Behavioral Finance Notes

Establishes foundational concepts and contrasts neoclassical finance with behavioral financial economics. Topics include the Efficient Market Hypothesis (EMH - Eugene Fama: weak, semi-strong, and strong forms of market efficiency; random walk hypothesis); theoretical foundations of traditional finance: Expected Utility Theory (von Neumann-Morgenstern), Capital Asset Pricing Model (CAPM), and arbitrage; limitations and empirical failures of standard finance paradigms; defining Behavioral Finance; the history and evolution of behavioral economic thought; and limits to arbitrage (fundamental risk, noise trader risk, implementation costs, short-sale constraints) explaining why rational arbitrageurs cannot eliminate market mispricing.

Deconstructs the cognitive shortcuts and mental rules of thumb used by investors under uncertainty. Topics include Heuristics defined: system 1 (fast, intuitive) versus system 2 (slow, analytical) thinking under Kahneman; Representativeness heuristic (base-rate neglect, sample size neglect, gambler's fallacy); Availability heuristic (recency bias, salience bias); Anchoring and adjustment bias; Overconfidence bias (better-than-average effect, miscalibration, illusion of control, self-attribution bias); Confirmation bias and cognitive dissonance; and Mental Accounting (Richard Thaler: categorizing money into non-fungible mental accounts, house money effect, sunk cost fallacy).

Delivers comprehensive mathematical and psychological analysis of Daniel Kahneman and Amos Tversky's Prospect Theory. Topics include Expected Utility Theory versus Prospect Theory; the S-shaped value function (reference dependence, diminishing sensitivity, loss aversion: losses loom larger than gains by a factor of 2 to 2.5); the probability weighting function (overweighting small probabilities, underweighting moderate and large probabilities); framing effects (choice shifts caused by presentation wording); Disposition Effect (Shefrin & Statman: tendency to sell winning stocks too early and hold losing stocks too long); and emotional biases: regret avoidance, endowment effect, status quo bias, and emotional herd mentality.

Examines empirical market patterns that contradict efficient market pricing and the anatomy of financial crises. Topics include Market Anomalies: Calendar anomalies (January effect, weekend/Monday effect, turn-of-the-month effect), Cross-sectional anomalies (size effect / small-firm anomaly, value versus growth anomaly, book-to-market ratio), and Time-series anomalies (momentum effect, long-term price reversal); the Equity Premium Puzzle; and the psychology of speculative asset bubbles: stages of a bubble (displacement, boom, euphoria, profit-taking, panic / Kindleberger-Minsky model), historical and modern bubbles (Tulip Mania, Dot-Com boom, Bitcoin volatility, 2008 subprime mortgage crisis), and investor herd behavior in financial markets.

Addresses executive decision-making biases in corporate management and behavioral policy interventions. Topics include behavioral corporate finance: managerial overconfidence and hubris in corporate mergers and acquisitions; over-optimism in capital budgeting forecasts; capital structure timing (issuing equity when overvalued); dividend policy signaling; investor profiling and behavioral investment coaching; wealth management applications; and Richard Thaler and Cass Sunstein's Nudge Theory: choice architecture, default options in retirement savings (Save More Tomorrow program), financial literacy programs, and regulatory behavioral interventions in retail investor protection.