Limited Time Offer: Save 10% on all 2022 Premium Study Packages with promo code: BLOG10

Behavioral Finance and Market Behaviour

Behavioral Finance and Market Behaviour

Some persistent market patterns such as momentum, value, bubbles, and crashes impact market efficiency and are regarded as functions of behavioral finance.

Market Anomalies

Anomalies are noticeable departures from the efficient market hypothesis, as evidenced by persistently aberrant returns. For instance, an anomaly such as misclassifications may stem from statistical problems, choice of asset pricing model, or temporary disequilibria.

There are ways of explaining some anomalies. Such ways include the analysis of the small sample sizes used, statistical bias in sample selection, survivorship bias, or data mining. It is also important to note that that the benchmark choice is paramount in determining the magnitude of any over or underperformance.

Momentum

When future price behavior aligns with that of the recent past, this is known as momentum or trending effects. Before reverting to the mean, the favorable association typically lasts about two years.

Availability, hindsight, and loss aversion biases can all contribute to momentum.

Regret is the feeling one experiences after missing out on an opportunity. It is often a manifestation of hindsight bias, reflecting the human predisposition to see past events as foreseeable. Thanks to regret, investors may feel an overwhelming urge to act emotionally not to miss out on the next big momentum play.

Bubbles and Crashes

Some bubbles may be products of sensible and logical reasoning. For instance, short-term performance-driven investment managers may attribute their decision to participate in a bubble to further advance their careers.

Bubbles excite confidence in investors. This leads to such anomalies as overtrading, underestimation of risks, failure to diversify, and rejection of any piece of information that contradicts their assessment of the market.

Excessive trading and overconfidence are connected to confirmation bias and self-attribution bias, contributing to a bubble. When a bubble bursts, markets may underreact due to anchoring. This occurs when investors fail to quickly update their beliefs.

Values

High book-to-market equity, low price-to-earnings ratios, and low price-to-dividend ratios are common characteristics of value stocks. High price-to-earnings ratios, low book-to-market equity, and high price-to-dividend ratios are distinguishing characteristics of growth stocks.

Behavioral reasons for value anomalies have been proposed in studies, such as in the Fama–French three-factor model (1993), portraying the anomalies as mispricing rather than compensating for greater risk. Less sophisticated investors who are easily driven by emotions may place a higher value on growth stocks.

Question

 Which of the following is most likely a characteristic of value stocks?

  1. Low book-to-market equity.
  2. Low price-to-dividend ratio.
  3. High price-to-earnings ratio.

The correct answer is B

Value stocks are usually characterized by high book-to-market equity, low price-to-earnings ratios, and low price-to-dividend ratios.

 A and C are incorrect. They are both characteristics of growth stocks. Growth stocks are characterized by high price-to-earnings ratios, low book-to-market equity, and high price-to-dividend ratios.

Shop CFA® Exam Prep

Offered by AnalystPrep

Featured Shop FRM® Exam Prep Learn with Us

    Subscribe to our newsletter and keep up with the latest and greatest tips for success
    Shop Actuarial Exams Prep Shop GMAT® Exam Prep


    Sergio Torrico
    Sergio Torrico
    2021-07-23
    Excelente para el FRM 2 Escribo esta revisión en español para los hispanohablantes, soy de Bolivia, y utilicé AnalystPrep para dudas y consultas sobre mi preparación para el FRM nivel 2 (lo tomé una sola vez y aprobé muy bien), siempre tuve un soporte claro, directo y rápido, el material sale rápido cuando hay cambios en el temario de GARP, y los ejercicios y exámenes son muy útiles para practicar.
    diana
    diana
    2021-07-17
    So helpful. I have been using the videos to prepare for the CFA Level II exam. The videos signpost the reading contents, explain the concepts and provide additional context for specific concepts. The fun light-hearted analogies are also a welcome break to some very dry content. I usually watch the videos before going into more in-depth reading and they are a good way to avoid being overwhelmed by the sheer volume of content when you look at the readings.
    Kriti Dhawan
    Kriti Dhawan
    2021-07-16
    A great curriculum provider. James sir explains the concept so well that rather than memorising it, you tend to intuitively understand and absorb them. Thank you ! Grateful I saw this at the right time for my CFA prep.
    nikhil kumar
    nikhil kumar
    2021-06-28
    Very well explained and gives a great insight about topics in a very short time. Glad to have found Professor Forjan's lectures.
    Marwan
    Marwan
    2021-06-22
    Great support throughout the course by the team, did not feel neglected
    Benjamin anonymous
    Benjamin anonymous
    2021-05-10
    I loved using AnalystPrep for FRM. QBank is huge, videos are great. Would recommend to a friend
    Daniel Glyn
    Daniel Glyn
    2021-03-24
    I have finished my FRM1 thanks to AnalystPrep. And now using AnalystPrep for my FRM2 preparation. Professor Forjan is brilliant. He gives such good explanations and analogies. And more than anything makes learning fun. A big thank you to Analystprep and Professor Forjan. 5 stars all the way!
    michael walshe
    michael walshe
    2021-03-18
    Professor James' videos are excellent for understanding the underlying theories behind financial engineering / financial analysis. The AnalystPrep videos were better than any of the others that I searched through on YouTube for providing a clear explanation of some concepts, such as Portfolio theory, CAPM, and Arbitrage Pricing theory. Watching these cleared up many of the unclarities I had in my head. Highly recommended.