U30273 Behavioral Finance Theoretical and Empirical Evidence

Question:

a)One line of research regarding IPO long-run under performance focuses on whether investors are systematically being fooled by accounting tricks and earnings management actions that managers of IPO firms employ around the time that their firms go public, with the goal being making the firms’ accounting performances look better than they are. Teoh, Welch and Wong (1998) and Roosenboom, van der Goot and Mertens (2003) are two papers along that line of research. First describe in detail the accounting actions on which these two papers focus to uncover this kind of activity by firms and then summarise their main empirical findings as to how the levels of these activities relate to long-run performance of IPO firms. 
 
b)  “Winner’s curse” is central to Rock’s (1986) explanation of IPO underpricing. First explain what winner’s curse means in general and specifically in the context of IPO allocations and underpricing. Then, explain how the informational assumptions and setting of the Rock model lead to IPO underpricing in equilibrium.
 
a)You are told that George studied mathematics in university and did especially well in probability and statistics modules that were part of his degree program. Which description of George has higher probability?
A – George works for a data management company

B – George works for a data management company where he performs statistical analysis of big data

Describe and critically discuss prospect theory and the prospective gain/loss based utility. 

  • Define post earnings announcement drift in stock prices. Describe how various cognitive biases and disposition behaviour on the part of investors might be causing this phenomenon. Discuss the empirical checks we have discussed that aim to determine which of the various hypotheses regarding what may be behind  post earnings announcement drift might have greater support from the data. Finally, discuss how momentum profits may arise if post earnings announcement drift happens regularly in stock markets. 
  • Evidence suggests that individuals’ savings are insufficient for their retirement and the resulting pension shortfall is accentuated by poor investment choices.  What psychological theories have been used to explain these phenomena?  How can these theories be used to ‘nudge’ individuals into making better choices?
  • “The presence of arbitrageurs ensures asset prices do not deviate substantially from fundamental values”.  Critically evaluate this claim with reference to both theoretical and empirical evidence. 
  • The following is an excerpt from Piotroski (2000)

 “Prior research (Rosenberg, Reid, and Lanstein [1984], Fama and French [1992], and Lakonishok, Shleifer, and Vishny [1994]) shows that a portfolio of high BM firms outperforms a portfolio of low BM firms. Such strong return performance has been attributed to both market efficiency and market inefficiency.”

Critically discuss both the market efficiency and market inefficiency based explanations to why we have been observing high book-to-market (BM) firms  outperforming low BM ones. Make sure you include the empirical findings in support of either the market efficiency based argument or the market inefficiency based arguments in your essay. 

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