Behavioral Finance Literature Summar

Behavioral Finance Literature Summar

Course Number: FINA 6278 - MSF Program               11 / 07 / 2012
Course title: Financial Theory and Research (Part 1 – Financial Markets and Asset Pricing)
Team Member: Haotian Lin; Nan Bai; Wenyi Gu; Yibo Zang

Summary
Standard finance (modern portfolio theory), compared with Behavioral finance, is no longer modern: dating back to the late 1950s modern portfolio theory was developed (Statman 2008) Behavioral finance offers alternative explanation for investors and markets. Behavioral finance, which has been a controversial subject and is becoming more widely accepted, is finance from a broader social science perspective including psychology and sociology (Shiller 2003). Behavioral finance helps identify the financial market’s inefficient reaction to public information, which cannot be explained by traditional financial models with assumptions such as expected utility maximization, rational investors, and efficient markets (Ritter 2003; Statman 2008). Statman (2008) compares “normal” investors and rational investors by pointing out the difference that normal investors are reluctant to realize losses since normal investors are affected by cognitive biases and emotions. Statman also compares Behavioral Portfolio Theory and Markowitz mean-variance theory. Another comparison made by Statman is between Behavioral Asset Pricing Model (BAPM) and capital asset pricing model (CAPM), stating that the asset pricing model of standard finance is moving away from CAPM toward Fama and French three-factor model, a model similar to the BAPM.
Bloomfield’s article discusses anomalies that market price deviation from action of rational traders.
The most robust anomaly is PEAD (Post-earnings-announcement drift), which is reported in 1968. PEAD describes market reaction to earnings announcement. It seems illogical that earnings instead of future cash flow could influence firm value. Chan, Frankel and Kothari (2002) find some evidence that investors underreact to a...

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