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6 Cards in this Set
- Front
- Back
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Traditional Finance |
Focuses on how investors "should" behave (i.e. the rational economic man) |
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Behavioral Finance |
Is descriptive and focuses on how investors actually behave and make decisions.
-Investors may or may not act in a risk-averse, utility maximizing manner - which can lead to inefficient markets (and suboptimal decisions from a TF perspective) |
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Micro Behavioral Finance |
Describes the decision making process of individuals |
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Macro Behavioral Finance |
Focuses on how and why markets deviate from what TF calls efficient |
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4 Axioms of a Rational Decision Maker |
1) Completeness: Assumes individuals know their preferences and use them to decide between mutually exclusive alternatives (i.e. given a or b, they can choose a, b, or be indifferent)
2) Transitivity: Assumes individuals consistently apply their completeness rankings. (if a is preferred to b and b is preferred to c, then a is preferred to c)
3) Independence: Rankings are additive and proportional. If A and B are mutually exclusive where A is preferred and D is an additional choice that adds positive utility, then A + x(D) will be preferred to B + x(D) (where x is some proportion of D)
4) Continuity: Assumes utility indifference curves are continuous - unlimited weighting combinations are possible. If A is preferred to B which is preferred to C, then there will be a combination of A and C for which the individual is indifferent to B |
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Bayes' Theorem |
Decision process of a Rational Economic Man: |
