Chapter 12 - Behavioral Finance and Technical AnalysisChapter 12 Behavioral Finance and Technical Analysis Multiple Choice Questions 1. 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 Conventional theories presume that investors are rational and behavioral finance presumes that they may not be rational. Difficulty: Easy 2. 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 that are much more sophisticated than the average person. D. B and C E. none of the above The premise of behavioral finance is that conventional financial theory ignores how real people make decisions and that people make a difference. Difficulty: Easy 12-1 given a probability distribution of returns. they often make inconsistent or suboptimal decisions E. they often make inconsistent or suboptimal decisions D. given a probability distribution of returns. Difficulty: Moderate 4. III and IV D. they always make consistent and optimal decisions B. none of the above Some economists believe that the anomalies literature is consistent with investors 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. II and III Information processing errors consist of forecasting errors. I and III C. I and II B. ability to always process information correctly and therefore they infer correct probability distributions about future rates of return.3. Some economists believe that the anomalies literature is consistent with investors ____________ and ____________. they often make inconsistent or suboptimal decisions. given a probability distribution of returns. Information processing errors consist of I) forecasting errors II) overconfidence III) conservatism IV) framing A. I. they always make consistent and optimal decisions C. IV only E. A. given a probability distribution of returns. ability to always process information correctly and therefore they infer correct probability distributions about future rates of return. and conservatism. inability to always process information correctly and therefore they infer incorrect probability distributions about future rates of return. overconfidence. inability to always process information correctly and therefore they infer incorrect probability distributions about future rates of return. Difficulty: Moderate . DeBondt and Thaler believe that high P/E result from investors A. earnings expectations that are too extreme. forecasting If a person gives too much weight to recent information compared to prior beliefs. selection bias C. they would make forecasting errors. earnings expectations that are not extreme enough.Behavioral Finance and Technical Analysis 5. If a person gives too much weight to recent information compared to prior beliefs. none of the above. research suggests that people correctly weight recent information. either A or B depending on whether the information was good or bad. stock price expectations that are too extreme. E. C. B. Forecasting errors are potentially important because research suggests that people overweight recent information. research suggests that people underweight recent information. D. they would make ________ errors. C.Chapter 12 . framing B. overconfidence D. B. none of the above. Forecasting errors are potentially important because A. E. stock price expectations that are not extreme enough. Difficulty: Moderate 6. Difficulty: Moderate 7. DeBondt and Thaler believe that high P/E result from investors earnings expectations that are too extreme. conservatism E. A. research suggests that people overweight recent information. D. Difficulty: Moderate 12-3 . Regret avoidance Overconfidence may be responsible for the prevalence of active versus passive investments management. sample neglect E. framing C. ____________ may be responsible for the prevalence of active versus passive investments management. overconfidence B. Mental accounting D. regret avoidance C. This is due to greater ________ among men. A.8. regret avoidance D. Conservatism E. They attribute this to A. conservatism E. This is due to greater overconfidence among men. A. Forecasting errors B. Difficulty: Moderate . Single men trade far more often than women. framing B. Difficulty: Moderate 10. none of the above Single men trade far more often than women. overconfidence D. Difficulty: Moderate 9. all of the above They attribute this to overconfidence. 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. Overconfidence C. Behavioral Finance and Technical Analysis 11. regret avoidance C. ________ bias means that investors are too slow in updating their beliefs in response to evidence. none of the above 12-5 .Chapter 12 . conservatism E. overconfidence D. framing B. A. Difficulty: Moderate 13. Psychologists have found that people who make decisions that turn out badly blame themselves more when that decision was unconventional. overconfidence E. regret avoidance C. Investors tend to have more regret if they chose the less conventional start-up stock. framing C. The name for this phenomenon is A. conservatism E. 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. Difficulty: Moderate 12. framing B. obnoxicity An investments example given in the text is buying the stock of a star-up firm that shows subsequent poor performance. regret avoidance B. DeBondt and Thaler say that such regret theory is consistent with the size effect and the book-to-market effect. overconfidence D. A. versus buying blue chip stocks that perform poorly. none of the above An example of framing 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. mental accounting D.Conservatism bias means that investors are too slow in updating their beliefs in response to evidence. Difficulty: Moderate . and V D. IV and V Arbitrageurs may be unable to exploit behavioral biases due to fundamental risk. III. conservatism E. mental accounting B. Difficulty: Moderate 12-7 . II. II. and III C. and IV E. 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.Behavioral Finance and Technical Analysis 14.Chapter 12 . I) fundamental risk II) implementation costs III) model risk IV) conservatism V) regret avoidance A. and model risk. III. I and II only B. I. A. II. regret avoidance C. I. implementation costs. Arbitrageurs may be unable to exploit behavioral biases due to ____________. none of the above Statman (1977) argues that mental accounting is consistent with some investors' irrational preference for stocks with high cash dividends and with a tendency to hold losing positions too long Difficulty: Moderate 16. overconfidence D. __________ was the grandfather of technical analysis. the originator of the Dow Theory. was the grandfather of technical analysis. II. and III C. I and II B. and V D. Harry Markowitz and William Sharpe might be considered the grandfathers of modern portfolio theory. D. and equity carve outs are good examples of the limits to arbitrage because they show that the law of one price is violated. identify long-term trends. identify head and shoulder patterns. E. Charles Dow D. identify breakaway points. C. V Siamese Twin Companies. Benjamin Graham E. . III. I. I) Siamese Twin Companies II) Unit trusts III) Closed end funds IV) Open end funds V) Equity carve outs A. none of the above Charles Dow. identify resistance levels. B. The goal of the Dow theory is to A. A. IV and V E. Difficulty: Moderate 18. Harry Markowitz B. William Sharpe C. ____________ are good examples of the limits to arbitrage because they show that the law of one price is violated. Difficulty: Easy 19. Benjamin Graham might be considered the grandfather of fundamental analysis. identify support levels. I. closed end funds.17. and III B. The Dow theory posits that the three forces that simultaneously affect stock prices are ____________. and IV E. intermediate trend. and IV C. I. which suggests that stock prices move in identifiable wave patterns. A. A. III. I) primary trend II) intermediate trend III) momentum trend IV) minor trend V) contrarian trend A. II. The Elliot Wave Theory ____________. III. II. is a recent variation of the Dow Theory B. Difficulty: Moderate 24.Behavioral Finance and Technical Analysis The Dow theory uses the Dow Jones Industrial Average as an indicator of long-term trends in market prices. is similar to the Kondratieff Wave theory D. I. Difficulty: Easy 12-9 . II. B. I. IV and V D. suggests that stock prices can be described by a set of wave patterns C. and V The Dow theory posits that the three forces that simultaneously affect stock prices are primary trend. III.Chapter 12 . Difficulty: Easy 23. and minor trend. A and B E. and C Both the Elliot Wave Theory and the Kondratieff Wave Theory are recent variations on the Dow Theory. 87. bullish signal by some fundamentalists E. bearish. bullish D.25. above D.000. it is considered to be a bearish signal when market price breaks through the moving average from above.15.866. C and D A trin ratio of less than 1.87. bearish.000) = 0. A. Difficulty: Easy 26. 0. bullish above E. 1991 there were 1. The trin ratio for that day was ________ and technical analysts were likely to be ________. A. bullish: below C. 0. In addition.0 is considered bullish because the declining stocks have lower average volume than the advancing stocks.87. A trin ratio of less than 1.0 is considered as a _________. 1.031/610) / (112. it is considered to be a ____________ signal when market price breaks through the moving average from ____________.000/58. B and C In regard to moving averages. indicating net buying pressure. bullish B. bearish signal by some technical analysts and a bullish signal by other technical analysts D.388. bearish E. indicating a buying pressure. it is considered to be a bullish signal when market price breaks through the moving average from below. The volume in advancing issues was 112. bearish signal B.031 stocks that advanced on the NYSE and 610 that declined.188. bearish C.000 and the volume in declining issues was 58. below B. In regard to moving averages. A. On October 29. A trin ratio less than 1 is considered bullish because advancing stocks have a higher volume than declining stocks. Difficulty: Moderate .15. 1. none of the above (1. Difficulty: Moderate 27.866. bullish signal C. bearish C. bullish E. bearish D. bullish or bearish B. bond yields. put-call ratio B. bond yields. the number of outstanding put options divided by outstanding call options. Difficulty: Moderate 30. confidence index E. the number of outstanding call options divided by outstanding put options. odd lot trades. The put/call ratio is computed as ____________ and higher values are considered ____________ signals. put/call ratios. bullish Then confidence index is computed from bond yields and higher values are considered bullish signals. all of the above Breadth 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. bullish E.Chapter 12 . trin ratio C. Then confidence index is computed from ____________ and higher values are considered ____________ signals. A. A. bullish D. Difficulty: Moderate 31. ____________ 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. bearish The put/call ratio is computed as the number of outstanding put options divided by outstanding call options and higher values are considered bullish or bearish signals. bearish B. A. Breadth D. 12-11 . the number of outstanding put options divided by outstanding call options. bullish C. odd lot trades. the number of outstanding put options divided by outstanding call options.Behavioral Finance and Technical Analysis 29. the number of outstanding call options divided by outstanding put options. The anomalies literature ____________. provides a conclusive rejection of market efficiency B. the mean-variance efficiency of the selected market proxy B. Tests of market efficiency have focused on ____________. strategies that would have provided superior risk-adjusted returns C. . all of the above Behavioral finance argues that 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. Difficulty: Moderate 34. the failure to uncover successful trading rules or traders cannot be taken as proof of market efficiency C. provides a conclusive support of market efficiency C. A. A. A and B Tests of market efficiency have focused on strategies that would have provided superior riskadjusted returns and results of actual investments of professional managers.Difficulty: Moderate 33. B and C E. even if security prices are wrong it may be difficult to exploit them B. investors are rational D. Difficulty: Moderate 35. A and B E. results of actual investments of professional managers D. suggests that several strategies would have provided superior returns D. A and C E. Behavioral finance argues that ____________. none of the above The anomalies literature suggests that several strategies would have provided superior returns. A. unlimited B. A. Framing errors C. A. people give too much weight to recent experience compared to prior beliefs. people give too little weight to recent experience compared to prior beliefs. A. Markets would be inefficient if irrational investors __________ and actions of arbitragers were __________. none of the above 12-13 . Mental accounting errors D. Difficulty: Moderate 38. Difficulty: Moderate 39. Regret avoidance E. none of the above Markets would be inefficient if irrational investors existed and actions if arbitragers were limited. tend to make forecasts that are not extreme enough given the uncertainty of their information E. 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 too extreme given the uncertainty of their information B. limited D. __________ can lead investors to misestimate the true probabilities of possible events or associated rates of return. existed. unlimited C. tend to make forecasts that are too extreme given the uncertainty of their information C.Chapter 12 . Information processing errors B. people give too little weight to recent experience compared to prior beliefs. Kahneman and Tversky (1973) report that __________ and __________. existed. did not exist. did not exist. limited E. all of the above Information processing errors can lead investors to misestimate the true probabilities of possible events or associated rates of return.Behavioral Finance and Technical Analysis Difficulty: Moderate 36. Kahneman and Tversky (1973) report that people give too much weight to recent experience compared to prior beliefs and tend to make forecasts that are too extreme given the uncertainty of their information. . all of the above The law-of-one-price posits that ability to arbitrage would force prices of identical goods to trade at equal prices. concave and defined in terms of loses relative to current wealth E.Chapter 12 . s-shaped (convex to losses and concave to gains) and defined in terms of wealth. closed-end funds D. A and C E. s-shaped (convex to losses and concave to gains) and defined in terms of loses relative to current wealth. convex and defined in terms of wealth. convex and defined loses relative to current wealth. s-shaped (convex to losses and concave to gains) and defined in terms of loses relative to current wealth C. However. Conventional theory assumes that utility functions are concave and defined in terms of wealth whereas prospect theory assumes that utility functions are s-shaped (convex to losses and concave to gains) and defined in terms of loses relative to current wealth.Behavioral Finance and Technical Analysis Difficulty: Moderate 45. However. The law-of-one-price posits that ability to arbitrage would force prices of identical goods to trade at equal prices. Difficulty: Difficult 46. The assumptions concerning the shape of utility functions of investors differ between conventional theory and prospect theory. equity carve outs C. A. concave and defined in terms of wealth D. A. 12-15 . concave and defined in terms of wealth. Siamese Twin Companies B. Conventional theory assumes that utility functions are __________ whereas prospect theory assumes that utility functions are __________. empirical evidence suggests that all of the above are often mispriced. concave and defined in terms of gains relative to current wealth The assumptions concerning the shape of utility functions of investors differ between conventional theory and prospect theory. s-shaped (convex to losses and concave to gains) and defined in terms of loses relative to current wealth B. empirical evidence suggests that __________ are often mispriced. incorrect relative pricing. is consistent with D. none of the above Studies of Siamese twin companies find incorrect relative pricing which does not support the EMH. is inconsistent with C. Difficulty: Moderate 56. strong support for the Law of One Price. strong support for the Law of One Price. A. evidence against the Law of One Price. violates C. none of the above Studies of equity carve-outs find evidence against the Law of One Price which violates the EMH. prices at a discount to NAV. is inconsistent with E. does not support C. evidence against the Law of One Price. Studies of Siamese twin companies find __________ which __________ the EMH. does not support E.Difficulty: Difficult 54. correct relative pricing. supports B. prices at a premium to NAV. supports B. Studies of closed-end funds find __________ which __________ the EMH. is consistent with B. supports E. Difficulty: Moderate 55. correct relative pricing. prices at a discount to NAV. Studies of equity carve-outs find __________ which __________ the EMH. B and D Studies of closed-end funds find prices at premiums and discounts to NAV which is inconsistent with the EMH. prices at a premium to NAV. supports D. violates D. incorrect relative pricing. Difficulty: Moderate . A. A. Behavioral Finance and Technical Analysis 12-17 .Chapter 12 .