Behavioral Finance Problem Set 1

Assume you purchased Applesoft Inc. on March 1, 2008 and want to sell it since it increased in price. After a quick thought you recognize that you bought it earlier, in Dec. 2007. Now you decide to keep Applesoft Inc. instead. How is this behavior called?

• Overconfidence

• Disposition Effect

• Loss Aversion

• Seasonality

What is true about (Behavioral) Finance?

• Less than fully rational behavior.

• Limits of arbitrage are possible.

• Perfect information processing.

• Mispricings are possible.

Assume you play a lottery, which earns you $0 with probability 0.9 and $1000 with probability 0.1 (Option A). Your second option is to win a certain amount of $100 (Option B). Which option would you choose, if you were risk-averse (without knowing the precise utility function)?

• Option A

• Option B

Recall the mean posterior belief from the Normal-Normal-Model of Bayesian Updating:
 $s\cdot\frac{\frac{1}{\sigma^2}}{\frac{1}{\sigma^2}+\frac{1}{\tau^2}}+\mu_0\cdot\frac{\frac{1}{\tau^2}}{\frac{1}{\sigma^2}+\frac{1}{\tau^2}}$ 
 What is the meaning of the term
 $\frac{\frac{1}{\sigma^2}}{\frac{1}{\sigma^2}+\frac{1}{\tau^2}}$  ?

• Signal

• Weight on the prior belief
  

• Prior belief
  

• Weight on the signal
  

In class you learned about mispricings resulting from spin-offs. Which possible reason(s) can explain this phenomenon?

• Currency Risk

• Taxation

• Noise Trader Risk

• Liquidity

Firm A wants to spin off its wholly owned subsidiary B. Stockholders of A will receive 1.5 shares of B per share of A. After the IPO of B we observe the following prices:

A: $80 and B: $70

What is the correct "stub value"?

• 10

• -50

• 50

• -25