Chapter 12 - Behavioral Finance and Technical Analysis

Chapter 12 Behavioral Finance and Technical Analysis

Multiple Choice Questions 1. Conventional theories presume that investors ____________ and behavioral finance presumes that they ____________. A. are irrational; are irrational B. are rational; may not be rational C. are rational; are rational D. may not be rational; may not be rational E. may not be rational; are rational

Conventional theories presume that investors are rational and behavioral finance presumes that they may not be rational.
Difficulty: Easy

2. The premise of behavioral finance is that A. conventional financial theory ignores how real people make decisions and that people make a difference. B. conventional financial theory considers how emotional people make decisions but the market is driven by rational utility maximizing investors. C. conventional financial theory should ignore how the average person makes decisions because the market is driven by investors that are much more sophisticated than the average person. D. B and C E. none of the above

The premise of behavioral finance is that conventional financial theory ignores how real people make decisions and that people make a difference.
Difficulty: Easy

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3. Some economists believe that the anomalies literature is consistent with investors ____________ and ____________. A. ability to always process information correctly and therefore they infer correct probability distributions about future rates of return; given a probability distribution of returns, they always make consistent and optimal decisions B. inability to always process information correctly and therefore they infer incorrect probability distributions about future rates of return; given a probability distribution of returns, they always make consistent and optimal decisions C. ability to always process information correctly and therefore they infer correct probability distributions about future rates of return; given a probability distribution of returns, they often make inconsistent or suboptimal decisions D. inability to always process information correctly and therefore they infer incorrect probability distributions about future rates of return; given a probability distribution of returns, they often make inconsistent or suboptimal decisions E. none of the above

Some economists believe that the anomalies literature is consistent with investors inability to always process information correctly and therefore they infer incorrect probability distributions about future rates of return and given a probability distribution of returns, they often make inconsistent or suboptimal decisions.
Difficulty: Moderate

4. Information processing errors consist of I) forecasting errors II) overconfidence III) conservatism IV) framing A. I and II B. I and III C. III and IV D. IV only E. I, II and III

Information processing errors consist of forecasting errors, overconfidence, and conservatism.

Difficulty: Moderate

Chapter 12 - Behavioral Finance and Technical Analysis

5. Forecasting errors are potentially important because A. research suggests that people underweight recent information. B. research suggests that people overweight recent information. C. research suggests that people correctly weight recent information. D. either A or B depending on whether the information was good or bad. E. none of the above.

Forecasting errors are potentially important because research suggests that people overweight recent information.
Difficulty: Moderate

6. DeBondt and Thaler believe that high P/E result from investors A. earnings expectations that are too extreme. B. earnings expectations that are not extreme enough. C. stock price expectations that are too extreme. D. stock price expectations that are not extreme enough. E. none of the above.

DeBondt and Thaler believe that high P/E result from investors earnings expectations that are too extreme.
Difficulty: Moderate

7. If a person gives too much weight to recent information compared to prior beliefs, they would make ________ errors. A. framing B. selection bias C. overconfidence D. conservatism E. forecasting

If a person gives too much weight to recent information compared to prior beliefs, they would make forecasting errors.
Difficulty: Moderate

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8. Single men trade far more often than women. This is due to greater ________ among men. A. framing B. regret avoidance C. overconfidence D. conservatism E. none of the above

Single men trade far more often than women. This is due to greater overconfidence among men.
Difficulty: Moderate

9. ____________ may be responsible for the prevalence of active versus passive investments management. A. Forecasting errors B. Overconfidence C. Mental accounting D. Conservatism E. Regret avoidance

Overconfidence may be responsible for the prevalence of active versus passive investments management.
Difficulty: Moderate

10. Barber and Odean (2000) ranked portfolios by turnover and report that the difference in return between the highest and lowest turnover portfolios is 7% per year. They attribute this to A. overconfidence B. framing C. regret avoidance D. sample neglect E. all of the above

They attribute this to overconfidence.

Difficulty: Moderate

Chapter 12 - Behavioral Finance and Technical Analysis

11. ________ bias means that investors are too slow in updating their beliefs in response to evidence. A. framing B. regret avoidance C. overconfidence D. conservatism E. none of the above

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Conservatism bias means that investors are too slow in updating their beliefs in response to evidence.
Difficulty: Moderate

12. Psychologists have found that people who make decisions that turn out badly blame themselves more when that decision was unconventional. The name for this phenomenon is A. regret avoidance B. framing C. mental accounting D. overconfidence E. obnoxicity

An investments example given in the text is buying the stock of a star-up firm that shows subsequent poor performance, versus buying blue chip stocks that perform poorly. Investors tend to have more regret if they chose the less conventional start-up stock. DeBondt and Thaler say that such regret theory is consistent with the size effect and the book-to-market effect.
Difficulty: Moderate

13. An example of ________ is that a person may reject an investment when it is posed in terms of risk surrounding potential gains but may accept the same investment if it is posed in terms of risk surrounding potential losses. A. framing B. regret avoidance C. overconfidence D. conservatism E. none of the above

An example of framing is that a person may reject an investment when it is posed in terms of risk surrounding potential gains but may accept the same investment if it is posed in terms of risk surrounding potential losses.
Difficulty: Moderate

Chapter 12 - Behavioral Finance and Technical Analysis

14. Statman (1977) argues that ________ is consistent with some investors' irrational preference for stocks with high cash dividends and with a tendency to hold losing positions too long. A. mental accounting B. regret avoidance C. overconfidence D. conservatism E. none of the above

Statman (1977) argues that mental accounting is consistent with some investors' irrational preference for stocks with high cash dividends and with a tendency to hold losing positions too long
Difficulty: Moderate

16. Arbitrageurs may be unable to exploit behavioral biases due to ____________. I) fundamental risk II) implementation costs III) model risk IV) conservatism V) regret avoidance A. I and II only B. I, II, and III C. I, II, III, and V D. II, III, and IV E. IV and V

Arbitrageurs may be unable to exploit behavioral biases due to fundamental risk, implementation costs, and model risk.
Difficulty: Moderate

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17. ____________ are good examples of the limits to arbitrage because they show that the law of one price is violated. I) Siamese Twin Companies II) Unit trusts III) Closed end funds IV) Open end funds V) Equity carve outs A. I and II B. I, II, and III C. I, III, and V D. IV and V E. V

Siamese Twin Companies, closed end funds, and equity carve outs are good examples of the limits to arbitrage because they show that the law of one price is violated.
Difficulty: Moderate

18. __________ was the grandfather of technical analysis. A. Harry Markowitz B. William Sharpe C. Charles Dow D. Benjamin Graham E. none of the above Charles Dow, the originator of the Dow Theory, was the grandfather of technical analysis. Benjamin Graham might be considered the grandfather of fundamental analysis. Harry Markowitz and William Sharpe might be considered the grandfathers of modern portfolio theory.
Difficulty: Easy

19. The goal of the Dow theory is to A. identify head and shoulder patterns. B. identify breakaway points. C. identify resistance levels. D. identify support levels. E. identify long-term trends.

Chapter 12 - Behavioral Finance and Technical Analysis

The Dow theory uses the Dow Jones Industrial Average as an indicator of long-term trends in market prices.
Difficulty: Easy

23. The Dow theory posits that the three forces that simultaneously affect stock prices are ____________. I) primary trend II) intermediate trend III) momentum trend IV) minor trend V) contrarian trend A. I, II, and III B. II, III, and IV C. III, IV and V D. I, II, and IV E. I, III, and V

The Dow theory posits that the three forces that simultaneously affect stock prices are primary trend, intermediate trend, and minor trend.
Difficulty: Moderate

24. The Elliot Wave Theory ____________. A. is a recent variation of the Dow Theory B. suggests that stock prices can be described by a set of wave patterns C. is similar to the Kondratieff Wave theory D. A and B E. A, B, and C

Both the Elliot Wave Theory and the Kondratieff Wave Theory are recent variations on the Dow Theory, which suggests that stock prices move in identifiable wave patterns.

Difficulty: Easy

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25. A trin ratio of less than 1.0 is considered as a _________. A. bearish signal B. bullish signal C. bearish signal by some technical analysts and a bullish signal by other technical analysts D. bullish signal by some fundamentalists E. C and D A trin ratio of less than 1.0 is considered bullish because the declining stocks have lower average volume than the advancing stocks, indicating net buying pressure.
Difficulty: Easy

26. On October 29, 1991 there were 1,031 stocks that advanced on the NYSE and 610 that declined. The volume in advancing issues was 112,866,000 and the volume in declining issues was 58,188,000. The trin ratio for that day was ________ and technical analysts were likely to be ________. A. 0.87, bullish B. 0.87, bearish C. 1.15, bullish D. 1.15, bearish E. none of the above (1,031/610) / (112,866,000/58,388,000) = 0.87. A trin ratio less than 1 is considered bullish because advancing stocks have a higher volume than declining stocks, indicating a buying pressure.
Difficulty: Moderate

27. In regard to moving averages, it is considered to be a ____________ signal when market price breaks through the moving average from ____________. A. bearish; below B. bullish: below C. bearish; above D. bullish above E. B and C In regard to moving averages, it is considered to be a bullish signal when market price breaks through the moving average from below. In addition, it is considered to be a bearish signal when market price breaks through the moving average from above.
Difficulty: Moderate

Chapter 12 - Behavioral Finance and Technical Analysis

29. ____________ is a measure of the extent to which a movement in the market index is reflected in the price movements of all stocks in the market. A. put-call ratio B. trin ratio C. Breadth D. confidence index E. all of the above

Breadth is a measure of the extent to which a movement in the market index is reflected in the price movements of all stocks in the market.
Difficulty: Moderate

30. Then confidence index is computed from ____________ and higher values are considered ____________ signals. A. bond yields; bearish B. odd lot trades; bearish C. odd lot trades; bullish D. put/call ratios; bullish E. bond yields; bullish

Then confidence index is computed from bond yields and higher values are considered bullish signals.
Difficulty: Moderate

31. The put/call ratio is computed as ____________ and higher values are considered ____________ signals. A. the number of outstanding put options divided by outstanding call options; bullish or bearish B. the number of outstanding put options divided by outstanding call options; bullish C. the number of outstanding put options divided by outstanding call options; bearish D. the number of outstanding call options divided by outstanding put options; bullish E. the number of outstanding call options divided by outstanding put options; bearish

The put/call ratio is computed as the number of outstanding put options divided by outstanding call options and higher values are considered bullish or bearish signals.

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Difficulty: Moderate

33. Tests of market efficiency have focused on ____________. A. the mean-variance efficiency of the selected market proxy B. strategies that would have provided superior risk-adjusted returns C. results of actual investments of professional managers D. B and C E. A and B

Tests of market efficiency have focused on strategies that would have provided superior riskadjusted returns and results of actual investments of professional managers.
Difficulty: Moderate

34. The anomalies literature ____________. A. provides a conclusive rejection of market efficiency B. provides a conclusive support of market efficiency C. suggests that several strategies would have provided superior returns D. A and C E. none of the above

The anomalies literature suggests that several strategies would have provided superior returns.
Difficulty: Moderate

35. Behavioral finance argues that ____________. A. even if security prices are wrong it may be difficult to exploit them B. the failure to uncover successful trading rules or traders cannot be taken as proof of market efficiency C. investors are rational D. A and B E. all of the above

Behavioral finance argues that even if security prices are wrong it may be difficult to exploit them and the failure to uncover successful trading rules or traders cannot be taken as proof of market efficiency.

Chapter 12 - Behavioral Finance and Technical Analysis

Difficulty: Moderate

36. Markets would be inefficient if irrational investors __________ and actions of arbitragers were __________. A. existed; unlimited B. did not exist; unlimited C. existed; limited D. did not exist; limited E. none of the above

Markets would be inefficient if irrational investors existed and actions if arbitragers were limited.
Difficulty: Moderate

38. __________ can lead investors to misestimate the true probabilities of possible events or associated rates of return. A. Information processing errors B. Framing errors C. Mental accounting errors D. Regret avoidance E. all of the above

Information processing errors can lead investors to misestimate the true probabilities of possible events or associated rates of return.
Difficulty: Moderate

39. Kahneman and Tversky (1973) report that __________ and __________. A. people give too little weight to recent experience compared to prior beliefs; tend to make forecasts that are too extreme given the uncertainty of their information B. people give too much weight to recent experience compared to prior beliefs; tend to make forecasts that are too extreme given the uncertainty of their information C. people give too little weight to recent experience compared to prior beliefs; tend to make forecasts that are not extreme enough given the uncertainty of their information D. people give too much weight to recent experience compared to prior beliefs; tend to make forecasts that are not extreme enough given the uncertainty of their information E. none of the above

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Kahneman and Tversky (1973) report that people give too much weight to recent experience compared to prior beliefs and tend to make forecasts that are too extreme given the uncertainty of their information.

Chapter 12 - Behavioral Finance and Technical Analysis

Difficulty: Moderate

45. The assumptions concerning the shape of utility functions of investors differ between conventional theory and prospect theory. Conventional theory assumes that utility functions are __________ whereas prospect theory assumes that utility functions are __________.

A. concave and defined in terms of wealth; s-shaped (convex to losses and concave to gains) and defined in terms of loses relative to current wealth B. convex and defined loses relative to current wealth; s-shaped (convex to losses and concave to gains) and defined in terms of loses relative to current wealth C. s-shaped (convex to losses and concave to gains) and defined in terms of loses relative to current wealth; concave and defined in terms of wealth D. s-shaped (convex to losses and concave to gains) and defined in terms of wealth; concave and defined in terms of loses relative to current wealth E. convex and defined in terms of wealth; concave and defined in terms of gains relative to current wealth

The assumptions concerning the shape of utility functions of investors differ between conventional theory and prospect theory. Conventional theory assumes that utility functions are concave and defined in terms of wealth whereas prospect theory assumes that utility functions are s-shaped (convex to losses and concave to gains) and defined in terms of loses relative to current wealth.
Difficulty: Difficult

46. The law-of-one-price posits that ability to arbitrage would force prices of identical goods to trade at equal prices. However, empirical evidence suggests that __________ are often mispriced. A. Siamese Twin Companies B. equity carve outs C. closed-end funds D. A and C E. all of the above

The law-of-one-price posits that ability to arbitrage would force prices of identical goods to trade at equal prices. However, empirical evidence suggests that all of the above are often mispriced.

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Difficulty: Difficult

54. Studies of Siamese twin companies find __________ which __________ the EMH. A. correct relative pricing; supports B. correct relative pricing; does not support C. incorrect relative pricing; supports D. incorrect relative pricing; does not support E. none of the above

Studies of Siamese twin companies find incorrect relative pricing which does not support the EMH.
Difficulty: Moderate

55. Studies of equity carve-outs find __________ which __________ the EMH. A. strong support for the Law of One Price; supports B. strong support for the Law of One Price; violates C. evidence against the Law of One Price; violates D. evidence against the Law of One Price; supports E. none of the above

Studies of equity carve-outs find evidence against the Law of One Price which violates the EMH.
Difficulty: Moderate

56. Studies of closed-end funds find __________ which __________ the EMH. A. prices at a premium to NAV; is consistent with B. prices at a premium to NAV; is inconsistent with C. prices at a discount to NAV; is consistent with D. prices at a discount to NAV; is inconsistent with E. B and D

Studies of closed-end funds find prices at premiums and discounts to NAV which is inconsistent with the EMH.
Difficulty: Moderate

Chapter 12 - Behavioral Finance and Technical Analysis

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