Question 1

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.

Accepted Answer

The anomalies literature in economics often points to the fact that investors do not always process information correctly, leading to incorrect inferences about future rates of return. This incorrect processing can result in inconsistent or suboptimal decision-making, even when investors are presented with a probability distribution of returns. This reflects the real-world observation that markets are not always efficient, and psychological biases can affect investment decisions.

Question 2

Suppose on August 27, there were 1,455 stocks that advanced on the NASDAQ 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) 1.16; bullish
D) 1.16; bearish

Accepted Answer

The TRIN ratio, also known as the Arms Index, is calculated by dividing the Advance/Decline Ratio by the Advance/Decline Volume Ratio. For this scenario, the Advance/Decline Ratio is 1,455/1,553 = 0.937, and the Advance/Decline Volume Ratio is 852,581/1,058,312 = 0.805. The TRIN ratio is therefore 0.937/0.805 = 1.16. A TRIN ratio above 1 typically indicates bearish sentiment among technical analysts, as it suggests that the volume in declining issues is greater relative to advancing ones.

Question 3

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

Accepted Answer

This is an example of framing, where the way information is presented (framed) affects decision-making. Framing can lead people to change their preferences depending on whether options are presented in terms of potential gains or losses, even if the underlying information is the same.

Question 4

Information processing errors consist ofI) 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

Accepted Answer

Information processing errors in decision-making include forecasting errors (incorrect predictions about future events), overconfidence (overestimating one's own ability to perform tasks or to make accurate assessments), and conservatism (the tendency to insufficiently revise one's beliefs when presented with new evidence).

Question 5

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

Accepted Answer

The answer of If a person gives too much weight...

Question 6

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.

Accepted Answer

Research indicates that people tend to give too much importance to recent information when making decisions or forecasts, a cognitive bias known as recency bias. This can lead to forecasting errors because the most recent information may not always be the most relevant or accurate for predicting future events.

Question 7

____________ are good examples of the limits to arbitrage because they show that the law of one price is violated.I) Siamese twin companiesII) Unit trustsIII) Closed-end fundsIV) Open-end fundsV) Equity carve-outs
A) I and II
B) I, II, and III
C) I, III, and V
D) IV and V
E) V

Accepted Answer

Siamese twin companies, closed-end funds, and equity carve-outs are examples where the law of one price is often violated, demonstrating limits to arbitrage. Siamese twin companies share assets but may have differing stock prices. Closed-end funds can trade at prices different from their net asset value. Equity carve-outs can lead to pricing inefficiencies between parent and subsidiary.

Question 8

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.

Accepted Answer

Behavioral finance challenges the conventional financial theory by emphasizing that real people do not always make rational, utility-maximizing decisions, and their behaviors and emotions can significantly impact the financial markets.

Question 9

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.

Accepted Answer

DeBondt and Thaler argue that high Price-to-Earnings (P/E) ratios result from investors having earnings expectations that are too extreme, meaning they are overly optimistic or pessimistic about future earnings, which can distort stock prices.

Question 10

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.

Accepted Answer

A TRIN ratio of less than 1.0 is generally considered a bullish signal because it indicates that more volume is flowing into advancing stocks than declining ones.

Question 11

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.

Accepted Answer

Barber and Odean (2000) attribute the difference in return between the highest and lowest turnover portfolios to overconfidence, suggesting that investors who trade more frequently, often due to overconfidence in their trading abilities, tend to achieve lower returns.

Question 12

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.

Accepted Answer

When the market price breaks through the moving average from below, it is considered a bullish signal. This indicates that the price is potentially starting an upward trend, suggesting a good time to buy.

Question 13

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

Accepted Answer

Mental accounting is consistent with investors' irrational preference for high cash dividends and holding losing positions too long, as it involves compartmentalizing financial decisions and treating money differently based on its source or intended use.

Question 14

____________ 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

Accepted Answer

Overconfidence can lead investors to believe they can outperform the market, thus favoring active investment management over passive strategies.

Question 15

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.

Accepted Answer

Regret avoidance is a psychological phenomenon where individuals tend to make decisions in a way that minimizes the potential for regret, especially in situations where an unconventional choice leads to a negative outcome. This leads to a tendency to blame oneself more for bad outcomes of unconventional decisions, as these decisions are seen as more avoidable or regrettable in hindsight.

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

Accepted Answer

The correct answer is C) overconfidence. Studies in behavioral finance have shown that single men tend to trade more often than women due to higher levels of overconfidence in their trading abilities and market predictions.

Question 17

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

Accepted Answer

Arbitrageurs may face difficulties exploiting behavioral biases due to fundamental risk (the risk that the asset's price moves against the arbitrage position), implementation costs (costs associated with executing trades), and model risk (the risk that the models used to identify arbitrage opportunities are flawed). Conservatism and regret avoidance are psychological biases that affect individual decision-making but are not direct obstacles for arbitrageurs in exploiting market inefficiencies.

Question 18

________ 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.

Accepted Answer

Conservatism bias refers to the tendency of investors to be overly cautious and to underreact to new information, leading them to update their beliefs more slowly than they should when presented with new evidence.

Question 19

____________ 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.

Accepted Answer

Breadth is a measure used to describe the general direction of the market by analyzing the number of companies advancing relative to the number declining. It helps in understanding whether the movement in the market index is broad-based, affecting many stocks, or narrow, affecting only a few.

Question 20

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

Accepted Answer

Regret avoidance refers to the tendency of individuals to make decisions in a way that allows them to avoid feeling regret in the future. In this example, the idea is that investing in a blue-chip stock feels less regrettable if it loses value compared to investing in a riskier, unknown start-up, because the blue-chip investment is perceived as a safer, more justifiable decision even if it results in a loss.

Quiz 12: Behavioral Finance and Technical Analysis

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

Suppose on August 27, there were 1,455 stocks that advanced on the NASDAQ 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 .

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.

Information processing errors consist ofI) forecasting errors.II) overconfidence.III) conservatism.IV) framing.

If a person gives too much weight to recent information compared to prior beliefs, they would make ________ errors.

Forecasting errors are potentially important because

____________ are good examples of the limits to arbitrage because they show that the law of one price is violated.I) Siamese twin companiesII) Unit trustsIII) Closed-end fundsIV) Open-end fundsV) Equity carve-outs

The premise of behavioral finance is that

DeBondt and Thaler believe that high P/E result from investors'

A trin ratio of less than 1.0 is considered as a

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

In regard to moving averages, it is considered to be a signal when market price breaks through the moving average from .

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.

____________ may be responsible for the prevalence of active versus passive investments management.

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

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

Arbitrageurs may be unable to exploit behavioral biases due to I) fundamental risk.II) implementation costs.III) model risk.IV) conservatism.V) regret avoidance.

________ bias means that investors are too slow in updating their beliefs in response to evidence.

____________ 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.

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.