Chapter 09 – Behavioral Finance and Technical Analysis
CHAPTER 09
BEHAVIORAL FINANCE AND TECHNICAL ANALYSIS
1. Note the following matches:
a. Investors are slow to update their beliefs when given new evidence –
Conservatism bias
b. Investors are reluctant to bear losses due to their unconventional decisions
– Regret avoidance
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 to exploit the mispricing because the correction to price could happen
4. The premise of behavioral finance is that conventional financial theory ignores
how real people make decisions and that people make a difference. Behavioral
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
6. a. Loss aversion.
Chapter 09 – Behavioral Finance and Technical Analysis
8. a. Selling losers quickly.
10. After the fact, you can always find patterns and trading rules that would have
11. Grinblatt and Han (2005) show that the disposition effect can lead to momentum
in stock prices even if fundamental values follow a random walk. This momentum
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
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
14. Trin = Volume Declining/Number Declines
15. Breadth:
Advances
Declines
Net Advancing
16. This exercise is left to the student.
17.
a. The confidence index increases from 5%/7% = 0.7143 to 6%/8% =
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;
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 4–8
21.902
Days 5–9
(21.13 + 22 + 21.88 + 22.50 + 23.13)/5 =
22.128
Days 6–10
(22 + 21.88 + 22.50 + 23.13 + 23.88)/5 =
22.678
Days 7–11
(21.88 + 22.50 + 23.13 + 23.88 + 24.50)/5 =
23.178
Days 8–12
( 22.50 + 23.13 + 23.88 + 24.50 + 23.25)/5 =
23.452
Days 9–13
(23.13 + 23.88 + 24.50 + 23.25 + 22.13)/5 =
23.378
Days 10–14
23.152
Days 11–15
(24.50 + 23.25 + 22.13 + 22 + 20.63)/5 =
22.502
Days 13–17
(22.13 + 22 + 20.63 + 20.25 + 19.75)/5 =
20.952
Days 14–18
(22 + 20.63 + 20.25 + 19.75 + 18.75)/5 =
20.276
Days 15–19
(20.63 + 20.25 + 19.75 + 18.75 + 17.50)/5 =
19.376
Days 16–20
(20.25 + 19.75 + 18.75 + 17.50 + 19)/5 =
19.050
Days 17–21
(19.75 + 18.75 + 17.50 + 19 + 19.63)/5 =
18.926
Days 18–22
(18.75 + 17.50 + 19 + 19.63 + 21.50)/5 =
19.276
Days 19–23
(17.50 + 19 + 19.63 + 21.50 + 22)/5 =
19.926
Days 20–24
21.052
Days 22–26
(21.50 + 22 + 23.13 + 24 + 25.25)/5 =
23.176
Days 23–27
24.126
Days 24–28
25.126
Chapter 09 – Behavioral Finance and Technical Analysis
Days 25–29
(24 + 25.25 + 26.25 + 27 + 27.50)/5 =
26.000
Days 26–30
(25.25 + 26.25 + 27 + 27.50 + 28)/5 =
26.800
Days 27–31
(26.25 + 27 + 27.50 + 28 + 28.50)/5 =
27.450
Days 28–32
(27 + 27.50 + 28 + 28.50 + 28)/5 =
27.800
Days 29–33
(27.50 + 28 + 28.50 + 28 + 27.50)/5 =
27.900
Days 30–34
(28 + 28.50 + 28 + 27.50 + 29)/5 =
28.200
Days 31–35
(28.50 + 28 + 27.50 + 29 + 29.25)/5 =
28.450
Days 32–36
(28 + 27.50 + 29 + 29.25 + 29.50)/5 =
28.650
Days 34–38
(29 + 29.25 + 29.50 + 30 + 28.50)/5 =
29.250
Days 35–39
(29.25 + 29.50 + 30 + 28.50 + 27.75)/5 =
29.000
Days 36–40
28.750
20.
Buy
30
X
28
X
0
26
X
24
X
22
X
0
X
20
X
0
X
18
0
X
16
21. This pattern shows a lack of breadth. Even though the index is up, more stocks
22.
Day
Advances
Declines
Net
Advances
Cumulative
Breadth
Chapter 09 – Behavioral Finance and Technical Analysis
2
653
986
–333
–131
3
721
789
– 68
–199
4
503
968
–465
–664
5
497
1,095
–598
6
970
702
268
–994
7
1,002
609
393
–601
8
903
722
181
–420
9
850
748
102
–318
766
766
–318
The signal is bearish as cumulative breadth is negative; however, the negative
number is declining in magnitude, indicative of improvement. Perhaps the worst
of the bear market has passed.
23. Trin = Volume Declining/Number Declining
Value Advancing/Number Advancing = 900,000,000/704
1,100,000,000/906 = 1.0529
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 graph also shows the values of the S&P 500 index.
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.]
a. The graphs summarize the relative strength of data for the Fidelity
Banking Fund.
105
115
145
155
Index and index MA
SP 500 index and 26-week moving average
Index level
26-week MA
Chapter 09 – Behavioral Finance and Technical Analysis
c. Over five-week intervals, relative strength decreases by more than 5%
thirty one times, out of 255 instances. The Fidelity Banking Fund
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 underperform the S&P 500 index than it is to outperform the
27. Pontiff (1996) demonstrates that deviations of price from net asset value in
closed-end funds tend to be higher in funds that are more difficult to arbitrage, for
example, those with more idiosyncratic volatility. Since well diversified funds
represent less of an opportunity for arbitrage by removing the impact of individual
stock anomalies, they would likely have smaller deviations from NAV.
0.20
0.60
0.80
1.20
2004.25 2004.75 2005.25 2005.75 2006.25 2006.75 2007.25 2007.75 2008.25
FSRBX/SP 500, MA
Year.week
Relative strength FSRBX vs. SP 500
Chapter 09 – Behavioral Finance and Technical Analysis
CFA 1
Answer:
i. Mental accounting is best illustrated by Statement #3. Sampson’s
requirement that his income needs be met via interest income and stock
dividends is an example of mental accounting. Mental accounting holds
that investors segregate funds into mental accounts (e.g., dividends and
capital gains), maintain a set of separate mental accounts, and do not
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
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
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 outcomes; a loss in one account is treated separately from a loss
in another account. One manifestation of mental accounting, in which
Chapter 09 – Behavioral Finance and Technical Analysis
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 market data on the Internet. He may have access to a large
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 for it. This fixation on a reference point, and the subsequent
c. Familiarity: Maclin is evaluating his holding of company stock based on his
familiarity with the company rather than on sound investment and portfolio
principles. Company employees, because of this familiarity, may have a
CFA 4
Answer:
Chapter 09 – Behavioral Finance and Technical Analysis
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
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 the Trust into two “accounts”: the returns that the Trust
CFA 5
Answer:
i. Overconfidence (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 reflecting overconfidence in
the form of both biased expectations and an illusion of control. Pierce is likely
more confident in the validity of those forecasts than is justified by the
accuracy of prior forecasts. Analysts’ consensus forecasts have proven
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
Chapter 09 – Behavioral Finance and Technical Analysis
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 current value as related
to original cost, her reference point. Her decision does not consider any