In-class discussion 1
About Presentation and Essay

Choose a time slot and fill in the table
10 minutes presentation
would have Q & A section

Bonus credit for reading + essay


Game 1 – tea auction




Take out a piece of paper
Write down the highest price you are
willing to pay for this tin of tea.
Congratulations, you get this tin of tea
for free!
Write down the lowest price you would
accept to sell this tin of tea.
What’s your WTP and WTA





Your first price is your WTP.
Your second price is your WTA.
In traditional finance theory,
WTP=WTA=your valuation of this tin of
tea.
But, look at your numbers…
Don’t worry, people behave like you!
WTP<<WTA




Experimental economics/finance
Why WTP<<WTA? Or what’s wrong
with traditional finance theory?
Traditional finance assume ‘traders’ in
financial markets are ‘rational’.
Behavioral finance theory says ‘traders’
have emotional and behavioral patterns.
Behavioral Finance Explanation



People hate to loose more than they
like to gain.
If you get something, you soon become
attached to it, and would ‘unrationally’
sell for a higher price than your
valuation of it.
You trade ‘emotionally’!
Critics about behavioral
finance point of view


Problematic experiments
Old friend – information problem


John List
sports card trading
Sell price=WTA
Buy price=WTP
No experience traders
Experienced traders
Related behavioral finance theories


Anchoring effect
Prospect theory
back
Prospective theory



Bought at $50, now trading at $55, but tomorrow
there’s half chance it would be $50, half chance
price be $60.
-- sell now or sell later?
Bought at $50, now trading at $45, but tomorrow
there’s half chance it would be $40, half chance
price be $50.
-- sell now or sell later?
back
Situation A: sell now, Situation B: sell later
Game 2 – portfolio choice






List two kinds of soft drinks that you like.
How to spend 10 dollars on these two drinks…
‘Simple diversification’
Suppose Ames and Kansas City both issue bonds,
you can buy 10 bonds in total, how much you
would buy on each?
‘Home basis’ – insufficient diversification
‘conservation’: too much weight on ‘base’ value
Game 3 - psychology


Write down how much score you think
you could get in the exam next Friday.
‘overconfidence’


excessive trading, trade (esp. buy) too often.
When there is a loss, tend to have optimism
and wishful thinking and don’t want to ‘stop
loss’. stuborn.
Conclusion




A revolution of behavioral finance
Classical economics => Game theory =>
Behavioral economics/Finance
People on the trading floor are not as
‘rational’ as optimization machines.
Emotion, psychology, social effects come
into play.