BUSI 4500 Chapter Notes - Chapter 7: Corporate Finance, Loss Aversion, Capital Structure

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Behavioral Corporate Finance
Efficient Market Hypothesis (EMH)
- investors are rational utility maximizers
- stock price reflect all info
- market price = optimal (Pt*=Pt+Ut)
Problem
- excess volatility
o div/earnings > volatile than MV
- momentum vs reversal
o observe behavior vs efficient market
o reversal : best performance become the worst
- under/over reaction
- bubble/ crash
o x buuble/crash in EMH
Rational behavior
- assume rational behavior when use behavioral finance to explain market
anomalies
- decision making process that leads to optimal lvl of benefit / utility for
indv
- x always rational, cognitive imperfection
- inherent bias
Behavioral Finance
- attempt to explain how reasoning error influence rational decision
making
- type of cognitive error
o biases
explain market anomalies/crashes/panics/less optimal
decision
overconfidence
overestimate skills/abilities
80% say they are above average
overoptimistic
overestimate + CF
underestimate CF
might accept NPV project
confirmation bias
give > weight to info & opinion u believe
only focus on info they want
o framing effects
frame dependence
the way you frame the ques
eg. 200 ppl saved vs 1/3 chance of 600ppl save &
2/3 die
loss aversion
focus on ST loss & gain, x overall wealth effect
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Document Summary

Efficient market hypothesis (emh) investors are rational utility maximizers stock price reflect all info. Excess volatility: div/earnings > volatile than mv. Momentum vs reversal: observe behavior vs efficient market, reversal : best performance become the worst. Bubble/ crash: x buuble/crash in emh. Assume rational behavior when use behavioral finance to explain market anomalies. Decision making process that leads to optimal lvl of benefit / utility for indv. X always rational, cognitive imperfection inherent bias. 2/3 die loss aversion focus on st loss & gain, x overall wealth effect: ppl act fast for gain, x loss, eg. confirm get 500 vs flip coin, 50% get 0, 50% get. Make decision based on potential loss/gain rather than final outcome. Eg. choose sure profit vs higher uncertain payoff. Smart money vs ordinary money smart money: cash invest by informed rational investors. Emh x need investor to be rational. X always have power to drive market prices.

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