GM1024, Behavioural Finance
Michael Kirchler, Oege Dijk
Faculty Board of the School of Business, Economics and Law
GM1024, Behavioural Finance,
7.5 higher education credits
Dr. Oege Dijk
Centre for Finance, University of Gothenburg
Oege.dijk@economics.gu.se
Dr. Michael Kirchler
Department of Banking and Finance, University of Innsbruck and
Centre for Finance, University of Gothenburg
michael.kirchler@uibk.ac.at
http://www2.uibk.ac.at/ibf/mitarbeiter/kirchler.html
Course Outline
This course covers a broad range of issues in behavioral and experimental finance. Its central theme will
be the “efficient market hypothesis” (EMH), one of the cornerstones of modern finance. The course will
be made up of two parts: the limits to rationality in human financial decision-making, and the limits of
markets to reach rational efficient equilibria. Special emphasis in this course is given to experimental
studies. To deepen the knowledge and understanding of the functioning of financial markets, both paper
and pencil and computerized market experiments are run during the course with near-to-reality market
designs. In particular, the course consists of the following connected themes.
The first part concerns some limitations to rationality. Psychological biases such as myopia, loss
aversion, ambiguity aversion, present biasedness, etc, can lead to observed phenomena such as the
endowment effect, the disposition effect, limited stock market participation or excessive risk taking.
Some simple choice experiments will demonstrate these ideas and their effects. A second part
investigates the efficiency of markets in general and drivers of bubble formation in financial markets in
particular. Again, experiments will be run to detect environments which fuel or diminish bubbles on
asset markets.
Furthermore, the course sheds some light onto the performance of different groups of investors like
insiders, mutual fund managers, etc. and thus covers the value of their private information. It will be
investigated whether they are able to outperform the market which would mean that the market prices do
not fully incorporate their information. Finally, experiments with asymmetrically endowed investors will
be run and analyzed in class to observe differences in returns and behavior among the different trader
groups.
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GM1024, Behavioural Finance
Michael Kirchler, Oege Dijk
Learning outcomes
Upon completion of the course the student will
1. Have a good understanding of how psychological biases can affect financial decision-making.
2. Have a good understanding of the functioning of markets and the mechanism of price
formation.
3. Have a good understanding of the efficiency of real-world financial markets and its
implications.
Details of the Course
Part 1: Biases in individual decision-making
Session 1: Standard model, intro Prospect Theory
 Standard models of risk aversion
 Calibration theorem
 Introducing Prospect Theory
 Loss aversion, convex utility in losses, probability weighting
Session 2: Endowment effect, disposition effect
 Endowment effect
 Disposition effect
Session 3: Mental accounting, Myopic Loss Aversion
 Mental accounting
 Myopic Loss Aversion
Session 4: Ambiguity aversion, Overconfidence, gender
 Ellsberg paradox
 Max-min preferences
 Overconfidence, gender effects
Part 2: Market experiments
Session 5: Market efficiency
 Overview
 Experiments with paper and pen
 Three forms of market efficiency
Session 6: The Value of Information on Financial Markets
 The value of information – experiment and literature
 Three types of market efficiency
 Expert Performance in General and on Financial Markets
Session 7: Bubbles
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GM1024, Behavioural Finance
Michael Kirchler, Oege Dijk


Expert Performance in General and on Financial Markets
Bubbles in asset markets – experiment and literature
Session 8: Presentations of mini-essays and the group paper
 Slots of 30 minutes for each group.
Grading
1. A written exam (learning outcomes 1-3) which accounts for 60% of the grade. At least 50% of
the total points of the exam must be achieved to get a positive grade in the course.
2. Two mini-essays detailing an application of the concepts presented in class in the real world.
(5% of the grade each). They will be presented in the last session of this course.
3. Group paper which include the group’s empirical or experimental study on financial decisionmaking or market efficiency (max. 3 students). Assessments 3 accounts for 30% of the grade.
Group paper:
Work together in groups of at maximum three. Try to find a research question on market efficiency (with special
emphasis on experimental research questions) and conduct the study according to the principles of scientific
work.
The case study should be written like a “short” scientific paper and hence should serve as a good practice for
writing your master thesis. The case study should contain the following sections:
1) Introduction and related literature
Here you should briefly state what you are willing to look at (a very short summary of your research
question) and you should shortly mention and explain related literature. Furthermore it is common
practice in scientific papers to include a brief paragraph with your main findings that the reader already
knows about the contribution of the paper from the beginning. The introduction is written in present
tense (the part on related literature may sometimes also be written in past tense).
2) Research question and method
The research question(s) should be deduced from existing literature which you presented in Section 1
and should be stated clearly. Furthermore you should explain your empirical model you test your
research questions with in the subsection “method”. If you write your case study on experiments we
conducted, you must also include a subsection on “model description” and explain the structure of the
experimental market (see the experimental papers in the references of this course). This section is
written in present tense.
3) Results
Based on the research question, the results should be presented. Statistical tests should be traceable with
the inclusion of p-values, sample size n, etc. The results section is written in present tense.
4) Conclusion and discussion
This section should contain a brief summary of the research question, the method applied and the most
important results. In the last paragraph it also makes sense to relate the results to existing literature and
to discuss shortly the practical implications of your study. Writing in past tense is best suited for the
summary of results. When discussing the results, present tense should be used.
Of course, the case study must also include a full list of references and, if necessary, an Appendix with
additional material. In total, the number of pages should be in the range of 10 to 15 (excluding the
reference list and Appendices).
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GM1024, Behavioural Finance
Michael Kirchler, Oege Dijk
Literature
General Literature
Shleifer, Andrei. 2000. Inefficient Markets, Oxford: New York: Oxford University Press.
Kahneman, Daniel and Mark W. Riepe. 1998. Aspects of Investor Psychology: Beliefs,
Preferences, and Biases Investment Advisors Should Know About. Journal of Portfolio
Management 24 (4) 52-56
Literature on Prospect theory
Rabin, Matthew. 2000. Risk aversion and expected utility theory: a calibration theorem.
Econometrica 68(5): 1281-1292
Kahneman, Daniel and Amos Tversky. 1979. Prospect theory: an analysis of decision under
risk. Econometrica 47(2): 263-292
Kahneman, Daniel and Amos Tversky. 1991. Advances in prospect theory: Cumulative
representation of uncertainty“. Journal of Risk and Uncertainty 5(4): 297-332
Barberis, Nicholas, Ming Huang, and Tano Santos. 2001. Prospect theory and asset prices.
Quarterly Journal of Economics 116(1): 1-53
Literature on Endowment effect and the Disposition effect
Kahneman, Daniel, J. Knetsch, and Richard Thaler. 1991. Anomalies: the Endowment Effect,
Loss Aversion, and Status Quo Bias. Journal of Economic Perspectives 5: 193-206.
Shefrin, Hersh and Meir Statman. 1985. The Disposition to Sell Winners Too Early and Ride
Losers Too Long: Theory and Evidence. Journal of Finance 15: 779-790
Odean, Terrance. 1998. Are Investors Reluctant to Realize Their Losses. Journal of Finance
53 (5): 1775–1798.
Overconfidence and gender
Malmendier, Ulrike and Geoffrey Tate. 2005. CEO Overconfidence and Corporate
Investment. The Journal of Finance 60: 2661-2700
Barber, Brad and Terrance Odean. 2000. Boys will be Boys: Gender, Overconfidence, and
Common Stock Investment. Quarterly Journal of Economics, 116 (1): 261-292
Myopic Loss Aversion
Thaler, Richard. 1999. Mental accounting matters. Journal of behavioral decision
making 12(3): 183-206.
Barberis, N. and M. Huang. 2001. Mental Accounting, Loss Aversion, and Individual Stock
Returns. The Journal of Finance 56: 1247–1292.
Benartzi, Shlomo and Richard Thaler. 1995. Myopic Loss Aversion and the Equity Premium
Puzzle, Quarterly Journal of Economics 110 (1): 73-92
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GM1024, Behavioural Finance
Michael Kirchler, Oege Dijk
Gneezy, Uri and Jan Potters. 1997. An experiment on risk-taking and evaluation periods.
Quarterly Journal of Economics 112 (2): 631-645
General Literature on Market Efficiency
Barber, Brad M., Terrance Odean. 2000. Trading is hazardous to your wealth: The common
stock investment performance of individual investors. Journal of Finance 55(2): 773806.
Carhart, Mark M. 1997. On the persistence in mutual fund performance. Journal of Finance
52(1): 57-82.
Fama, Eugene F. 1991. Efficient capital markets II. Journal of Finance 66: 1575-1616.
Malkiel, Burton G. 2003. The efficient market hypothesis and its critics. Journal of Economic
Perspectives 17: 59-83.
Malkiel, Burton G. 2005. Reflections on the efficient market hypothesis: 30 years later. The
Financial Review 40: 1-9.
Literature on Expert Performance
Törngren, Gustaf, Henry Montgomery. 2004. Worse than chance? Performance and
confidence among professionals and laypeople in the stock market. The Journal of
Behavioral Finance 5(3): 148-153.
Literature on Bubbles in Asset Markets
Dufwenberg, Martin, Tobias Lindqvist, Evan Moore. 2005. Bubbles and experience: An
experiment. The American Economic Review 95(5): 1731–1737.
Haruvy, Ernan, Charles N. Noussair. 2006. The effect of short selling on bubbles and crashes
in experimental spot asset markets. Journal of Finance 61(3): 1119-1157.
Kirchler, Michael, Jürgen Huber, Thomas Stöckl. 2011. Thar she bursts – Reducing confusion
reduces bubbles. An experimental study. American Economic Review: forthcoming.
Noussair, Charles N., Stephane Robin, Bernard Ruffieux. 2001. Price bubbles in laboratory
asset markets with constant fundamental values. Experimental Economics 4: 87-105.
Xiong, Wei, Jialin Yu. 2011. The Chinese Warrants bubble. American Economic Review 101:
2723-2753.
Literature on the Value of Information
Huber, Jürgen, Michael Kirchler, Matthias Sutter. 2008. Is more information always better?
Experimental Financial markets with cumulative information. Journal of Economic
Behavior & Organization 65: 86-104.
Kirchler, Michael. 2010. Partial knowledge is a dangerous thing - On the value of asymmetric
fundamental information in asset markets. Journal of Economic Psychology 21: 643658.
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GM1024, Behavioural Finance
Michael Kirchler, Oege Dijk
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