Lecture 7 - Behavioral Finance: The Role of Psychology

Behavioral Finance is a relatively recent revolution in finance that applies insights from all of the social sciences to finance. New decision-making models incorporate psychology and sociology, among other disciplines, to explain economic and financial phenomenon, such as erratic stock price variations. Psychological patterns such as overconfidence and perceived kinks in the value function seem to impact financial decision-making, but are not included in classical theories such as the Expected Utility Theory. Kahneman and Tversky's Prospect Theory addresses such issues and sheds light on irrational deviations from traditional decision-making models. **Reading assignment:** ;Robert Shiller, Irrational Exuberance, chapters 3, 4, 8 and 9 ;Jeremy Siegel, Stocks for the Long Run, chapter 19 ;Fisher, Irving. "The Stock Market Panic in 1929." Journal of the American Statistical Association, Proceedings, 25 (169), pp. 93-6, 1930. ;Jenter, Dirk, and Fadi Kanaan. "CEO Turnover and Relative Performance Evaluation." NBER Working Paper No. 12068, February 2006. **Resources:** ;[[http://oyc.yale.edu/sites/default/files/Lecture07_0.pdf|PowerPoint slides from screen - Lecture 7[PDF]]] ;[[http://oyc.yale.edu/sites/default/files/problem_set3.pdf|Problem Set 3: Stock Market Forecasting Exercise [PDF]]]