Deck 12: Behavioral Finance and Technical Analysis

Question 1

An example of ________ is that it is not as painful to have purchased a blue chip stock that decreases in value as it is to lose money on an unknown start up firm.

A) mental accounting
B) regret avoidance
C) overconfidence
D) conservatism

Answer 1

B
Explanation: An example of regret avoidance is that it is not as painful to have purchased a blue chip stock that decreases in value, as it is to lose money on an unknown start up firm.

Question 2

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.

Answer 2

A
Explanation: DeBondt and Thaler believe that high P/E result from investors' earnings expectations that are too extreme.

Question 3

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

Answer 3

E
Explanation: Information processing errors consist of forecasting errors, overconfidence, and conservatism.

Question 4

Some economists believe that the anomalies literature is consistent with investors'

A) ability to always process information correctly, and therefore, they infer correct probability distributions about future rates of return; and 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; and 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; and 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; and given a probability distribution of returns, they often make inconsistent or suboptimal decisions.

Question 5

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

Question 6

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

Question 7

____________ 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

Question 8

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

Question 9

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 who are much more sophisticated than the average person.
D) conventional financial theory considers how emotional people make decisions, but the market is driven by rational utility maximizing investors and should ignore how the average person makes decisions because the market is driven by investors who are much more sophisticated than the average person.
E) None of the options are correct.

Question 10

Suppose on August 27, there were 1,455 stocks that advanced on the NYSE and 1,553 that declined. The volume in advancing issues was 852,581, and the volume in declining issues was 1,058,312. 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

Question 11

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.

Question 12

____________ 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

Question 13

________ 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 options are correct.

Question 14

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

Question 15

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) research suggests that people either underweight recent information or overweight recent information depending on whether the information was good or bad.
E) None of the options are correct.

Question 16

Single men trade far more often than women. This is due to greater ________ among men.

A) framing
B) regret avoidance
C) overconfidence
D) conservatism

Question 17

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) bearish signal by some technical analysts, a bullish signal by other technical analysts, and a bullish signal by some fundamentalists.

Question 18

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

Question 19

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.

Question 20

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) bullish; above
D) None of the options are correct.

Question 21

Kahneman and Tversky (1973) reported that __________ give too much weight to recent experience compared to prior beliefs when making forecasts.

A) young men
B) young women
C) people
D) older men
E) older women

Question 22

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

Question 23

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) strategies that would have provided superior risk adjusted returns and results of actual investments of professional managers.
E) the mean variance efficiency of the selected market proxy and strategies that would have provided superior risk adjusted returns.

Question 24

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

Question 25

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

Question 26

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

Question 27

If information processing was perfect, many studies conclude that individuals would tend to make __________ decisions using that information due to __________.

A) less than fully rational; behavioral biases
B) fully rational; behavioral biases
C) less than fully rational; fundamental risk
D) fully rational; fundamental risk
E) fully rational; utility maximization

Question 28

__________ 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

Question 29

Kahneman and Tversky (1973) reported that people give __________ weight to recent experience compared to prior beliefs when making forecasts. This is referred to as ____________.

A) too little; hyper rationality
B) too little; conservatism
C) too much; framing
D) too much; memory bias

Question 30

The anomalies literature

A) provides a conclusive rejection of market efficiency.
B) provides conclusive support of market efficiency.
C) suggests that several strategies would have provided superior returns.
D) provides a conclusive rejection of market efficiency and suggests that several strategies would have provided superior returns.
E) None of the options are correct.

Question 31

The efficient market hypothesis

A) implies that security prices properly reflect information available to investors.
B) has little empirical validity.
C) implies that active traders will find it difficult to outperform a buy and hold strategy.
D) has little empirical validity and implies that active traders will find it difficult to outperform a buy and hold strategy.
E) implies that security prices properly reflect information available to investors and that active traders will find it difficult to outperform a buy and hold strategy.

Question 32

Conservatism implies that investors are too __________ in updating their beliefs in response to new evidence and that they initially __________ to news.

A) quick; overreact
B) quick; under react
C) slow; overreact
D) slow; under react

Question 33

Barber and Odean (2001) report that men trade __________ frequently than women.

A) less
B) less in down markets
C) more in up markets
D) more

Question 34

Barber and Odean (2001) report that men trade __________ frequently than women and the frequent trading leads to __________ returns.

A) less; superior
B) less; inferior
C) more; superior
D) more; inferior

Question 35

The 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

Question 36

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) 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.
E) All of the options are correct.

Question 37

DeBondt and Thaler (1990) argue that the P/E effect can be explained by

A) forecasting errors.
B) earnings expectations that are too extreme.
C) earnings expectations that are not extreme enough.
D) regret avoidance.
E) forecasting errors and earnings expectations that are too extreme.

Question 38

Errors in information processing can lead investors to misestimate

A) true probabilities of possible events and associated rates of return.
B) occurrence of possible events.
C) only possible rates of return.
D) the effect of accounting manipulation.
E) fraud.

Question 39

____________ 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 options are correct.

Question 40

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) Siamese twin companies and closed end funds
E) All of the options are correct.

Question 41

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

Question 42

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) prices at premiums and discounts to NAV; is inconsistent with

Question 43

____________ measures the extent to which a security has outperformed or underperformed either the market as a whole or its particular industry.

A) Put call ratio
B) Trin ratio
C) Breadth
D) Relative strength
E) All of the options are correct.

Question 44

__________ effects can help explain momentum in stock prices.

A) Conservatism
B) Regret avoidance
C) Prospect theory
D) Mental accounting
E) Model risk

Question 45

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

Question 46

Barber and Odean (2001) report that women trade __________ frequently than men.

A) less
B) less in down markets
C) more in up markets
D) more

Question 47

Barber and Odean (2001) report that women __________ men.

A) earn higher returns than
B) earn lower returns than
C) earn about the same returns as
D) generate higher trading costs than

Question 48

Barber and Odean (2001) report that men __________ women.

A) earn higher returns than
B) earn lower returns than
C) earn about the same returns as
D) generate lower trading costs than