Behavioral Finance
Overview topics per lecture. Important building blocks of decision: beliefs and preferences
Week 1:
- Lecture 1: Introduction + Judgmental Biases 1
- Lecture 2: Judgmental Biases 2
Week 2:
- Lecture 3: Preferences
- Lecture 4: Negotiation with applications to real estate
Week 3:
- Lecture 5: Biases in the wild
- Lecture 6: Biases in Real estate valuation
o Concepts
Money illusion, Nominal loss aversion, Background contrast effect
o Impact on housing decisions
Effect on willingness to accept for seller or willingness to pay for buyer
o Increase understanding empirical research on housing
Ruling out alternative explanations, thinking about data
Week 4:
- Lecture 7: Mortgage choices
o Understand mortgages (SMP vs AMP, FRM vs ARM)
o Financial Literacy (Definition, measurement, consequences)
o Mortgage choice (Financial literacy, Present bias)
o Mortgage refinancing (What is it, do people do it? Inattention vs inertia)
o Strategic default (What is it, do people do it? Morals and beliefs)
- Lecture 8: Real estate and financial markets
o Individuals and markets
o Market efficiency
o Real estate markets
Week 5
- Lecture 9: Bubbles and crashes
o Bubbles and crashes
o Empirical and experimental research
- Lecture 10: Bubbles and crashes in financial markets
Week 6
- Guest lecture: Valuers: Humans or machines
- Guest lecture: Behavioral finance in private real estate
1
,LECTURE 1: INTRODUCTION + JUDGMENTAL BIASES 1 (H1 & H2)
Market efficiency
- Efficient market fanatic:
o Security prices are always to intrinsic value
o It is impossible to accurately predict (risk adjusted) returns
- Behavioral finance fanatic
o Stock prices only depend on market psychology
o It is easy to predict stock price movements
- Sensible middle ground
o Security prices are highly correlated with intrinsic value, but sometimes
diverge to significant degree
o It is possible to predict (risk adjusted) returns, but not with great precision
How we think: two systems
System 1: intuitive and automatic (uncontrolled, unconscious, fast, skilled, effortless)
System 2: reflective and deliberate (Controlled, effortful, slow, self-aware)
Priming: a phenomenon in which a recent experience activates thoughts that
subconsciously influence future thought and actions
Three forms of overconfidence (overconfidence and optimism)
- Overprecision: excessive precision in one’s belief (overconfidence)
- Overestimation of one’s actual performance (optimism)
- Overplacement of one’s performance relative to others (above average, optimism)
LECTURE 2: JUDGMENTAL BIASES 2 (H3 & 4)
Representativeness heuristic: The likelihood of a hypothesis is evaluated by considering the
degree to which available info is representative of the hypothesis. Probability that X belongs
to set Y is judged on the basis of how similar X is to the stereotype Y (alternative formulation
or Similarity heuristic).
Monty hall problem, switch from door after you pick one and another one is opened.
Increase your chance of winning.
Law of large number: is a probability theorem that describes the result of performing the
same experiment a large number of times. According to the law, the average of the results
obtained from a large number of trials should be close to the expected value and will tend
to become closer as more trials are performed.
Law of small numbers: Judgmental bias which occurs when it is assumed that the
characteristics of a sample population can be estimated from a small number of
observations or data points.
2
, Confirmation heuristic: tendency to look for conformation of existing beliefs
- Biased search for evidence; look for information that is expected
- Biased interpretation of evidence (self-serving reasoning); accept confirming
evidence at face value
Anchoring: tendency to rely too heavily on one piece of information
- Best estimates as a starting point; insufficient adjustment
- Outcome knowledge works as an anchor, leads people to think of information that is
consistent with that anchor
Availability heuristic: frequency or probability is estimated by the ease with which instances
or associations can be brought to mind.
- Ease of recall (how well instances are stored in memory, appear more frequent)
- Retrievability (how easily instances can be searched for in memory
- Imaginability (how well instances are not stored in memory can be imagined)
Heuristic: any approach to problem solving, learning, or discovery that employs a practical
method, not guaranteed to be optimal, perfect, logical, or rational, but instead sufficient for
reaching an immediate goal
Bounded awareness: prevents us from noticing (and using) relevant data.
- Inattentional blindness (failure to see something which you are not looking for, even
when you are looking directly at it)
- Change blindness (failure to notice obvious changes in environment)
- Focalism / focusing illusion (make judgments on the basis of attention to only a
subset of available information)
o Affective forecasting error (error in predicting future emotional state)
3
Overview topics per lecture. Important building blocks of decision: beliefs and preferences
Week 1:
- Lecture 1: Introduction + Judgmental Biases 1
- Lecture 2: Judgmental Biases 2
Week 2:
- Lecture 3: Preferences
- Lecture 4: Negotiation with applications to real estate
Week 3:
- Lecture 5: Biases in the wild
- Lecture 6: Biases in Real estate valuation
o Concepts
Money illusion, Nominal loss aversion, Background contrast effect
o Impact on housing decisions
Effect on willingness to accept for seller or willingness to pay for buyer
o Increase understanding empirical research on housing
Ruling out alternative explanations, thinking about data
Week 4:
- Lecture 7: Mortgage choices
o Understand mortgages (SMP vs AMP, FRM vs ARM)
o Financial Literacy (Definition, measurement, consequences)
o Mortgage choice (Financial literacy, Present bias)
o Mortgage refinancing (What is it, do people do it? Inattention vs inertia)
o Strategic default (What is it, do people do it? Morals and beliefs)
- Lecture 8: Real estate and financial markets
o Individuals and markets
o Market efficiency
o Real estate markets
Week 5
- Lecture 9: Bubbles and crashes
o Bubbles and crashes
o Empirical and experimental research
- Lecture 10: Bubbles and crashes in financial markets
Week 6
- Guest lecture: Valuers: Humans or machines
- Guest lecture: Behavioral finance in private real estate
1
,LECTURE 1: INTRODUCTION + JUDGMENTAL BIASES 1 (H1 & H2)
Market efficiency
- Efficient market fanatic:
o Security prices are always to intrinsic value
o It is impossible to accurately predict (risk adjusted) returns
- Behavioral finance fanatic
o Stock prices only depend on market psychology
o It is easy to predict stock price movements
- Sensible middle ground
o Security prices are highly correlated with intrinsic value, but sometimes
diverge to significant degree
o It is possible to predict (risk adjusted) returns, but not with great precision
How we think: two systems
System 1: intuitive and automatic (uncontrolled, unconscious, fast, skilled, effortless)
System 2: reflective and deliberate (Controlled, effortful, slow, self-aware)
Priming: a phenomenon in which a recent experience activates thoughts that
subconsciously influence future thought and actions
Three forms of overconfidence (overconfidence and optimism)
- Overprecision: excessive precision in one’s belief (overconfidence)
- Overestimation of one’s actual performance (optimism)
- Overplacement of one’s performance relative to others (above average, optimism)
LECTURE 2: JUDGMENTAL BIASES 2 (H3 & 4)
Representativeness heuristic: The likelihood of a hypothesis is evaluated by considering the
degree to which available info is representative of the hypothesis. Probability that X belongs
to set Y is judged on the basis of how similar X is to the stereotype Y (alternative formulation
or Similarity heuristic).
Monty hall problem, switch from door after you pick one and another one is opened.
Increase your chance of winning.
Law of large number: is a probability theorem that describes the result of performing the
same experiment a large number of times. According to the law, the average of the results
obtained from a large number of trials should be close to the expected value and will tend
to become closer as more trials are performed.
Law of small numbers: Judgmental bias which occurs when it is assumed that the
characteristics of a sample population can be estimated from a small number of
observations or data points.
2
, Confirmation heuristic: tendency to look for conformation of existing beliefs
- Biased search for evidence; look for information that is expected
- Biased interpretation of evidence (self-serving reasoning); accept confirming
evidence at face value
Anchoring: tendency to rely too heavily on one piece of information
- Best estimates as a starting point; insufficient adjustment
- Outcome knowledge works as an anchor, leads people to think of information that is
consistent with that anchor
Availability heuristic: frequency or probability is estimated by the ease with which instances
or associations can be brought to mind.
- Ease of recall (how well instances are stored in memory, appear more frequent)
- Retrievability (how easily instances can be searched for in memory
- Imaginability (how well instances are not stored in memory can be imagined)
Heuristic: any approach to problem solving, learning, or discovery that employs a practical
method, not guaranteed to be optimal, perfect, logical, or rational, but instead sufficient for
reaching an immediate goal
Bounded awareness: prevents us from noticing (and using) relevant data.
- Inattentional blindness (failure to see something which you are not looking for, even
when you are looking directly at it)
- Change blindness (failure to notice obvious changes in environment)
- Focalism / focusing illusion (make judgments on the basis of attention to only a
subset of available information)
o Affective forecasting error (error in predicting future emotional state)
3
