Three concepts of behavioral finance which is demonstrated in the comments of Pierce and explain each concept. Discuss how these concepts will be challenged by the investor practicing traditional or standard finance. Introduction: Overconfidence refers to the behavioral bias which stand dangerous, especially in the financial markets. It was assumed that overconfidence does not impact the investor, however the more the investor is overconfidence the more it will impact. In other words, it depicts underestimation of risk, overestimation of knowledge and exaggerating the ability of controlling the events. Loss aversion reflects the tendency of the people to avoid incurring losses for earning equivalent amount of gains. For instance the investors that possess behavioral characteristics of loss aversion find it optimum to find $5 but not to lose $5. This principle also stands important in economics domain. Reference point stands to be one of the keys in the world of behavioral finance to understand that the outcomes are evaluated by the people in relation to a relative point and then the classification of loss and gain is done.

Question

Want to see the full answer?

Answer 1

Question

Chapter 12, Problem 5CP

Summary Introduction

To determine:

Three concepts of behavioral finance which is demonstrated in the comments of Pierce and explain each concept. Discuss how these concepts will be challenged by the investor practicing traditional or standard finance.

Introduction:

Overconfidence refers to the behavioral bias which stand dangerous, especially in the financial markets. It was assumed that overconfidence does not impact the investor, however the more the investor is overconfidence the more it will impact. In other words, it depicts underestimation of risk, overestimation of knowledge and exaggerating the ability of controlling the events.

Loss aversion reflects the tendency of the people to avoid incurring losses for earning equivalent amount of gains. For instance the investors that possess behavioral characteristics of loss aversion find it optimum to find $5 but not to lose $5. This principle also stands important in economics domain.

Reference point stands to be one of the keys in the world of behavioral finance to understand that the outcomes are evaluated by the people in relation to a relative point and then the classification of loss and gain is done.

Expert Solution & Answer

Want to see the full answer?

Check out a sample textbook solution

See solution

Students have asked these similar questions

Annie Williams is considering a retirement portfolio and wonders if she should move some of her money into an international investment. She has been working for a short time period (she graduated University just four years ago, she has put her retirement savings into a mutual fund whose strategy mimicked the return of the S&P 500 stock index/ large company stock), this fund has historically earned a return averaging 12% over the last 80 years, but recently the returns were somewhat depressing, as the economy is going through a mild recession because of this Annie is considering an international mutual fund that diversifies its holdings around the industrialized economies of the world and average 14% annual rate of return. The international funds higher average return is offset by the fact that the standard deviation in its return is 30% compared to only 20% for the domestic index fund. Reviewing more closely, she learned that the domestic and international fund tend to earn high…

Suppose you have been hired by President Emmanuel Macron of France as an economic policy consultant. In order to finance an increase in unemployment benefits, the French government needs to raise €10 billion in additional tax revenue. President Macron is considering two policies to achieve this goal: a new tax on gasoline or a new tax on bequests (money left to your children or other heirs). Which of these two policies would be the most economically efficient? Why? Explain why the policy you recommended in a.) might be politically unpopular. Dismayed by your assessment, President Macron proposes a third alternative: a broad decrease in current taxes. Explain why this could increase tax revenue for the French government, but it is unlikely to work in practice.

Ms. Callan, a citizen of the United States who resides in the country, wants to invest in a UK government bond that matures in 10 years. The government bond in which she will invest pays interest once a year in British pounds, and the principal repayment is also in British pounds. The government bond she is considering pays 4% and she belies that interest rate over the next 20 years in the United Kingdom will not fall below 4%. In the opinion of Ms. Callan, she will be able earn at a minimum a 4% return on her investment. What is your opinion regarding the risks of realizing at least a 4% return?