Premium Essay

Corporate Finance Paper

In: Business and Management

Submitted By maxxied
Words 1661
Pages 7
Content Behavior Biases discussed in the article 2 Other behavior biases and empirical challenges 2
Lose aversion 2
Representativeness 3
Conservatism 3
Herd behavior 4
Limits to arbitrage 5
Weak-form efficiency. 5
Semi-strong form efficiency 6
Strong-form efficiency 6
Cross country and market settings difference 6 Appendix 8 References 13

Behavior biases discussed in the article
The behavior biases that have been discussed are over-confidence and over-optimism. Those two biases lead investors to overestimate their knowledge, understate the risks and exaggerate their ability to control the situation and hence to trade excessively. Overconfidence about certain signals may cause overreaction and hence phenomena such as the book/market effect and long-run reversals whereas self-attribution allows prices to continue to overreact, creating momentum. In the longer-run there is reversal as prices revert to fundamentals.

Other behavior biases and empirical challenges
First of all, it is impractical to claim that people in general and investors in particular are fully rational. Several biases contribute to the irrationality.
Loss aversion
People don’t look at the levels of final wealth they can attain but at gains and losses relative to some reference points. They tend to avoid actions that could create discomfort over prior decisions, even though those actions may be in the individual’s best interest. Researchers have showed evidence of investors’ reluctance to sell losing positions.
Representativeness
Individuals placed too much weight on a small number of recent events. In financial markets, investors make systematic errors in assessing the probability of uncertain events.
It is found that value stocks actually outperformed glamour stocks by about 8.7% per annum possibly because most investors pursue naïve strategies by extrapolating trends, overreacting and...

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