Chapter 09 – Behavioral Finance and Technical Analysis
CHAPTER 09
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Chapter 09 – Behavioral Finance and Technical Analysis
BEHAVIORAL FINANCE AND TECHNICAL ANALYSIS
1. Note the following matches:
a. Investors are slow to update their beliefs when given new evidence –
b. Investors are reluctant to bear losses due to their unconventional decisions –
c. Investors exhibit less risk tolerance in their retirement accounts versus their other
d. Investors are reluctant to sell stocks with “paper” losses – Disposition effect
e. Investors disregard sample size when forming views about the future from the
2. Representativeness bias. The sample size is not considered when making future decisions.
3. Fundamental risk means that even if a security is mispriced, it still can be risky to attempt
4. The premise of behavioral finance is that conventional financial theory ignores how real
5. An unfortunate consequence of behavioral finance (BF) is a tendency for investors to
assume more than actually is claimed by the field. While BF is highly critical of EMH
6. c. Loss aversion.
7. a. Fear of regret.
8. a. Selling losers quickly.
9. Statement b, that a price has moved above its 52 week moving average, is considered a
10. After the fact, you can always find patterns and trading rules that would have generated
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Chapter 09 – Behavioral Finance and Technical Analysis
11. Grinblatt and Han (2005) show that the disposition effect can lead to momentum in stock
12. Arbitrage assumes the ability to initiate trades based on arbitrage information. A severe
limit of the theory is that similar assets should be priced similarly (law of one price). An
example of a limit in which such a trade is not possible is the case of Royal Dutch
13. Some people may say it is consistent with both. This is consistent with efficient markets
since the price does approach intrinsic value. Behavioral would say it is consistent since
14. Trin =
Volume Declining/Number Declining
Value Advancing/Number Advancing
=
Equity in Account
Value of Stock
Equity in Account
Value of Stock
231,468,687/270
4,681,742,414/2,787
= 0.5103
This trin ratio, which is below 1.0, would be taken as a bullish signal.
15. Breadth:
Advances Declines Net Advancing
2,787 270 2,517
16. This exercise is left to the student.
17. The confidence index increases from 5%/7% = 0.7143 to 6%/8% = 0.7500. This
18. At the beginning of the period the relative strength of Computers, Inc., the price of
the stock divided by the industry index, was 19.63/50.0 = 0.3926; by the end of the
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distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a
website, in whole or part.
Chapter 09 – Behavioral Finance and Technical Analysis
19. Five day moving averages:
Trading Day 5-Day Moving Average
Days 1–5 (19.63 + 20 + 20.50 + 22 + 21.13)/5 = 20.652
Days 2–6 (20 + 20.50 + 22 + 21.13 + 22)/5 = 21.126
Days 3–7 (20.50 + 22 + 21.13 + 22 + 21.88)/5 = 21.502
Days 21–25 (19.63 + 21.50 + 22 + 23.13 + 24)/5 = 22.052 Buy signal
(day 21 price > moving average)
Days 22–26 (21.50 + 22 + 23.13 + 24 + 25.25)/5 = 23.176
Days 33–37 (27.50 + 29 + 29.25 + 29.50 + 30)/5 = 29.050 Sell signal
(day 33 price < moving average)
20.
Buy
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distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a
website, in whole or part.
Chapter 09 – Behavioral Finance and Technical Analysis
30
X
28
X 0
26
X
X X
21. This pattern shows a lack of breadth. Even though the index is up, more stocks declined
22.
Day Advances Declines Net
Advances
Cumulative
Breadth
1 906 704 202 202
2 653 986 –333 –131
3 721 789 – 68 –199
4 503 968 –465 –664
23. Trin =
Volume Declining/Number Declining
Value Advancing/Number Advancing
=
900,000,000/704
1,100,000, 000/906
=
9-5
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distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a
website, in whole or part.
Chapter 09 – Behavioral Finance and Technical Analysis
24. Confidence Index =
Yield on Top-Rated Corporate Bonds
Yield on Intermediate-Grade Corporate Bonds
25. [Note: In order to create the 26-week moving average for the S&P 500, we first converted
the weekly returns to weekly index values, using a base of 100 for the week prior to the
first week of the data set.]
a. The graph below summarizes the data for the 26-week moving average. The
b. The S&P 500 crosses through its moving average from below fifteen times, as
c. The S&P 500 crosses through its moving average from above sixteen times, as
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distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a
website, in whole or part.
Chapter 09 – Behavioral Finance and Technical Analysis
26. [Note: In order to create the relative strength measure, we convert the weekly returns for
the Fidelity Banking Fund and for the S&P 500 to base 100 weekly index values.]
b. Over five-week intervals, relative strength increased by more than 5% sixteen
c. Over five-week intervals, relative strength decreases by more than 5% thirty one
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Chapter 09 – Behavioral Finance and Technical Analysis
d. An increase in relative strength, as in part (b) above, is regarded as a bullish
signal. However, in our sample, the Fidelity Banking Fund is more likely to
27. Pontiff (1996) demonstrates that deviations of price from net asset value in closed-end
CFA 1
Answer:
i. Mental accounting is best illustrated by Statement #3. Sampson’s requirement
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distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a
website, in whole or part.
Chapter 09 – Behavioral Finance and Technical Analysis
ii. Overconfidence (illusion of control) is best illustrated by Statement #6.
Sampson’s desire to select investments that are inconsistent with his overall
iii.Reference dependence is best illustrated by Statement #5. Sampson’s desire to
retain poor performing investments and to take quick profits on successful
CFA 2
Answer:
a. Frost’s statement is an example of reference dependence. His inclination to sell the
international investments once prices return to the original cost depends not only
b. Frost’s statement is an example of susceptibility to cognitive error, in at least two
ways. First, he is displaying the behavioral flaw of overconfidence. He likely is
more confident about the validity of his conclusion than is justified by his rate of
success. He is very confident that the past performance of Country XYZ indicates
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distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a
website, in whole or part.
Chapter 09 – Behavioral Finance and Technical Analysis
c. Frost’s statement is an example of mental accounting. Mental accounting holds
that investors segregate money into mental accounts (e.g., safe versus
speculative), maintain a set of separate mental accounts, and do not combine
In standard finance, decisions consider the risk and return profile of the entire
portfolio rather than anticipated gains or losses on any particular account,
investment, or class of investments. Alternatives should be considered in terms of
CFA 3
Answer:
a. Illusion of knowledge: Maclin believes he is an expert on, and can make accurate
forecasts about, the real estate market solely because he has studied housing
Overconfidence: Overconfidence causes us to misinterpret the accuracy of our
information and our skill in analyzing it. Maclin has assumed that the information
b. Reference point: Maclin’s reference point for his bond position is the purchase
price, as evidenced by the fact that he will not sell a position for less than he paid
c. Familiarity: Maclin is evaluating his holding of company stock based on his
familiarity with the company rather than on sound investment and portfolio
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distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a
website, in whole or part.
Chapter 09 – Behavioral Finance and Technical Analysis
CFA 4
Answer:
a. The behavioral finance principle of biased expectations/overconfidence is most
consistent with the investor’s first statement. Petrie stock provides a level of confidence
and comfort for the investor because of the circumstances in which she acquired the
b. The behavioral finance principle of mental accounting is most consistent with the
investor’s second statement. The investor has segregated the monies distributed from
CFA 5
Answer:
i. Overcondence (Biased Expectations and Illusion of Control): Pierce
is basing her investment strategy for supporting her parents on her
confidence in the economic forecasts. This is a cognitive error
re ecting overconfidence in the form of both biased expectations
Standard finance investors understand that individuals typically
have greater confidence in the validity of their conclusions than is
justified by their success rate. The calibration paradigm, which
9-11
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distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a
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Chapter 09 – Behavioral Finance and Technical Analysis
ii. Loss Aversion (Risk Seeking): Pierce is exhibiting risk aversion in deciding
to sell the Core Bond Fund despite its gains and favorable prospects.
She prefers a certain gain over a possibly larger gain coupled with a
smaller chance of a loss. Pierce is exhibiting loss aversion (risk
Standard finance investors are consistently risk averse, and
systematically prefer a certain outcome over a gamble with the same
iii. Reference Dependence: Pierce’s inclination to sell her Small
Company Fund once it returns to her original cost is an example
of reference dependence. Her sell decision is predicated on the
In standard finance, alternatives are evaluated in terms of terminal
wealth values or final outcomes, not in terms of gains and losses
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distribution in any manner. This document may not be copied, scanned, duplicated, forwarded, distributed, or posted on a
website, in whole or part.