Behavioral Finance exam

Answer only FIVE questions out of SEVEN

 

Question 1

We have discussed Robert Shiller’s model of noise herding, namely:

 

Pt ¥ Et(D1t++rj+EjtY)t+k

k+1

k=0                           

 

  1. Can this model be applied to herding in crypto asset markets?

Choose an answer first:

  • Yes, it can.
  • No, it cannot.

(5 marks)

 

  1. If you answer (1), discuss how and what potential modification the application could entail. If you answer (2), discuss why.

 

(15 marks)

 

Question 2

According to Business Insider, in 2019 the average American spent $7,750 on an engagement ring. This was only slightly less than in 2018. The resale value of an engagement ring in the US is 25-50% of the purchase price (depending on the diamond’s quality), before factoring in appraisal fees and the jeweller’s commission (typically around 20%). These aspects indicate that, as an asset, diamonds embedded in engagement rings lose value rapidly and substantially, and that they are difficult to resell. This is puzzling, since we are made to think that “diamonds are forever.”

 

  1. What behavioural principle can explain this phenomenon?

 

(5 marks)

  1. Why don’t we see the same phenomenon in the case of equities? Why doesn’t a previously owned share of, say, Tesla, lose value when

resold?                                                                                    (15 marks)

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Question 3

 

In a study from 1997, Colin Camerer and collaborators find that cab drivers in NYC work less on rainy days, impacting thus their incomes. This is puzzling, because on rainy days there are more customers looking for taxi rides and taxi fares are higher. Camerer and collaborators discard various possible explanations, such as: drivers are tired; drivers are liquidity constrained; drivers take unrecorded breaks; data is biased.

 

  1. Which of the following do you think explains best taxi drivers working less on working days in New York City? Is it:
    • the January effect;
    • probability weighting;
    • MLA;
    • overconfidence; (5) wealth maximisation).

 

(5 marks)

  1. After having answered (a), explain your choice.

 

(15 marks)

 

Question 4

 

The Euro football championship is taking place these days. Financial investors are aware of arbitraging opportunities related to the championship and are seeking to construct portfolios exploiting them. We assume all other things are equal.

 

  1. Which of the following do you think is a realistic arbitrage strategy related to the championship:

 

  • Buy a portfolio of companies advertising on the stadiums.
  • Go long on a portfolio of companies for which the players have made endorsements in the past six months and short a portfolio of comparable companies unendorsed by players.
  • Build portfolios replicating the stock indices on the participating countries. After each match, go long on a replication of the stock market index associated with the country that wins that match and short the replication of the index associated with the losing country.

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  • Long the stock of the construction companies that build the stadiums where the most winning matches took place.
  • Go long on the stock of companies producing football gear and short the stock of companies producing ski equipment.

 

(5 marks)

 

  1. b) After having answered (a), justify and explain your choice using a behavioural effect.

(15 marks)

 

Question 5

 

In the US, tickets to ball games are sold sometimes in sealed bid auctions. A study from 2001 found that willingness to pay for a basketball ticket sold in a sealed bid auction is up to 100% higher when credit card use is required compared with the situation when cash is required. What behavioural principle can explain this observation?

Explain and justify your answer.

(20 marks)

 

Question 6

The existence of the dividend puzzle is acknowledged by finance scholars, yet there is no unanimous explanation for it. It has been argued, among others, that managers pay dividends as a way of signalling healthy cash flows, but we don’t have a satisfactory explanation why investors prefer dividend paying stock to non-dividend paying one, although it makes little economic sense.

 

  1. Which of the following concepts do you think is most likely and more closely related to this phenomenon:
    • risk aversion;
    • investment horizon;
    • spurious herding;
    • overreaction; (5) mental accounting.

(5 marks)

  1. Explain and justify your choice.

(15 marks)

 

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Question 7

There is agreement among finance scholars that reducing the disposition effect is beneficial to investors. What is less agreed upon is how to achieve this reduction. Various experimental studies have suggested various ways of achieving this.

 

  1. a) Which of the following do you think could be an effective means for reducing the disposition effect?
  • Banning short sales.
  • Reducing frequency of trading on Fridays.
  • Providing less information on screen about the purchase price.
  • Eliminating market makers.
  • Providing more on screen information about small cap equities.

 

(5 marks)

b). Explain and justify your answer.

 

(15 marks)

 

End of Paper