the three forces that simultaneously affect stock prices are primary
trend, intermediate trend, and minor trend.
AACSB: Analytic
Bloom's: Understand
Difficulty: Intermediate
Topic: Technical Analysis and Behavioral Finance
12-30
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Chapter 12 - Behavioral Finance and Technical Analysis
24. The Elliot Wave Theory ____________.
A. is a recent variation of the Dow Theory
B. suggests that stock prices can be described by a set of wave patterns
C. is similar to the Kondratieff Wave theory
D. is a recent variation of the Dow Theory and suggests that stock prices can be described by
a set of wave patterns
E. is a recent variation of the Dow Theory, suggests that stock prices can be described by a set
of wave patterns, and is similar to the Kondratieff Wave theory
Both the Elliot Wave Theory and the Kondratieff Wave Theory are recent variations on the
Dow Theory, which suggests that stock prices move in identifiable wave patterns.
AACSB: Analytic
Bloom's: Remember
Difficulty: Basic
Topic: Technical Analysis and Behavioral Finance
25. A trin ratio of less than 1.0 is considered as a _________.
A. bearish signal
B. bullish signal
C. bearish signal by some technical analysts and a bullish signal by other technical analysts
D. bullish signal by some fundamentalists
E. bearish signal by some technical analysts, a bullish signal by other technical analysts and
bullish signal by some fundamentalists
A trin ratio of less than 1.0 is considered bullish because the declining stocks have lower
average volume than the advancing stocks, indicating net buying pressure.
AACSB: Analytic
Bloom's: Understand
Difficulty: Basic
Topic: Technical Analysis and Behavioral Finance
12-31
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Chapter 12 - Behavioral Finance and Technical Analysis
26. On October 29, 2009 there were 1,031 stocks that advanced on the NYSE and 610 that
declined. The volume in advancing issues was 112,866,000 and the volume in declining issues
was 58,188,000. The trin ratio for that day was ________ and technical analysts were likely to
be ________.
A. 0.87, bullish
B. 0.87, bearish
C. 1.15, bullish
D. 1.15, bearish
E. None of these is correct.
(1,031/610)/(112,866,000/58,388,000) = 0.87. A trin ratio less than 1 is considered bullish
because advancing stocks have a higher volume than declining stocks, indicating a buying
pressure.
AACSB: Analytic
Bloom's: Apply
Difficulty: Intermediate
Topic: Technical Analysis and Behavioral Finance
27. In regard to moving averages, it is considered to be a ____________ signal when market
price breaks through the moving average from ____________.
A. bearish; below
B. bullish; below
C. bearish; above
D. bullish; above
E. both bullish; below and bearish; above
In regard to moving averages, it is considered to be a bullish signal when market price breaks
through the moving average from below. In addition, it is considered to be a bearish signal
when market price breaks through the moving average from above.
AACSB: Analytic
Bloom's: Understand
Difficulty: Intermediate
Topic: Technical Analysis and Behavioral Finance
12-32
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Chapter 12 - Behavioral Finance and Technical Analysis
28. Two popular moving average periods are
A. 90-day and 52 week
B. 180-day and three year
C. 180-day two year
D. 200-day and 53 week
E. 200-day and two year
Two popular moving average periods are 200-day and 53 week.
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Technical Analysis and Behavioral Finance
29. ____________ is a measure of the extent to which a movement in the market index is
reflected in the price movements of all stocks in the market.
A. Put-call ratio
B. Trin ratio
C. Breadth
D. Confidence index
E. All of these are correct.
Breadth is a measure of the extent to which a movement in the market index is reflected in the
price movements of all stocks in the market.
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Technical Analysis and Behavioral Finance
12-33
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Chapter 12 - Behavioral Finance and Technical Analysis
30. Then confidence index is computed from ____________ and higher values are considered
____________ signals.
A. bond yields; bearish
B. odd lot trades; bearish
C. odd lot trades; bullish
D. put/call ratios; bullish
E. bond yields; bullish
Then confidence index is computed from bond yields and higher values are considered bullish
signals.
AACSB: Analytic
Bloom's: Understand
Difficulty: Intermediate
Topic: Technical Analysis and Behavioral Finance
31. The put/call ratio is computed as ____________ and higher values are considered
____________ signals.
A. the number of outstanding put options divided by outstanding call options; bullish or
bearish
B. the number of outstanding put options divided by outstanding call options; bullish
C. the number of outstanding put options divided by outstanding call options; bearish
D. the number of outstanding call options divided by outstanding put options; bullish
E. the number of outstanding call options divided by outstanding put options; bearish
The put/call ratio is computed as the number of outstanding put options divided by
outstanding call options and higher values are considered bullish or bearish signals.
AACSB: Analytic
Bloom's: Understand
Difficulty: Intermediate
Topic: Technical Analysis and Behavioral Finance
12-34
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Chapter 12 - Behavioral Finance and Technical Analysis
32. The efficient market hypothesis ____________.
A. implies that security prices properly reflect information available to investors
B. has little empirical validity
C. implies that active traders will find it difficult to outperform a buy-and-hold strategy
D. has little empirical validity and implies that active traders will find it difficult to
outperform a buy-and-hold strategy
E. implies that security prices properly reflect information available to investors and implies
that active traders will find it difficult to outperform a buy-and-hold strategy
The efficient market hypothesis implies that security prices properly reflect information
available to investors and active traders will find it difficult to outperform a buy-and-hold
strategy.
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Behavioral Critique
33. Tests of market efficiency have focused on ____________.
A. the mean-variance efficiency of the selected market proxy
B. strategies that would have provided superior risk-adjusted returns
C. results of actual investments of professional managers
D. strategies that would have provided superior risk-adjusted returns and results of actual
investments of professional managers
E. the mean-variance efficiency of the selected market proxy and strategies that would have
provided superior risk-adjusted returns
Tests of market efficiency have focused on strategies that would have provided superior riskadjusted returns and results of actual investments of professional managers.
AACSB: Analytic
Bloom's: Understand
Difficulty: Intermediate
Topic: Behavioral Critique
12-35
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Chapter 12 - Behavioral Finance and Technical Analysis
34. The anomalies literature ____________.
A. provides a conclusive rejection of market efficiency
B. provides conclusive support of market efficiency
C. suggests that several strategies would have provided superior returns
D. provides a conclusive rejection of market efficiency and suggests that several strategies
would have provided superior returns
E. None of these is correct.
The anomalies literature suggests that several strategies would have provided superior returns.
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Behavioral Critique
35. Behavioral finance argues that ____________.
A. even if security prices are wrong it may be difficult to exploit them
B. the failure to uncover successful trading rules or traders cannot be taken as proof of market
efficiency
C. investors are rational
D. even if security prices are wrong it may be difficult to exploit them, and the failure to
uncover successful trading rules or traders cannot be taken as proof of market efficiency
E. All of these are correct.
Behavioral finance argues that even if security prices are wrong it may be difficult to exploit
them and the failure to uncover successful trading rules or traders cannot be taken as proof of
market efficiency.
AACSB: Analytic
Bloom's: Understand
Difficulty: Intermediate
Topic: Behavioral Critique
12-36
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Chapter 12 - Behavioral Finance and Technical Analysis
36. Markets would be inefficient if irrational investors __________ and actions if arbitragers
were __________.
A. existed; unlimited
B. did not exist; unlimited
C. existed; limited
D. did not exist; limited
E. None of these is correct.
Markets would be inefficient if irrational investors existed and actions if arbitragers were
limited.
AACSB: Analytic
Bloom's: Understand
Difficulty: Intermediate
Topic: Limits to Arbitrage
37. If prices are correct __________ and if prices are not correct __________.
A. there are no easy profit opportunities; there are no easy profit opportunities
B. there are no easy profit opportunities; there are easy profit opportunities
C. there are easy profit opportunities; there are easy profit opportunities
D. there are easy profit opportunities; there are no easy profit opportunities
E. None of these is correct.
If prices are correct there are no easy profit opportunities and if prices are not correct there are
no easy profit opportunities.
AACSB: Analytic
Bloom's: Understand
Difficulty: Intermediate
Topic: Limits to Arbitrage
12-37
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Chapter 12 - Behavioral Finance and Technical Analysis
38. __________ can lead investors to misestimate the true probabilities of possible events or
associated rates of return.
A. Information processing errors
B. Framing errors
C. Mental accounting errors
D. Regret avoidance
E. All of these are correct.
Information processing errors can lead investors to misestimate the true probabilities of
possible events or associated rates of return.
AACSB: Analytic
Bloom's: Understand
Difficulty: Intermediate
Topic: Limits to Arbitrage
39. Kahneman and Tversky (1973) report that __________ and __________.
A. people give too little weight to recent experience compared to prior beliefs; tend to make
forecasts that are too extreme given the uncertainty of their information
B. people give too much weight to recent experience compared to prior beliefs; tend to make
forecasts that are too extreme given the uncertainty of their information
C. people give too little weight to recent experience compared to prior beliefs; tend to make
forecasts that are not extreme enough given the uncertainty of their information
D. people give too much weight to recent experience compared to prior beliefs; tend to make
forecasts that are not extreme enough given the uncertainty of their information
E. None of these is correct.
Kahneman and Tversky (1973) report that people give too much weight to recent experience
compared to prior beliefs and tend to make forecasts that are too extreme given the
uncertainty of their information.
AACSB: Analytic
Bloom's: Understand
Difficulty: Challenge
Topic: Technical Analysis and Behavioral Finance
12-38
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Chapter 12 - Behavioral Finance and Technical Analysis
40. Errors in information processing can lead investors to misestimate __________.
A. true probabilities of possible events and associated rates of return
B. occurrence of possible events
C. only possible rates of return
D. the effect of accounting manipulation
E. fraud
Errors in information processing can lead investors to misestimate true probabilities of
possible events and associated rates of return.
AACSB: Analytic
Bloom's: Understand
Difficulty: Intermediate
Topic: Technical Analysis and Behavioral Finance
41. DeBondt and Thaler (1990) argue that the P/E effect can be explained by __________.
A. forecasting errors
B. earnings expectations that are too extreme
C. earnings expectations that are not extreme enough
D. regret avoidance
E. both forecasting errors and earnings expectations that are too extreme
DeBondt and Thaler (1990) argue that the P/E effect can be explained by forecasting errors
and earnings expectations that are too extreme.
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Behavioral Critique
12-39
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Chapter 12 - Behavioral Finance and Technical Analysis
42. Barber and Odean (2001) report that men trade __________ frequently than women and
the frequent trading leads to __________ returns.
A. less; superior
B. less; inferior
C. more; superior
D. more; inferior
E. None of these is correct.
Barber and Odean (2001) report that men trade more frequently than women and the frequent
trading leads to inferior returns.
AACSB: Analytic
Bloom's: Understand
Difficulty: Intermediate
Topic: Behavioral Critique
43. Conservatism implies that investors are too __________ in updating their beliefs in
response to new evidence and that they initially __________ to news.
A. quick; overreact
B. quick; under react
C. slow; overreact
D. slow; under react
E. None of these is correct.
Conservatism implies that investors are too slow in updating their beliefs in response to new
evidence and that they initially under react to news.
AACSB: Analytic
Bloom's: Understand
Difficulty: Intermediate
Topic: Behavioral Critique
12-40
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Chapter 12 - Behavioral Finance and Technical Analysis
44. If information processing were perfect, many studies conclude that individuals would tend
to make __________ decisions using that information due to __________.
A. less-than-fully rational; behavioral biases
B. fully rational; behavioral biases
C. less-than-fully rational; fundamental risk
D. fully rational; fundamental risk
E. fully rational; utility maximization
If information processing were perfect, many studies conclude that individuals would tend to
make less-than-fully rational decisions using that information due to behavioral biases.
AACSB: Analytic
Bloom's: Understand
Difficulty: Intermediate
Topic: Behavioral Critique
45. The assumptions concerning the shape of utility functions of investors differ between
conventional theory and prospect theory. Conventional theory assumes that utility functions
are __________ whereas prospect theory assumes that utility functions are __________.
A. concave and defined in terms of wealth; s-shaped (convex to losses and concave to gains)
and defined in terms of loses relative to current wealth
B. convex and defined in terms of loses relative to current wealth; s-shaped (convex to losses
and concave to gains) and defined in terms of loses relative to current wealth
C. s-shaped (convex to losses and concave to gains) and defined in terms of loses relative to
current wealth; concave and defined in terms of wealth
D. s-shaped (convex to losses and concave to gains) and defined in terms of wealth; concave
and defined in terms of loses relative to current wealth
E. convex and defined in terms of wealth; concave and defined in terms of gains relative to
current wealth
The assumptions concerning the shape of utility functions of investors differ between
conventional theory and prospect theory. Conventional theory assumes that utility functions
are concave and defined in terms of wealth whereas prospect theory assumes that utility
functions are s-shaped (convex to losses and concave to gains) and defined in terms of loses
relative to current wealth.
AACSB: Analytic
Bloom's: Understand
Difficulty: Challenge
Topic: Behavioral Critique
12-41
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Chapter 12 - Behavioral Finance and Technical Analysis
46. The law-of-one-price posits that ability to arbitrage would force prices of identical goods
to trade at equal prices. However, empirical evidence suggests that __________ are often
mispriced.
A. Siamese Twin Companies
B. equity carve outs
C. closed-end funds
D. both Siamese Twin Companies and closed-end funds
E. All of these are correct.
The law-of-one-price posits that ability to arbitrage would force prices of identical goods to
trade at equal prices. However, empirical evidence suggests that Siamese Twin Companies,
equity carve outs, and closed-end funds are often mispriced.
AACSB: Analytic
Bloom's: Understand
Difficulty: Challenge
Topic: Limits to Arbitrage
47. Kahneman and Tversky (1973) reported that people give __________ weight to recent
experience compared to prior beliefs when making forecasts. This is referred to as
__________.
A. too little; hyper rationality
B. too little; conservatism
C. too much; framing
D. too much; memory bias
E. None of these is correct.
Kahneman and Tversky (1973) reported that people give too much weight to recent
experience compared to prior beliefs when making forecasts. This is referred to as memory
bias.
AACSB: Analytic
Bloom's: Understand
Difficulty: Intermediate
Topic: Behavioral Critique
12-42
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Chapter 12 - Behavioral Finance and Technical Analysis
48. Kahneman and Tversky (1973) reported that __________ give too much weight to recent
experience compared to prior beliefs when making forecasts.
A. young men
B. young women
C. people
D. older men
E. older women
Kahneman and Tversky (1973) reported that people give too much weight to recent
experience compared to prior beliefs when making forecasts.
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Behavioral Critique
49. Barber and Odean (2001) report that men trade __________ frequently than women.
A. less
B. less in down markets
C. more in up markets
D. more
E. None of these is correct.
Barber and Odean (2001) report that men trade more frequently than women.
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Behavioral Critique
12-43
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Chapter 12 - Behavioral Finance and Technical Analysis
50. Barber and Odean (2001) report that women trade __________ frequently than men.
A. less
B. less in down markets
C. more in up markets
D. more
E. None of these is correct.
Barber and Odean (2001) report that men trade more frequently than women.
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Behavioral Critique
51. Barber and Odean (2001) report that men __________ than women.
A. earn higher returns
B. earn lower returns
C. earn about the same returns
D. generate lower trading costs
E. None of these is correct.
Barber and Odean (2001) report that men trade more frequently than women and have lower
returns.
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Behavioral Critique
12-44
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Chapter 12 - Behavioral Finance and Technical Analysis
52. Barber and Odean (2001) report that women __________ than men.
A. earn higher returns
B. earn lower returns
C. earn about the same returns
D. generate higher trading costs
E. None of these is correct.
Barber and Odean (2001) report that men trade more frequently than women and have lower
returns.
AACSB: Analytic
Bloom's: Remember
Difficulty: Intermediate
Topic: Behavioral Critique
53. __________ effects can help explain momentum in stock prices.
A. Conservatism
B. Regret avoidance
C. Prospect theory
D. Mental accounting
E. Model risk
Mental accounting effects can help explain momentum in stock prices.
AACSB: Analytic
Bloom's: Understand
Difficulty: Intermediate
Topic: Behavioral Critique
12-45
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Chapter 12 - Behavioral Finance and Technical Analysis
54. Studies of Siamese twin companies find __________ which __________ the EMH.
A. correct relative pricing; supports
B. correct relative pricing; does not support
C. incorrect relative pricing; supports
D. incorrect relative pricing; does not support
E. None of these is correct.
Studies of Siamese twin companies find incorrect relative pricing which does not support the
EMH.
AACSB: Analytic
Bloom's: Understand
Difficulty: Intermediate
Topic: Limits to Arbitrage
55. Studies of equity carve-outs find __________ which __________ the EMH.
A. strong support for the Law of One Price; supports
B. strong support for the Law of One Price; violates
C. evidence against the Law of One Price; violates
D. evidence against the Law of One Price; supports
E. None of these is correct.
Studies of equity carve-outs find evidence against the Law of One Price which violates the
EMH.
AACSB: Analytic
Bloom's: Understand
Difficulty: Intermediate
Topic: Limits to Arbitrage
12-46
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Chapter 12 - Behavioral Finance and Technical Analysis
56. Studies of closed-end funds find __________ which __________ the EMH.
A. prices at a premium to NAV; is consistent with
B. prices at a premium to NAV; is inconsistent with
C. prices at a discount to NAV; is consistent with
D. prices at a discount to NAV; is inconsistent with
E. both prices at a premium to NAV; is inconsistent with and prices at a discount to NAV; is
inconsistent with
Studies of closed-end funds find prices at premiums and discounts to NAV which is
inconsistent with the EMH.
AACSB: Analytic
Bloom's: Understand
Difficulty: Intermediate
Topic: Limits to Arbitrage
Short Answer Questions
57. Compare and contrast the efficient market hypothesis with the school of thought termed
behavioral finance.
The efficient market hypothesis posits that investors are fully informed, rational, utility
maximizers. Thus, security prices will fully reflect all information available to the investors.
If any security becomes mispriced, the collective buying and selling actions of investors will
quickly cause prices to change. Given an efficient market, it would be difficult to find a
trading rule that would consistently outperform the market. Moreover, failure to uncover
profitable trading strategies may be taken as proof of market efficiency. Behavioral finance
argues that conventional theory ignores how real people make decisions and that people make
a difference. Behavioral finance says that investors possess two "irrationalities". First,
investors do not always process information correctly and secondly they often make
systematically suboptimal decisions. Given less than perfectly rational investors, prices may
be wrong and it still may be hard to exploit them. Thus, failure to uncover profitable trading
strategies may not be taken as proof of market efficiency.
AACSB: Reflective Thinking
Bloom's: Understand
Difficulty: Challenge
Topic: Behavioral Critique
12-47
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Chapter 12 - Behavioral Finance and Technical Analysis
58. Behavioral finance posits that investors possess information processing errors. Discuss the
importance of information processing errors then list and explain the four information
processing errors discussed in the text.
Information processing errors are important because they can lead investors to misestimate
the true probabilities of possible events or associated rates of return. The four information
processing errors are forecasting errors, overconfidence, conservatism, and sample size
neglect. Forecasting errors arise when people give too much weight to recent experience. This
leads to forecasts that are too extreme. Overconfidence refers to traders believing that they are
better than average. This belief that they are superior leads to frequent trading (and according
to empirical evidence, lower returns). Conservatism refers investors being slow in responding
to new information rather than acting immediately. Sample size neglect refers to investors
ignoring the size of a sample and making inferences based on a small sample.
Feedback: This question tests the students understanding of information processing errors.
AACSB: Reflective Thinking
Bloom's: Understand
Difficulty: Challenge
Topic: Behavioral Critique
12-48
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Chapter 12 - Behavioral Finance and Technical Analysis
59. Behavioral finance posits that investors possess behavioral biases. Discuss the importance
of behavioral biases then list and explain the four behavioral biases discussed in the text.
Behavioral biases are important because even if information processing was perfect,
individuals may tend to make less-than-fully rational decisions using that information. The
four behavioral biases are framing, mental accounting, regret avoidance, and prospect theory
(or loss aversion). Framing refers to the tendency of investors to change preferences due to
the way an investment is "framed" (i.e., in terms of risk or in terms of return). Mental
accounting is a specific form of framing where an investor takes a lot of risk with one
investment account but little risk with another account. Regret avoidance refers to the
tendency of investors to blame themselves more for an unconventional investment that was
unsuccessful than a conventional investment that was unsuccessful. Prospect theory (loss
avoidance) suggests that the investor's utility curve is not concave and defined in terms of
wealth. Instead, the investor's utility function would be defined in terms of losses relative to
current wealth. Thus, the utility curve is convex to losses and concave to gains giving rise to
an s-shaped utility curve.
Feedback: This question tests the students understanding of behavioral biases.
AACSB: Reflective Thinking
Bloom's: Understand
Difficulty: Challenge
Topic: Behavioral Critique
12-49
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Chapter 12 - Behavioral Finance and Technical Analysis
60. Discuss what technical analysis is, what technical analysts do, and the relationship
between technical analysis, fundamental analysis, and behavioral finance.
Technical analysis attempts to exploit recurring and predictable patterns in stock prices to
generate superior portfolio performance. To determine recurring patterns, technical analysts
examine historical returns by means of charts and or time-series analysis (such as moving
averages). Technical analysts do not deny fundamental analysis but believe that prices adjust
slowly to new information. Therefore, the key is to exploit the slow adjustment to the correct
new price when information is released. Technical analysts also use volume and other data to
assess market sentiment in an attempt to ascertain the future direction of the market.
Behaviorists believe that behavioral biases may be related to both price and volume data.
Thus, technical analysis can be related to behavioral finance.
Feedback: This question tests the students understanding of technical analysis; and how
technical analysis relates to fundamental analysis and behavioral finance.
AACSB: Reflective Thinking
Bloom's: Understand
Difficulty: Challenge
Topic: Technical Analysis and Behavioral Finance
12-50
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