Behavioral Finance
Economics 437
Behavioral Finance
Biases
Feb 25 2016
Imagine that one in every thousand athletes use steroids. Imagine also that the test
for steroids has a 5 % false positive rate. If a particular athlete tested positive for
steroids what is the probability that that athlete was a steroid user
A. [0.001]
B. [0.020]
C. [0.65]
D. [0.95]
Behavioral Finance
Biases
Feb 25 2016
A Dilemna
 US is preparing for the outbreak of an unusual foreign disease
which is expected to kill 600 people

Program A: 200 people will be saved

Program B: 1/3 probability that 600 will be saved; 2/3
probability that no one will be saved
Behavioral Finance
Biases
Feb 25 2016
Another Dilemna
 Program C: If adopted 400 people will die
 Program D: 1/3 probability that no one will die
and 2/3 probability that 600 people will die
Behavioral Finance
Biases
Feb 25 2016
Concurrent Decisions:
 Choose Between:


A: A sure gain of $ 240
B: 25 % gain of $ 1,000 and 75 % chance to
gain nothing
 Choose Between:


C: A sure loss of $ 750
D: 75 % chance to lose $ 1,000 and 25 %
chance to lose nothing
Behavioral Finance
Biases
Feb 25 2016
Oops
 Choose Between:
A: A sure gain of $ 240
 B: 25 % gain of $ 1,000 and 75 % chance to gain nothing
 Choose Between:
 C: A sure loss of $ 750
 D: 75 % chance to lose $ 1,000 and 25 % chance to lose nothing

 If you chose A & D:

25 % gain of $ 240 and 75 % chance to lose $ 760
 {B & C} dominates {A & D}

25 % gain of $ 250 and 75 % chance to lose $ 750
Behavioral Finance
Biases
Feb 25 2016
Make a choice
You have been given $ 2,000
 Choose between A and B


A: 50 % chance of losing $ 1,000 or receiving
nothing
B: A sure loss of $ 500
Behavioral Finance
Biases
Feb 25 2016
Make a choice
You have been given $ 1,000
 Choose between C and D


C: 50 % chance of winning $ 1,000 or
receiving nothing
D: A sure $ 500
Behavioral Finance
Biases
Feb 25 2016
Make a choice
 Choose between A and B (assuming you have been given $ 1,000)


A: 50 % chance of winning $ 1,000
B: A sure gain of $ 500
 Choose between C and D (assuming you have been given $ 2,000)


C: 50 % chance of losing $ 1,000 or receiving nothing
D: A sure loss of $ 500
A and C are identical
Behavioral Finance
B and D are identical
Biases
Feb 25 2016
Another Choice
 Which would you prefer?


A: Certain gain of $ 30
B: 80% chance to win $ 45 and 20% chance to
win $ 0
Behavioral Finance
Biases
Feb 25 2016
Another
 C: 25 % chance to win $ 30 and 75 % chance
to win nothing, or
 D: 20 % chance to win $ 45 and 80 % chance
to win nothing
Behavioral Finance
Biases
Feb 25 2016
And again
 A Two Stage Game


75 % chance of ending the game winning
nothing and 25 % chance of going to second
stage of the game
At second stage


Behavioral Finance
R:Certain win of $ 30, or
S:80% chance to win $ 45 and 20% chance to
win nothing
Biases
Feb 25 2016
Mental Accounting
 Sale of two items
$ 150 Jacket
 $ 5 calculator
 Will you go to the store two blocks away to buy $
145 jacket?
 To get the calculator for free
 Get a free ticket to go to the play. Lose the ticket that
morning, will you go?
 Find $ 1,000 on the street. Get a $ 1,000 unexpected
dividend on your stock.

Behavioral Finance
Biases
Feb 25 2016
First Mid Term – Thursday, March
3, 2016
 During regular class time; in Wilson
Auditorium
 Covers:

Lectures and Reading up to and including Feb
18, 2016



Behavioral Finance
Subjects: EMH, Noise Trading and including readings
from Malkiel, Shiller, Fama, Shleifer (chapters 1 and 2),
Burton-Shah, pp. 1-51.
Utility lectures: Feb 16 and Feb 18
All lectures and powerpoint presentations up to and
including Feb 18, 2016
Biases
Feb 25 2016
Format of Mid-Term
 Five or six questions
 First question:


8 to 12 identifications
Answers need to be very precise to
identification question
 Four to five additional questions


Tend to be essay
Could be problems as well
 Nothing is ruled out
Behavioral Finance
Biases
Feb 25 2016
The End
Behavioral Finance
Biases
Feb 25 2016