FINA/MANA 7397: Behavioral Finance

Summer I, 2009

(Page last updated 3/25/2009)

    The deliverables for the class are reading four books, taking three exams, producing two individual projects, and producing a team project (with two other team members).  I have a busy summer session planned for us. It will be worth all of your time, money and effort.  (Every time I teach this class, four or five students tell me after it ends that it was the best class of their college career. )

The day-by-day assignments can be found after the course overview materials below.

 

  

 My Teaching Philosophy and This Class

My teaching philosophy focuses on learning by doing. Thus, we will spend as little time as possible with formal lecture and as much time as possible with the class actively involved in exercises and activities that promote learning. An important learn-by-doing component of the class will be a team project. In teams, class members will collect decision data for a topic of their choice, analyze, and present the results in an oral presentation and in a written report at the end of the term. There will be three essay exams which will focus on application of the course theories and concepts to new situations.  

My Pledge

Time will pass quickly during class. We will study many interesting theories and concepts that you can apply to your own investments and those of others. During the many exercises and activities I have planned, you will make hundreds of decisions with money riding on them.

The Content of the Class

          For a good overview of the field, skim Nofsinger’s The Psychology of Investing (the publication information is listed below).

          The main purpose of the class is to provide you with conceptual tools that will help you to accumulate wealth.  Because the stock market is an important venue for building wealth, our focus will be on a) operating characteristics of the stock market and b) operating characteristics of you as a decision maker in that context.  We will examine four major questions.

          1) Can the stock market be predicted?  Long term success is most relevant. It is extremely difficult to accurately predict the market long term.

          2) Can one identify people or techniques that can predict the market?  Due to great variations in market returns, evaluation of predictors and prediction methods is difficult. 

          3) What decision processes are used by investors and how do they lead investors astray?  We are “programmed” to seek patterns in information and to extrapolate from limited information.  We find it easy to believe that we have found “the method.”  Unfortunately, the market is extremely unforgiving making it is very risky to believe that you can predict the stock market when you cannot.

     On a more formal level, behavioral finance is a) the study of how systematic departures from rationality affect financial markets and the welfare of investors and b) a new field focused on the interface between finance and the fields of psychology and management. Three general topics comprise the field. The first major topic is the decision behavior of individuals acting within a market context such as the stock market. A major focus is systematic errors that investors make. The second is application of psychological principles to predict market movement. Third are real world market anomalies, which are difficult to explain with market models such as the efficient market hypothesis. The emphases for the class are a) understanding individual decision behavior within a market context (85%), and b) applying psychological principles to modify parameters within market models (5%), and c) market anomalies (10%).

          4) How can retirement systems be designed to minimize organizational costs and maximize employee welfare?

 Behavioral decision theory is the psychology of judgment and decision making which has developed as a field of study over the last 50 years. It is an important foundation of behavioral finance which researchers has drawn on heavily as they have attempted to explain the behavior of the market and individual investors.

Books for the Class (all are available used and in paperback from Amazon.com)

Ferri, Richard  (2006). All about index funds.  New York:  McGraw-Hill.  Although there are many typos in the book (including one on the front cover), this book is an excellent introduction to index funds.

Malkiel, B. G. (2007) A random walk down Wall Street (9th Ed.). New York: W.W. Norton and Company. An excellent presentation of the efficient market hypothesis by a crown prince of market efficiency. Pay special attention to the thorough discussion of market bubbles. 

Nofsinger, J. R. (2008) The psychology of investing (3rd Ed.). Upper Saddle River, NJ: Prentice Hall. A primer on behavioral finance.

Stanley, T., & Danko, W. (1996) The millionaire next door. Marietta, GA: Longstreet Press. A best seller since it was published, this book will provide us with a useful introduction to the class.

 Laboratory Fee

There will be a $9.00 laboratory fee for the class which will be collected by the instructor. This is important because a core tenet of behavioral finance is that decisions be made with money riding on the outcome. A variety of classroom games and auctions will be played for real money. You must have paid the lab fee to play. You may win or lose money during these demonstrations. You will be paid your winnings and pay for your losses from the laboratory fees according to the rules of the demonstration. During the class, more money will be paid out to students than is paid in by them. However, some students will pay more money than they receive and some demonstrations will result in net losses to students in aggregate. If you miss an game/exercise, you forfeit the fee for that particular exercise to the class pool. For example, if you miss the auction/stock market exercise, the $5 from your lab fee which goes toward the auction will be forfeited to the class pool.

 

Assignment for Tuesday, June 2

    Read the introduction and chapters 1, 2, 3, 5, and 8 in The Millionaire Next Door

    Go to Dave Ramsey’s website (https://www.daveramsey.com/elphub/index.cfm?event=showArchives) and listen to an hour of a Friday show from his archives (Friday is when listeners call in and celebrate being debt free).

    Go to PBS (http://www.pbs.org/wgbh/pages/frontline/retirement/) and watch the one hour show, “Can you afford to retire?

    Download the note packet which will be available the week before class.

 

 

 

 

 

 

 

 

 

 

 

 

 

Below are the assignments from summer, 2008 when I taught the class during the 6 week session (which lasted only 4.5 weeks). The items listed below will be expanded to fill the nine week session (which lasts 6.5 weeks).

 

1) Download the course note packet from here:  7397.NOTES.Summer.2008.doc.

2) Read over pages 7-22 of the notes for Wednesday.  Most of the lens model concepts will not make sense at this point.  Reading about them will begin to familiarize you with the terms.  Things will fall into place as we go along.

3) Download and read the instructions for the stock market simulation:  auction instructions.doc

Assignment for Sunday, June 8

Horse race judgments are due by 6 p.m.

Assignment for Monday, June 9

Malkiel quiz over Malkiel Chapters 1,2,3,4,5,11,12

Utility project is due.

Prepare problems 2,5,6 pp. 30-36

Skim notes pp. 38-51

Assignment for Wednesday, June 11

Ferri quiz over chapters 1,2,3,12,13,14,15

Prepare problems 7,8,9,10,11,12 pp. 30-36

Assignment for Saturday, June 14

Horse race project is due by 5 p.m.  These assignments will be graded by Sunday 6/15 at 5 p.m. and grades will be posted on WebCT.  I will email anyone who scored below a 20 and tell them what they missed.

Assignment for Monday, June 16

Exam 1 (5:50 p.m. to 7:30 p.m.)

Prepare problems 1 and 2, pp 49-51 and problems 1, 2, and 3 p. 62.

Exam Preparation 

 

Below are comments from three former students (all of whom did well) regarding testing in my classes:

 

-You can not just memorize facts, you must be able to apply the theories.

- The exams are not difficult, but they are not easy, you must be able to apply the theories

- All the examples that were discussed in class should be thoroughly understood.

- Your hand will probably fall off by the time you are done :)

 

With regard to your tests, I would say that they are definitely fair. 

Thinking about studying for them, the most helpful thing I found was - I believe this was your suggestion - to go through and outline your notes. 

Then, once I had a handle on the material itself, I would go through your in-class questions section by section and answer, using the concepts from the outline.  The examples/situations from the questions to me were really the most helpful part of studying, since they focused on application of the concepts vs. just memorization.  Also, I found that studying with other people was helpful - literally going thru the questions one by one as a small group and answering/discussing out loud... This helped flush out any lingering questions/misunderstandings that any of us may have had. 

 

Step 1:  Understand all of the concepts.  If you missed class, this will be very difficult.  If you don't understand the class notes completely, ask Dale or ask a classmate.  Also use the textbook or Internet as alternative sources.  If you don't understand the concepts, the next steps will not help you, since Dale's exams require you to be able to apply concepts learned in class.

Step 2: Be able to name all of the concepts that will be on the exam.  This will require a little memorization.

Step 3: Memorize all of the key points for each concept.  This requires a lot of memorization and I found note cards to be helpful.  (Note cards are also great if you find yourself in line at the grocery story.)

Step 4: At the beginning of the exam, before you look at any questions, write down all of the key concepts as well as the key points for each concept.  This way, you will have all of the answers to the exam in front of you, and the "only" thing you need to do is make sure you use the right concept with the right question.  Having a list of the "answers" also allows you to use process of elimination if you get stuck on a question.

The exams are fair, and the questions are similar to questions in the class handout (note packet).

 

Assignment for Wednesday, June 18

 

Prepare problems 4, 5, and 6 pp. 63-64.