Behavioural Finance

The study of Behavioural finance is relatively new and examines how individuals' attitudes and behaviour affect their financial decisions and financial markets. 'Behavioural Finance' builds on existing knowledge and skills that students have already gained on an introductory finance or corporate finance course. The primary focus of the book is on how behavioural approaches extend what students already know. At each stage the theory is developed by application to the FTSE 100 companies and their valuation and strategy. This approach helps the reader understand how behavioural models can be applied to everyday problems faced by practitioners at both a market and individual company level. The book develops simple formal expositions of existing attempts to model the impact of behavioural bias on investor/managers' decisions. Where possible this is done grounding the discussion in practical, numerical, examples from the financial press and business life.

Preface. Acknowledgements. 1 Introduction. 1.1 Illustration and Structure. 1.2 Finance Theory as an Engine not a Camera. 1.3 Rebuilding on New Foundations. 1.4 Challenging the Classical Assumptions of Finance. 1.5 Modelling Behavioural Aspects of Finance. 1.6 The Structure of the Book. Appendix: A Financial Tsunami. Notes. References. Part I FOUNDATIONS. 2 Financial Decision Making. 2.1 Illustration and Structure. 2.2 The Expected Utility Rule. 2.3 Expected Utility Theory: Simple But Untrue? 2.4 Frames for Actions, Contingencies and Outcomes. 2.5 Conclusion and Summary. Questions. Notes. References. 3 Discounting. 3.1 Illustration and Structure. 3.2 The Discounted Utility Model. 3.3 How and Why Discount Rates Vary. 3.4 Investment Behaviour When Discount Rates are Declining: Investing in a 'Golden Egg'. 3.5 Hyperbolic Discount Factors. 3.6 Valuation by Using the Matching Law. 3.7 How Investment Decisions are Made When Discount Factors Decline Over Time. 3.8 Conclusion and Summary. Appendix: Timely Choice: Euler Equations - Dynamics and Inter-Temporal Choice. Questions. Notes. References. 4 Learning. 4.1 Illustration and Structure. 4.2 Rational Learning. 4.3 Do We Learn the Bayesian Way? 4.4 Over Inference and the Law of Small Numbers. 4.5 Disagreement, Tastes and the Capital Asset Pricing Model. 4.6 Conclusion and Summary. Appendix: Case Study - Baseball the Bayesian Way. Questions. Notes. References. 5 Bubbles. 5.1 Illustration and Structure. 5.2 Tulipmania and the Didactic Value of Bubbles. 5.3 The Regulatory Origins of the Most Recent Bubble. 5.4 Bubbles: Past, Present and Future. 5.5 The 1929 Stock-Market Crash. 5.6 Should Government Burst the Bubble? 5.7 Conclusion and Summary. Appendix: Tulips as Assets and Art. Questions. Notes. References. Part II ASSET PRICING. 6 Noise Traders. 6.1 Illustration and Structure. 6.2 The De Long, Shleifer, Summers and Waldmann Model. 6.3 Can Investors Get Emotional? 6.4 Conclusion and Summary. Questions. Notes. References. 7 Overconfidence and Optimism. 7.1 Illustration and Structure. 7.2 A Model of Trading Amongst Optimistic Investors. 7.3 Do Investors Trade Too Much? 7.4 Conclusion and Summary. Appendix A: Hubris at Work: The AOL-Time Warner Merger. Appendix B: Derivation of Results in Odean's Model. Questions. Notes. References. 8 Asset Pricing under Prospect Theory. 8.1 Illustration and Structure. 8.2 The Basics of Prospect Theory. 8.3 Does Prospect Theory Work? 8.4 The Cumulative Probability Version of Prospect Theory. 8.5 Does Cumulative Prospect Theory Work? 8.6 Conclusion and Summary. Appendix: CARA Utility. Questions. Note. References. 9 Overreaction and/or Underreaction. 9.1 Illustration and Structure. 9.2 The DHS Model. 9.3 No News Is ...? 9.4 Conclusion and Summary. Questions. Note. References. 10 Momentum. 10.1 Illustration and Structure. 10.2 Grinblatt and Han's (2005) Model. 10.3 What Drives Stock-Market Momentum? 10.4 What Causes PEAD? 10.5 Conclusion and Summary. Questions. Note. References. 11 Herding. 11.1 Illustration and Structure. 11.2 The FSS Model. 11.3 Conformity as a Force for Social Good and Evil. 11.4 Conclusion and Summary. Appendix: The United States vs. Microsoft. Questions. Note. References. 12 Insider Trading. 12.1 Illustration and Structure. 12.2 Insider Trading Here for Better or Worse. 12.3 The Hirshleifer, Subrahmanyam and Titman Model. 12.4 Insider Trading, Stock Options and the Construction of Earnings. 12.5 Insider Trading and its Consequence for Outsiders. 12.6 Conclusion and Summary. Appendix A: Why Don't Later Informed Traders Trade in Period 1 in the HST Model? Appendix B: Deriving Investor Demands as Linear Functions of the Random Variables Underpinning the Model. Questions. Notes. References. 13 Equity Premium Puzzle. 13.1 Illustration and Structure. 13.2 The Puzzle. 13.3 Loss Aversion in a Reference-Dependent Utility Model. 13.4 Conclusion and Summary. Questions. References. Part III CORPORATE FINANCE. 14 Incorporation. 14.1 Illustr

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