IOP 3708 NOTES

• Theories and definitions of behavioural finance and behavioural economics and Neuroeconomics are researched to explain investment behaviour and the challenges to market efficiency • Standard economic theory and behavioural economic theory are compared with examples. Prospect theory, framing and mental accounting are defined, described and applied to explain behaviour • Systematic biases, heuristics, overconfidence, emotional foundations and values distortion are defined. How these cause investors to behave irrationally or contra to their espoused values are discussed with reference to recent events • The emerging field of Neuroeconomics, how it relates to behavioural finance and what contributions it could make • The outcome will be assessed by the student’s ability to demonstrate how psychological concepts, principles and theories affect investment decisions in written assessments and an open book exam where integration and application is assessed. Specific Outcome 1 Differentiate the following concepts (5 marks each) Prospect - Prospect in economics terms refers to a series of wealth outcomes or advancements in profits which are associated with a certain probability. - To which the probability in this case is the likelihood that something may or may not occur. Probability distribution - Statistically, probability distribution refers to the allocation of those wealth outcomes that is then linked to each outcome therefore indicating the probabilities linked from lowest to highest expected values from which the investor can chose from. Risk - Risk in financial terms can be described as a threat to loss. - When an investor is faced with risk, it is important to know and select from a list of probabilities to measure their loss in a case where the prospect responds negatively and have a plan on how to mitigate such outcomes - This is because the expected return might turn to be lower than the actual return promised by a particular asset. Uncertainty - Uncertainty simply refers to an outcome that is completely unknown and this is when the wealth outcomes cannot be assigned to any probability. - Here there are probabilities that can be linked to any outcome and this can create a negative investor confidence in them wishing to buy such assets. Utility function - Utility function in this case refers to identification of preference to potential outcomes according to the expected returns that will bring about satisfaction to the investor. - Utility measures to size of the cash flow or wealth outcome linked to their probabilities from least desired to the most preferred from the distribution list or table where investors can make their choices relative to the available probabilities. Expected utility -