BBLS Spring08 Mwang

Topics in Behavioral Finance (I)
Mei Wang
Brownbag Lunch Seminar, March 3, 2008
1
About myself...
Bachelor in Computer Science, Xiamen University, China
PhD in Decision Science, Carnegie Mellon University,
Pittsburgh, USA
Assistant professor of Finance and Financial Markets.
Leader of University Priority Research Program Finance
and Financial Markets: subproject Behavioral Finance
Research: Teaching:
Behavioral Finance Behavioral Finance
Decision Theory Banking: Structured products
Cultural Finance Behavioral Decision Theory
Mei Wang, Topics in Behavioral Finance Brownbag Lunch Seminar, March 3rd, 2008
2
A couple of words about
Carnegie Mellon University
Department of Social and Decision Science:

Behavioral Economics
Experimental economics
Policy analysis
Active in interdisciplinary research
Herbert Simon: Bounded Rationality
What is behavioral finance?
Behavioral Finance = open-minded Finance
Sometimes, in order to find the solution to an

empirical puzzle, it is necessary to entertain
the possibility that some of the agents in the
economy behave less than fully rationally
some of the time. Any financial economist
willing to consider this possibility seriously is
ready to take a try at behavioral finance.
(Thaler, 1993)
4
Key issues in BF
Empirical work: Theoretical work:
Phenomena inconsistent What if we relax
with fully-rational rational assumptions?
framework
Does further empirical evidence supports the improved model?
5
A brief overview of my research
1. Prospect Theory
Empirical tests
Theoretical improvements
2. Risk Perception (in financial investments)
3. Cross-cultural comparison
Risk-attitudes
Financial data (e.g. equity premium)
6
1. Prospect Theory
Descriptive extension of Expected Utility Theory. Main ideas:
ADVANCES IN PROSPECT THEORY 313
O0
0
s .
D sS .,"
0 s" o'~
0.
ss .'"
sss .,'"
,,e3 f'"
.lJ r
.~s
..J
0
, .s' s
,gs
,s
.'J
0
0
I I I I I I
0.0 0.2 0.4 0.6 0.8 1.0
P
Figure 3. Weightingfunctionsfor gains (w + ) and for losses (w - ) based on median estimates of y and 8 in
Utility function depends

equation (12).
Small probabilities are
on reference point and is overweighted with a
Figures 4a and 4b are in general agreement with the main empirical generalizations
that have emerged from the studies of the triangle diagram; see Camerer (1992), and
Camerer and Ho (1991) for reviews. First, departures from linearity, which violate ex-
pected utility theory, are most pronounced near the edges of the triangle. Second, the
convexconcave. nonlinear function w.

indifference curves exhibit both fanning in and fanning out. Third, the curves are concave
in the upper part of the triangle and convex in the lower right. Finally, the indifference
curves for nonpositive prospects resemble the curves for nonnegative prospects reflected
around the 45 line, which represents risk neutrality. For example, a sure gain of $100 is
equally as attractive as a 71% chance to win $200 or nothing (see figure 4a), and a sure
loss of $100 is equally as aversive as a 64% chance to lose $200 or nothing (see figure 4b).
7
The approximate reflection of the curves is of special interest because it distinguishes the
present theory from the standard rank-dependent model in which the two sets of curves
are essentially the same.
Empirical studies on PT
Comparison of Chinese and American
Experiments
(with Fischbeck, J. of Risk Research, 2008)
Field data
(with Fischbeck, J. of Risk & Uncertainty, 2004)
Predictive power of PT
Disposition effect
(with Martin Vlcek, working paper)
8
Theoretical studies on PT
(with M. O. Rieger)
St. Petersburg Paradox in PT

(Economic Theory 2007)
PT for continuous distribution

(J. of Risk & Uncertainty 2008)
PT compared with other heuristics

(Psy. Rev., 2008)
9
2. Risk perception
Perceived risk on financial products

(with Siegrist & Keller, working paper)
Are pension fund managers overconfident?
(with Gort & Siegrist; J. of Beh. Finance, 2008)
Perceived risk of financial products
5 High risk
High
perceived risk
4
commodity fund
art/antique
blue chip USA

equity fund world wide
equity fund Europe
Easy
Easy
gold
sustainable fund
blue chip Switzerland real estate fund
Difficult
Difficult
3
first-class bond dollar
1 2 3 bond worldwide 4 5
equity fund Switzerland
bond Europe understanding
first-class bond Euro
bond Switzerland
first-class bond CHF
private house life insurance
third pillar
bank account
1 Low
Low risk
11
Figure 1: Confidence intervals for historical returns
Figure 1 shows the median lower and the median upper boundaries for the confidence intervals in
the professional and the laypeople sample for historical return estimates of 6 different asset classes
Are pension fund managers overconfident?
as well as the upper and lower boundaries of the realized return of those asset classes over the last
36 years.
12
3. Cross-cultural comparison
Important to know cultural differences (e.g.
when offering financial services in different
cultures).
Studies can help to find influencing factors
(different countries as natural experiment).
Hens, T. & Wang M. (2007): Does finance have
a cultural dimension? NCCR working paper.
I present two ongoing projects as examples:

International Test of Risk-attitudes, INTRA
Equity premium a meta-analysis
Ongoing projects (1)
INTRA International comparison of risk attitudes
(with Thorsten Hens and Marc Oliver Rieger)
Goals:
compare risk-attitudes (PT framework), time
discounting, ambiguity aversion and cultural
dimensions across 30-40 countries
test predictive power of cultural and macro-
economic variables for risk-attitudes
results can be used as input variables for
further studies on international markets
14
Ongoing projects (2)
Equity premium an international comparison
(with M.O. Rieger)
Meta-analysis of 13 studies on the equity

premium in 44 countries.
Goal: finding common factors that can help
to explain the equity premium puzzle.
15
Equity Premium and
Uncertainty Avoidance
Short-term Equity Premium vs. Uncertainty avoidance
20
Y
Predicted Y
15
10
equity permium
0
0 10 20 30 40 50 60 70 80 90 100
Uncertainty avoidance
-5
Equity Premium and Individualism
20
Y
Predicted Y
15
10
equity permium
eqyu
0
0 10 20 30 40 50 60 70 80 90 100
INdividualism
-5
Further ongoing projects (1)
Value of information
(with Daniel Hausmann and Marc Oliver Rieger)
Experimental study on the reasons why people
tend to oversearch for information in investment
decisions.
Goal is to distinguish mistakes in the estimation
of the objective probability for usefulness of
information from attributing an intrinsic
(irrational) value to information.
Relation to underreaction on stock markets.
18
Further ongoing projects (2)
Experiments on:
Real option pricing
(with Marc Chesney)
Emission trading
(with Marc Chesney & Luca Taschini)
Framing in financial decisions

(with Marc Oliver Rieger)
19
Potential topics
So much about my current research.

What about other potential topics for
Your PhD thesis?
Potential topics (1)
Reaction to news
21
Methodology on reaction to news
Experiment
design experiment to control the timing of
events
real option experiment data (with Chesney)
Proxies of perceived probability in the field
prediction market
news analysis
22
Potential topics (2)
Cross-country comparison of home bias
What determines the degree of home bias?
(Institutional factors, transaction cost, familiarity bias)
Huber, G. (2001) Familarity breeds Investment. Review of Financial
Studies. 14(3):259-280.
French, K.R. and J.M. Poterba (1991). Investor Diversification and
International Equity Markets. American Economic Review, 81(2):
222226.
Merton, R. C. (1987). A simple model of capital market equilibrium
with incomplete information. Journal of Finance, 42:483510.
Lane, Philip R. Gian Maria Milesi-Ferretti: The external wealth of
nations mark II:Revised and extended estimates of foreign assets and
liabilities, 1970-2004. 06/69, IMF working paper, 2006.
23
Some general advice...
Start early when searching for a topic and

an advisor!
Work together with your advisor and

other professors!
Why should you start early?
There is a lot to do before you can actually
start writing your summer research paper:
literature review
feasibility check
match faculty
narrow down your research question
trial and error
25
Why should you work together?
Important to know:
Independent research

no collaborations
You can and should work with senior
researchers to learn and to avoid mistakes.
26
Thanks for your interest!
Mei
wang@isb.uzh.ch

BBLS Spring08 Mwang

Uploaded by

Document Information

Original Title

Copyright

Available Formats

Share this document

Share or Embed Document

Sharing Options

Did you find this document useful?

Is this content inappropriate?

Copyright:

Available Formats

BBLS Spring08 Mwang

Uploaded by

Copyright:

Available Formats

Topics in Behavioral Finance (I)

Brownbag Lunch Seminar, March 3, 2008

Department of Social and Decision Science:

Sometimes, in order to find the solution to an

Does further empirical evidence supports the improved model?

Utility function depends

convexconcave. nonlinear function w.

St. Petersburg Paradox in PT

PT for continuous distribution

PT compared with other heuristics

Perceived risk on financial products

blue chip USA

private house life insurance

I present two ongoing projects as examples:

Meta-analysis of 13 studies on the equity

Framing in financial decisions

So much about my current research.

Start early when searching for a topic and

Work together with your advisor and

You might also like