Finance Chapter 13 Behavioral Aspects Investments Behavioral Aspects Investments This Question Seeks Identify

Chapter 13 – Behavioral Aspects of Investments

CHAPTER 13

Behavioral Aspects of Investments

1. This question seeks to identify whether students will make judgments of risk and return by

relying on textbook valuation techniques or will instead rely on heuristics such as “good

stocks are stocks of good companies.” The central point of the question pertains to whether

students use the CAPM to arrive at their judgments of expected return and risk? For those

that did, what values did they use for the risk-free rate and market risk premium? What

fraction of students arrived at expected returns by beginning with the CAPM, but then

2. The statement about “short-term price reversals” appears to be inconsistent with the

general evidence about short-term momentum. Semantics might be important, as the

Chapter 13 – Behavioral Aspects of Investments

3

For Microsoft, the market factor is the most significant factor, and the negative coefficient

suggests that Microsoft’s stock behaves like a large cap stock.

MSFT

SUMMARY OUTPUT

Regression Statistics

Multiple R 0.643265674

R Square 0.413790727

Adjusted R Square 0.393400839

Standard Error 0.056277501

Observations 120

ANOVA

df SS MS

Regression 4 0.257096115 0.064274

Residual 115 0.364223064 0.0031672

Total 119 0.621319179

Coefficients Standard Error t Stat

Intercept 0.004084437 0.005205316 0.7846665

Excess Return on the Market 1.102463381 0.131786692 8.3655137

Small–Minus-Big Return -0.708668152 0.244067096 –2.9035792

High-Minus-Low Return –0.020112346 0.213929119 –0.0940141

Momentum Factor –0.001066309 0.118365068 –0.0090086

4

For Apple, the most significant factor is the market factor. In addition, Apple stock behaves

like a growth stock.

AAPL

SUMMARY OUTPUT

Regression Statistics

Multiple R 0.646405363

R Square 0.417839893

Adjusted R Square 0.397590846

Standard Error 0.07124195

Observations 120

ANOVA

df SS MS

Regression 4 0.418925599 0.1047314

Residual 115 0.583672778 0.0050754

Total 119 1.002598377

Coefficients Standard Error t Stat

Intercept 0.01437873 0.006589434 2.1820886

Excess Return on the Market 1.375692856 0.166829387 8.2461063

Small–Minus-Big Return –0.26473376 0.308965673 –0.8568387

High-Minus-Low Return –1.096434546 0.270813868 –4.0486647

Momentum Factor –0.115573816 0.149838891 –0.7713206

Chapter 13 – Behavioral Aspects of Investments

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For Walmart, the most significant factor is the market factor. In addition, Walmart’s stock

behaves like a large cap stock, but during this period it also exhibited a momentum effect.

WMT

SUMMARY OUTPUT

Regression Statistics

Multiple R 0.388055392

R Square 0.150586988

Adjusted R Square 0.121042187

Standard Error 0.042962518

Observations 120

ANOVA

df SS MS

Regression 4 0.037631007 0.0094078

Residual 115 0.212264468 0.0018458

Total 119 0.249895475

Coefficients Standard Error t Stat

Intercept 0.004190512 0.003973764 1.0545449

Excess Return on the Market 0.380261164 0.100606603 3.779684

Small–Minus-Big Return -0.419173402 0.186322011 –2.2497256

High-Minus-Low Return 0.259495276 0.163314532 1.5889295

Momentum Factor 0.215533836 0.09036047 2.3852669

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For eBay, the most significant factor is the market factor. During this period, eBay’s stock

also featured a reversal effect corresponding to negative momentum.

Taken together, these results suggest that the CAPM is a strong starting point for analyzing

EBAY

SUMMARY OUTPUT

Regression Statistics

Multiple R 0.692114649

R Square 0.479022687

Adjusted R Square 0.460901737

Standard Error 0.068294464

Observations 120

ANOVA

df SS MS

Regression 4 0.493180747 0.1232952

Residual 115 0.536375389 0.0046641

Total 119 1.029556136

Coefficients Standard Error t Stat

Intercept 0.002047838 0.00631681 0.3241885

Excess Return on the Market 1.40637079 0.159927171 8.7938202

Small–Minus-Big Return -0.293437873 0.296182867 –0.9907321

High-Minus-Low Return –0.454302237 0.259609513 –1.7499445

Momentum Factor –0.281684792 0.143639621 –1.9610522

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reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.

4. Answers to question 4 appear below.

4.1 Categorization and representativeness are concepts strongly related to Precept Capital

Management’s investing strategy. Categorization (page A13-17) involves excessive focus on

7), whereby investors underreact to earnings announcement.

4.2 According to the perspective of Precept Capital Management, Aetna’s CEO was wise to

4.3 The second and third quarters of 2015 featured the kind of divergence displayed in

4.4 Walmart featured a divergence in late 2014, with a sell signal. MGM featured a

divergence in late 2014, with a buy signal. Intel featured a divergence in late 2014, with a

8

reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.

6. Whether full fee broker or discount broker, Martha Stewart’s portfolio contained more

stocks than the average investor. However, her portfolio was concentrated in technology

stocks, and was not well diversified. When the dot.com bubble burst, she appears to have

7. 7.1 (a), 7.2 (c), 7.3 (b), 7.4 (a), 7.5 (b), 7.6 (72/20 = 3.6 years)

8. The context for question 8 is that question 7 is used as a short quiz to measure financial

literacy across the U.S. population. The subquestions in question 7 provide a general sense of

9

9. The Bolt’s financial planner might proceed by identifying a series of issues and questions

for discussion. Some examples are the following:

i. What are some of the key factors that will ensure that William and Mira do not

outlive their retirement assets? Answering this question requires the elicitation of additional

There are textbook techniques for performing a quantitative analysis of matching

consumption spending to wealth and investment strategies. One example is the following:

This spreadsheet displays the case of William, age 52 (column A), with the family income

Chapter 13 – Behavioral Aspects of Investments

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will depend on the Bolt’s rate of consumption. Base Consumption (in Column I) reflects

regular consumer spending. Extra consumption reflects additional items such as spending on

children’s education. Column H displays the Bolt’s wealth accumulation, and column L

The above analysis is oversimplified, and the numerical inputs refined as the Bolt’s financial

planner interacts with them to identify their situation.

Other issues to consider are the following. It is important to reevaluate their portfolio as their

situation changes. For instance, in the earlier years, the Bolts may be more willing to take on

ii. There are benefits to keeping savings in a mix of taxable, tax-deferred, and tax-free

accounts. Critical issues in the decision pertain to minimizing taxes, generating returns, and

Chapter 13 – Behavioral Aspects of Investments

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to access if withdrawals are premature. Taxable accounts are costly from a tax perspective,

but offer flexibility in terms of access.

iv. Is there a concern about the Bolt’s investment portfolio being overly concentrated in

William’s company’s stock? The answer is yes, for the reasons described in the chapter. The

vi. Does William exhibit any problematic mental accounting issues? William

compartmentalizes his wealth by matching his 401(k) and Mira’s SEP–IRA to fund

retirement and his RSUs to fund children’s education. Mental accounting-based thinking can

Chapter 13 – Behavioral Aspects of Investments

vii. Should Mira purchase life insurance? Mira should purchase life insurance, not so much to

replace her income, but to provide for the funding of what would be needed to replace many

of the major services she provides to her family.

viii. What guidance can the Big Five framework offer a financial planner in the case of the

Bolts? The financial planner can infer that William is more open and extraverted than Mira,

10. James Stewart judged eBay to be a very good company, “in the process of transforming

world commerce and has a natural monopoly,” which appears to be the only basis for his

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reproduction or further distribution permitted without the prior written consent of McGraw-Hill Education.

11. Sommer’s argument touches on several behavioral issues associated with dividends. The

dividend premium is one of the components of the Baker-Wurgler sentiment index. Both the

12. When Warren Buffett described his investment philosophy as being greedy when others

are fearful and being fearful when others are greedy, he meant being a contrarian. The

empirical evidence suggests that stocks with high sentiment beta perform poorly subsequent

Chapter 13 – Behavioral Aspects of Investments

Minicase

Case Analysis Questions

1. The most important factors for both foundations relate to the desire to respect the wishes

of the two respective HP founders. At various times, foundation and executive board

members for both foundations discussed diversifying their respective portfolios. David

3. Group homogeneity is one of the main conditions associated with groupthink. Group

members who value esprit de corps become unwilling to challenge each other’s position, and