City University Business School
Behavioural Finance
by
Gulnur Muradoglu
Aims of Course
The course aims to introduce students to the key insights in ``behavioural finance'', an emerging
body of knowledge that attempts to understand the effect of cognitive bias and social psychology
on asset valuation and hence pricing. Students are motivated to grasp these ideas by application in
trading games, forecasting exercises and computer simulations designed to record the degree of
bias in responses and suggest techniques to combat such bias.
Content of Course
The course will start with a review of modern theory of finance on asset valuation. The experience
of practitioners on the use of modern finance theory and related problems/possible solutions will be
discussed. The course is expected to cover the major issues in behavioural finance. These include
biases, which frequently occur in financial decision-making such as optimism, mental framing,
over-reaction, trend-chasing, conservatism and anchoring of expectations. Emphasis will be made
on related work in psychology in terms of several theories of human behaviour that have policy
implications, in Finance.
Course Assessment:
The course assessment will be as via a take-home examination. The participants will be asked to
design either (a) an experiment or (a) an empirical study that will investigate any bias that could be
encountered in financial decision making. The participants are not expected to carry out the
experiment or the empirical work, but they are required to design the experimental or the empirical
test of their choice. The research question and its significance in financial literature must be given
explicitly. The details of experimental or empirical design must be given with reference to the
research question. Finally, the implications of possible results must be discussed.
Reference:
Forbes, W., Behavioural Finance, John Wiley and Sons, West Sussex, UK, 2009.
Montier, J. Behavioural Finance: Insights into Irrational Minds and Markets, John Wiley
and Sons, West Sussex, UK, 2002.
Shefrin, H., A behavioural Approach to Asset Pricing, Elsevier Academic Press, London,
UK, 2005.
Shiller, R., The Subprime solution, Princeton University Press, 2008.
Shiller, R., The New Financial order: Risk in the 21st Century, Princeton University Press,
New Jersey, USA, 2003.
Shefrin, H., Beyond Greed and Fear: Understanding Behavioural Finance and the
Psychology of Investing, McGraw Hill, London, 1999.
Thaler, R.H., Advances in Behavioural Finance, Russell Sage Foundation, NY, 1993
Thaler, R.H., Quasi Rational Economics, Russell Sage Foundation, NY, 1991.
Thaler, R.H., Sunstein, C. Nudge: Improving decisions about health, wealth and happiness,
Yale University Press, 2008
Course Outline
Week
1
Lecture Topic
Introduction
Assignment
Fundamentals of Asset Pricing
Fama, E. “Efficient Capital Markets II”, Journal of Finance, 46, 1575-1617, 1991.
DeBondt, W., Forbes, W., Hamalainen, P., Muradoglu, G. “What can behavioural Finance teach us
about finance?” Qualitative Research in Financial Markets, 2010, 2(1), p.29-36.
DeBondt, W. Muradoglu, G., Shefrin, H. Staikouras, S. K., “Behavioural Finance: Quo Vadis?”,
Journal of Applied Finance, 2009, 18(2) p.7-21.
Muradoglu, G., “The Banking and Financial Crisis of 2008: What is real and what is behavioural?,
Qualitative Research in Financial Markets, 2010, 2/1, p.1-15.
Daniel, K., Hirshleifer, D., Teoh, S.H., “Investor Psychology in Capital Markets: Evidence and Policy
Implications”, Journal of Monetary Economics, 49, 139-209, 2002.
2
Biases In Financial Decision Making
Forecasting Game 1
Kahneman, D. and Riepe, M.W., “Aspects of Investor Psychology”, The Journal of Portfolio Management,
52-65, Summer, 1998.
DeBondt, W.F.M. and Thaler, R. “Does the Stock Market Overreact?”, The Journal of Finance, 40, 793-805,
1985.
Coval, J.D. and Shumway, T., (2005) “Do Behavioral Biases Affect Prices? Journal of Finance 60(1) 1-34.
Carhart, M. M. (1997) “Persistence In Mutual Fund Performance”, Journal of Finance, 57-82.
3
Prospect Theory and Loss Aversion
Forecasting Game 2
Shefrin, H.M., and Statman, M. “The disposition to sell winners too early and ride losers too long: Theory
and Evidence” Journal of Finance, 15/3 , 777-790, 1985.
Kahneman, D and A. Tversky, “Prospect Theory: An analysis of decision under risk”, Econometrica, 47,
263-292, 1979.
Frazzini, A. (2006) The Disposition Effect and Underreaction to News, Journal of Finance, 61(4) 20172046.
Haig, M.S. and List, J.A., “Do Professional Traders Exhibit Myopic Loss Aversion? An Experimental
Analysis The Journal of Finance, 40(1) 2005, 523-534.
4
Mental Framing
Forecasting Game 3
Thaler, R.H., “Mental Accounting Matters”, Journal of Behavioural Decision Making, 12, 183-206, 1999.
Thaler, R.H., “Homo Economicus to Homo Sapiens” Journal of Economic Perspectives, 14/1, 133-141,2000.
Grinblatt, M. and Han, B. “Prospect theory, mental accounting, and momentum” Journal of Financial
Economics 78, 2005, 311–339.
Barber, B.M. and Odean, T. (2000) “Trading is Hazardous to Your Wealth: The Common Stock Investment
Performance of Individual Investors” Journal of Finance 55(2), 773-806.
5
Heuristics and Biases in Financial Forecasts
Feedback on Forecasts
Muradoglu, G. “Portfolio Managers’ and Novices Forecasts of Risk and Return, Journal of Forecasting, 395416, 2002.
Muradoglu, G. and Önkal, D."An Exploratory Analysis of Portfolio Managers' Probabilistic Forecasts of
Stock Prices". Journal of Forecasting. Vol. 13, 1994, 565-578.
Bernhardta, D and Campellob, M, Kutsoati, E., (2006) “Who herds?” Journal of Financial Economics 80
657–675
Clement, M.B., and Tse, S.Y., (2005) “Financial Analyst Characteristics and Herding Behavior in
forecasting, The Journal of Finance, 40(1), 307-341.
6.
Conclusions
Coursework presentations and feedback on coursework