Behavioral Economics and Finance
FINC-GB.2111.20, Spring 2016 (first half).
Venue: 44 W 4th St, room KMEC 2-80
Wed 3-5.45pm, February 3 to March 9
Instructor: Xavier Gabaix, [email protected], KMEC 9-77
Administrative assistant: Olivia Domba [email protected], KMEC (near 9-72)
Requirements: There will be 2-3 problems sets, and a short term paper. I may ask some of your
to be “scribes” for some lectures.
There is no textbook.
We shall study the main behavioral facts and models. We will discuss the empirical evidence,
but we’ll emphasize the models – especially the novel, promising approaches, rather than a
review of past successes.
Topics will include: bounded rationality, inattention, imperfect understanding of probabilities,
non-rational expectations, narrow framing, boundedly rational dynamic programming, dynamic
reference point; and more specialized finance models: limits of arbitrage, aggregate stock market
behavior, cross-sectional stock market behavior, loss aversion in stock trading, behavioral
corporate finance.
The course can be followed by students with little knowledge in finance
We’ll try to follow the following plan. Please let me know if there’s (potentially additional)
material that particularly interests you.
The latest version of the syllabus is at:
http://pages.stern.nyu.edu/~xgabaix/papers/BehavioralPhDGabaixSyllabus.pdf
1. Introduction [0.5]
2. Bounded rationality [1]
a. Facts
b. Inattention, slow adjustment
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3.
4.
5.
6.
7.
8.
c. Sparsity approach
d. Entropy-based modeling of inattention: Sims, Woodford
Dual-self models: Laibson, Gul-Pesendorfer, Fudenberg-Levine, etc. [0.5]
Loss aversion and dynamic reference point. [1]
a. Kahneman-Tversky’s basic prospect theory
b. Koszegi Rabin: endogenous reference point
c. Difficulties of dealing with small probability events:
a. Barberis, Fehr-Duda
b. Overvaluation of small stocks etc.
Formation of expectations [0.5]
a. Some facts.
b. Macro-models for expectations
c. Beshears, Laibson et al.
d. BR updating of probabilities, what comes to mind
e. Rabin, Rabin and Vayanos: law of small numbers.
Household finance [0.25]
Agents in the markets, behavioral IO [0.25]
Implications in Finance [2]
a. Limits of arbitrage, price pressure: Shleifer Vishny. Gromb Vayanos
b. The aggregate stock market
c. The cross-section of stocks
d. Propensity to sell winners rather than losers: Barberis, Odean, Hirshleifer:
reluctance to sell losers, and the modeling of that.
e. Corporate finance implications
Recommended texts (optional).
Kahneman, D. Thinking, Fast and Slow, Farrar, Straus, Giroux (2011).
Kahneman, D. and Tversky, A. (editors), Choices, Values, and Frames, Cambridge University
Press, New York, NY, (2000).
Shleifer, A. Inefficient Markets, Clarendon Lectures, Oxford; New York: Oxford
UniversityPress, (2000).
Introduction
Kahneman, D. “Maps of Bounded Rationality: Psychology for Behavioral Economics,” AER
2003.
DellaVigna, S. “Psychology and Economics: Evidence from the Field,” JEL 2009.
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Rabin, M. “Economics and Psychology,” JEL 1998.
Bounded rationality
Kahneman, D. “Maps of Bounded Rationality: Psychology for Behavioral Economics,” AER
2003.
Tversky, A. and D Kahneman “Judgment under uncertainty: Heuristics and biases”,
Science 1974
Limited attention and salience
Bordalo, P., N. Geannaioli and A. Shleifer "Salience and Consumer Choice", JPE 2013
Gabaix, X. "A Sparsity-Based Model of Bounded Rationality” Quarterly Journal of Economics,
2014.
Gabaix, X. "Behavioral Macroeconomics via Sparse Dynamic Programming," 2014.
Koszegi, B. and A. Szeidl A Model of Focusing in Economic Choice QJE 2013
Mental accounts and decision vs experienced utility
Farhi, E. and Xavier Gabaix “Optimal Taxation with Behavioral Agents”
https://www.dropbox.com/s/1r02vbs3nq0q9s4/BR-Taxes.pdf
Inattention, slow adjustment
Fernando Alvarez & Luigi Guiso & Francesco Lippi, 2012. "Durable Consumption and Asset
Management with Transaction and Observation Costs," American Economic Review, American
Economic Association, vol. 102(5), pages 2272-2300, August.
Gabaix, X and D Laibson "The 6D Bias and the Equity Premium Puzzle", with David
Laibson, NBER Macroeconomics Annual, 2002, vol. 16, pp. 257-312.
Mankiw, N. Gregory, and Ricardo Reis. "Sticky information versus sticky prices: a proposal to
replace the New Keynesian Phillips curve." The Quarterly Journal of Economics 117.4 (2002):
1295-1328.
Reis, Ricardo. "Inattentive consumers." Journal of Monetary Economics 53.8 (2006): 1761-1800.
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Entropy-based rational inattention
Sims, C. “Rational Inattention and Monetary Economics,” Handbook of Monetary Economics
2010.
Sims, C. and Matejka, F. “Discrete Actions in Information-Constrained Tracking Problems,”
CERGE-EI June 2011.
Woodford, M. “Inattentive Valuation and Reference-Dependent Choice,” February 2012.
Veldamp, L. Information Choice in Macroeconomics and Finance, 2012 (book).
Please also look for updates from Andrew Caplin’s web page.
Some other approaches
Esponda, I. “Behavioral equilibrium in economies with adverse selection,” AER 2008.
Jehiel, Philippe. Analogy-Based Expectation Equilibrium JET 2005
Rubinstein, A. Modeling Bounded Rationality, MIT Press 1998.
Dual Self Models
Laibson, D. “Golden eggs and hyperbolic discounting”, QJE 1997.
Gul, F. and Pesendorfer, W. “Self-control and the theory of consumption,” October 2000.
O'Donoghue, T. and Rabin, M. “Doing It Now or Later”, AER, 1999.
Bernheim, B.D. and Rangel, A. “Addiction and Cue-Triggered Decision Processes,” AER 2004.
Benabou, R. and Tirole, J. “Willpower and Personal Rules,” JPE 2004.
Brocas, I. and Carillo, J. “The Brain as a Hierarchical Organization,” AER 2008.
Fudenberg, D. and Levine, D. "A Dual-Self Model of Impulse Control," AER 2006.
Fudenberg, D. and Levine, D. "Timing and Self-Control," ECMA 2012.
Attitudes towards Risk and reference-dependence
Kahneman, D., Tversky, A. “Prospect theory: An analysis of decision under risk,” ECMA 1979.
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Erev, Ert and Plonsky ``From Anomalies to Forecasts: A Choice Prediction Competition for
Decisions under Risk and Ambiguity”
http://departments.agri.huji.ac.il/economics/teachers/ert_eyal/CPC2015.pdf
Rabin, M. “Risk Aversion and Expected-Utility Theory: A Calibration Theorem,” ECMA 2000.
Tversky, A. and Kahneman, D. “Advances in Prospect theory: Cumulative representation of
uncertainty”, Journal of risk and uncertainty, v. 5 (4), 1992 (not available online). CVF 3.
Bordalo, P., Genaioli, N., and Shleifer, A. "Salience Theory of Choice Under Risk,” QJE 2012.
Reference point and its dynamics
Koszegi, B. and Rabin, M. “A Model of Reference-Dependent Preferences,” QJE 2006.
Koszegi, B. and Rabin, M. “Reference-Dependent Risk Attitudes,” AER 2007.
Koszegi, B. and Rabin, M. “Reference-Dependent Consumption Plans,” AER 2009.
Pagel, M. A News-Utility Theory for Inattention and Delegation in Portfolio Choice (2014)
Andries, M. and V. Haddad Information Aversion 2014
The formation of expectations
Greenwood, R. and Shleifer, A. "Expectations of Returns and Expected Returns." October 2012.
RFS 2014
http://scholar.harvard.edu/files/shleifer/files/expectations_of_returns_public._feb_2014_print.pdf
Barberis, Nicholas, Robin Greenwood, Lawrence Jin, and Andrei Shleifer "X-CAPM: An
Extrapolative Capital Asset Pricing Model", JFE 2015
Benjamin, Daniel J., Matthew Rabin, and Collin Raymond (2013). “A Model of Non-Belief in
the Law of Large Numbers.” WP.
Benjamin, Daniel J., Don Moore, and Matthew Rabin (2013). “Misconceptions of Chance:
Evidence from an Integrated Experiment.” Cornell University mimeo, March.
Evans, G. and Honkapohja, S.. “Learning and Macroeconomics,” ARE 2009.
Fuster, A., Hebert, B. and Laibson, D. “Natural Expectations, Macroeconomic Dynamics, and
Asset Pricing,” NBER August 2011.
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Woodford, M. “Macroeconomic analysis without the rational expectations hypothesis,” Annual
review of economics, 2013.
Rabin, M. and Vayanos, D. "The Gambler's and Hot-Hand Fallacies: Theory and
Applications", RES 2010.
Rabin, M. "Inference by Believers in the Law of Small Numbers," QJE 2002.
Griffin, Dale, and Amos Tversky. "The weighing of evidence and the determinants of
confidence." Cognitive psychology 24.3 (1992): 411-435.
Household finance
Agarwal, S., Driscoll, J., Gabaix, X., and Laibson, D. "The Age of Reason: Financial Decisions
over the Life-Cycle and Implications for Regulation," BPEA 2009.
Campbell, J., Calvet, L., Sodini, P. “Down or Out: Assessing the Welfare Costs of Household
Investment Mistakes,” JPE 2007.
Choi, J., Laibson, D., Madrian, B. "Why Does the Law of One Price Fail? An Experiment on
Index Mutual Funds," RFS 2010.
Lusardi, Annamaria and Olivia S. Mitchell “The Economic Importance of Financial Literacy:
Theory and Evidence” JEL 2014.
Madrian, B. and Shea, D.F. “The Power of Suggestion: Inertia in 401(k) Participation and
Savings Behavior,” QJE 2001.
Annamaria Lusardi’s facts: http://www.dartmouth.edu/~alusardi/pub.html
Behavioral agents in the market
Della Vigna, S. and Malmendier, U. “Contract Design and Self- Control: Theory and
Evidence,” QJE 2004.
Della Vigna, S. and Malmendier, U. “Paying Not to Go to the Gym.” AER 2006.
Gabaix, X. and Laibson, D. “Shrouded Attributes, Consumer Myopia, and Information
Suppression in Competitive Markets,” QJE 2006.
Koszegi, B., Heidhues, P. and Murooka, T. “The Market for Deceptive Products,” Working
Paper May 2012.
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Brown, J., Hossain, T. and Morgan, J. “Shrouded Attributes and Information Suppression:
Evidence from the Field,” QJE 2010.
Spiegler, Rani. Bounded Rationality and Industrial Organization
Finance models
Limits of arbitrage
Inefficient markets, Ch. 2, 4.
Shleifer, A. and Vishny, R. “The Limits of arbitrage”, JOF 1997.
Gromb, D. and Vayanos, D. “Limits of Arbitrage: The State of the Theory,” ARFE 2010.
Garleanu, N. and Pedersen, L.N. “Margin-Based Asset Pricing and Deviations from the Law of
One Price,” RFS 2011.
Full-Scale macro / finance models
Barberis, N., Huang, M. and Santos, T. “Prospect Theory and Asset Prices,” QJE 2001.
Andries, Marianne. “Consumption-based Asset Pricing with Loss Aversion,” 2013.
Gabaix, X. "Variable Rare Disasters: An Exactly Solved Framework for Ten Puzzles in MacroFinance," QJE 2012.
Benartzi, S. and R. Thaler. “Myopic Loss Aversion and the Equity Premium Puzzle,” QJE 1995
Barberis, Greenwood, Jin, Shleifer, "X-CAPM: An Extrapolative Capital Asset Pricing Model",
JFE 2015
Gabaix, X. and Matteo Maggiori “International Liquidity and Exchange Rate Dynamics”, QJE
2015, especially section II.B on the modelling of financiers.
Vayanos, D. and P. Woolley An Institutional Theory of Momentum and Reversal, Review of
Financial Studies, 2013, 26, 1087-1145.
The cross-section of stocks
Fehr-Duda, H. and Epper, T. “Probability and Risk: Foundations and Economic Implications of
Probability-Dependent Risk Preferences,” ARE 2012.
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Barberis, N. and Huang, M. "Stocks as Lotteries: The Implications of Probability Weighting for
Security Prices," AER 2008.
Barberis, N., Huang, M. and Thaler, R. "Individual Preferences, Monetary Gambles, and Stock
Market Participation: A Case for Narrow Framing," AER 2006.
Bordalo, P., Gennaioli, N. and Shleifer, A. "Salience and Asset Prices," AER PP 2013.
Propensity to sell winners
Odean, T. “Are Investors Reluctant to Realize Their Losses?” JOF, 1998.
Barberis, N. and Huang, M. "Realization Utility," JFE 2012.
Ben-David I. and Hirshleifer, D. “Are Investors Really Reluctant to Realize their Losses?
Trading Responses to Past Returns and the Disposition Effect,” RFS 2012.
Behavioral corporate finance
Baker, M. Wurgler, J. “Behavioral Corporate Finance: An Updated Survey,” HEF 2012.
Potential Other topics
Duffie, D. ``Presidential Address: Asset Price Dynamics with Slow-Moving Capital”, JOF 2010.
http://www.darrellduffie.com/uploads/pubs/DuffieAFAPresidentialAddress2010.pdf
Post-earnings announcement drift
Inattention: Dellavigna Pollet, Cohen et al.
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