1. Behavioral Finance
Economics 437

2. Mental Accounting Sale of two items $ 150 Jacket $ 5 calculator
Will you go to the store two blocks away to buy $ 145 jacket?
To get the calculator for free
Get a free ticket to go to the play. Lose the ticket that morning, will you go?
Find $ 1,000 on the street. Get a $ 1,000 unexpected dividend on your stock.

3. Fairness and “Reference Points”
Shortage of cars develops
Dealer raises prices $ 200 above list
71 % unfair
Dealer has been selling these cars at a discount of $ 200 below list price. He now eliminates the discount
Only 42 % unfair

4. Cutting wages
A small co employs several people. Workers’ incomes have been about average for the community. Business is slow. Owners reduce the workers’ wages by 10 percent for the year
61 % unfair
A small co employs several people. The workers have been receiving a 10% bonus each year. Business is slow. Owners eliminate the bonus for the year.
20 % unfair

5. Tipping
Survey
A restaurant you visit frequently, bill is $ 10, what is the tip?
$ 1.28 on average
A restaurant in another city that you do not intend to return to
$ 1.27 on average

6. Another Example Can of insecticide costs $ 10 Same can but has no risk
Current risk level 15 out of 10,000 (injured)
What would you pay to eliminate the risk
Result of survey $ 3.78
Same can but has no risk
What price reduction would be okay to have a 1 in 10,000 risk?
77 % said they would refuse to buy the product at any price if the risk were increased

7. Is Steve? Farmer Salesman Airline Pilot Librarian Physician
Steve is very shy and withdrawn, invariably helpful, but with little interest in people, or in the world of a reality
Is Steve?
Farmer
Salesman
Airline Pilot
Librarian
Physician

8. Hmmm? We are in a room of 70 engineers and 30 lawyers
Bill is a 30 year old man. He is married with no children. A man of high ability and high motivation, he promises to be quite successful in his field. He is well liked by his colleagues
Is Bill more likely to be a lawyer or an engineer?

9. Going to the UVA Basketball Game
Paid $ 200 for a courtside ticket
As you try to enter, you realize you have lost the ticket
Someone offers to sell you another ticket for $ 200….would you buy it?
You are on the way to the basketball game and have decided to pay $ 200 for a courtside ticket
As you try to enter, you realize that you have lost two hundred dollar bills, but still have several left and can buy the ticket
Would you still buy the ticket?

10. Sunk Costs
A man joins a tennis club and pays a $ 3000 yearly membership fee. After two weeks of playing, he develops a tennis elbow
He continues to play (in pain) saying: “I don’t want to waste the $ 300”

11. Naïve Diversification
Four Choices:
Three Bond Funds
One Stock Fund
Put ¼ in each
Four Other Choices
Three Stock Funds
One Bond Fund

12. Biases
Small Sample Bias: “The strong bias toward believing that small samples closely resemble the population from which they are drawn…” page (e.g. cancer in rural counties)
Anchoring including “anchoring and adjusting”
Was Ghandi more or less than 144 when he died?
Limit of 12 per person (average taken was seven, much higher than when there was no limit)

13. Availability Saliency Buying airport insurance
Related to overconfidence and over reaction

14. Regression to the mean
Highly intelligent females tend to marry men who are less intelligent than they are
The correlation between the intelligence scores of spouses is less than perfect (and men and women do not differ in intelligence on average)

15. Predictions Paul Meehl Dr. Apgar High school grades; one aptitude test
Outperformed complex batteries of test
“Clinical vs Statistical” Prediction
Dr. Apgar
Five variables: (heart rate, respiration, reflex, muscle tone, color)…give it a 0,1,2
Score of 8 or above – great!
Score of 4 or less – trouble!

16. Analyzing Past Success
Books about great business leaders
Ignore “right place, right time” phenomenon
Chance may be more important
“Outliers” by Malcolm Gladwell
“I was smart” versus “I was lucky”

17. Optimism and Overconfidence
Business start ups
Four in five fail
But, no one ever assumes they are in the “four”

18. Regret
Mr. Brown almost never picks up hitchhikers. Yesterday he gave a man a ride and was robbed
Mr. Smith frequently picks up hitchhikers. Yesterday, he gave a man a ride and was robbed
Which of the two will experience greater regret?
Who will be criticized most severely by others?

19. Another Framing Example
The one-month survival rate is 90 %
There is a 10 % mortality rate in the first month
Do these sound different to you?

20. Mathematical Illusions
Adam switches from a gas-guzzler of 12 mpg to a slightly less voracious guzzler that runs at 14 mpg
The environmentally virtuous Beth switches from a 30 mpg car to one that runs at 40 mpg
Who saves more gas?

21. The End