Newcastle University

Aims

This module aims to provide students with a detailed understanding of Behavioural Finance (BF). The module will focus in particular on the use of empirical work for investigating BF theories.

Original Summary:
BF is an unorthodox area of finance that assumes financial markets are fundamentally inefficient. Advocates of BF believe that investor behaviour and decision making are driven by aspects of personal and market psychology. This course will involve an introduction to BF followed by a detailed analysis of the main issues.

Outline Of Syllabus

1. Introduction: What is ‘traditional’ view in finance, challenges of the traditional view, behavioural finance as an alternative approach

Part 1: The Traditional View
2. ‘Traditional’ finance theory: utility analysis, portfolio theory, asset pricing models, arbitrage, rational stock valuation
3. Efficient market hypothesis: theoretical underpinnings of the EMH, empirical evidence, irrational investors and market efficiency

Part 2: Limits to Arbitrage
4. Noise trader risk and arbitrage: risk due to noise trader activities, limited arbitrage and its consequences for the EMH
5. Investor sentiment and closed-end funds: irrational investors and their systematic impact on stock prices, empirical evidence
6. Agency theory and limits of arbitrage: agency theory and fund managers’ behaviour, limited arbitrage and the consequences for stock prices

Part 3: Irrational Investors
7. Investor psychology: rational behaviour, deviations from rationality in investor’s preferences and beliefs, prospect theory and cognitive biases
8. A model of investor sentiment: investment decisions driven by representativeness and conservatism, deviations from market efficiency
9. Positive feedback investment strategies and destabilizing speculations: extrapolative expectations, investing on noise rather than information, rational arbitrage destabilizing stock prices
10. Behavioural corporate finance: managerial decision making and exploitation of market inefficiencies, managers and investors as irrational individuals

Teaching Rationale And Relationship

Lectures provide the basic structure of the methods and theories that are introduced and an overview of the current issues.

Seminars provide an opportunity to enhance understanding of the empirical methods and the theoretical aspects of the module.

Assessment Rationale And Relationship

The essay tests understanding of BF and in particular the application of empirical methods of BF issues.