1. 5.11 Asset Pricing There is an enormous discrepancy between returns on stocks and fixed income securities. Between 1926 and 1990, for instance, the annual real rate of return on U.S. stocks has been about 7%, while the real return on U.S. treasury bills has been less than 1%. The choice of the initial year is interesting! The Wall Street Crash of October 1929, was the most devastating stock market crash in the history of the United States. Monday, 18 May 20156:58 PM

2. 5.22 Asset Pricing Definition A Treasury Bill also called a T-bill, is a short-term security issued by the federal government. Treasury bills have face values ranging from $10,000 to $1 million, and sell at a discount based on current interest rates. It is a short-term obligation that is not interest bearing (it is purchased at a discount); can be traded on a discount basis for 91 days.

3. 5.33 Asset Pricing Definition A Treasury Bond is the longest-term investment issued by the Federal Government. They have maturities between ten and thirty years and pay interest every six months until maturity.

4. 5.44 Asset Pricing Definition Stock is the capital raised by a corporation through the issue of shares entitling holders to an ownership interest (equity); “he owns a controlling share of the company's stock”. In finance, in general, you can think of equity as ownership in any asset after all debts associated with that asset are paid off.

5. 5.55 Asset Pricing Here’s what will happen if the U.S. defaults on its debt, as nearly happened in 2013. Nobody knows exactly when America would default on its bills if Congress fails to raise a cap on government borrowing. But the recent past gives a pretty good idea of how a default could unfold. Even the Treasury Department can’t know how much tax revenue will come in each day after Oct. 17, when it expects to hit its US$16.7 trillion debt ceiling. Nor can officials anticipate exact costs, such as how many people will apply for jobless benefits that week. Financial Post – ReutersFinancial Post – Reuters 4 October 2013

6. 5.66 Asset Pricing Things get really spooky on Halloween (31 Oct 2013) when a US$6 billion interest payment to bond holders comes due. Financial Post – ReutersFinancial Post – Reuters 4 October 2013 Hence the name, Halloween Bonds! The US Congress has passed a bill to reopen the federal government and approve new sovereign borrowings, ending three weeks of high drama on Capitol Hill that pushed the US to the edge of a debt default. Financial TimesFinancial Times 17 October 2013

7. 5.77 Ethics Did you think ethics was a county north-east of London? Is ethical banking an oxymoron (a figure of speech that combines contradictory terms)?

8. 5.88 Islamic Banking On October 28, 2013, George Osborne, the chancellor, announced the launch of an Islamic bond plan. Mr. Osborne will on Tuesday announce plans for Britain to issue the first Islamic bond outside the Muslim world, as he seeks to turn the City of London into the “unrivalled western centre for Islamic finance”. Mr. Osborne hopes that £200m bond or sukuk will act as a catalyst for the City to become a leading player in the sharia-compliant finance market, which is worth $1tn globally. To read more on Islamic Finance, see four articles introducing Islamic banking and finance concepts written by Mark Andrews, Risk Reward Ltd.Islamic Finance

9. 5.99 Despite lower volumes in 2013, sukuk issuance is on track for a record year Not long ago it looked like the bottom had fallen out of the Islamic capital markets, with a succession of high-profile sukuk (shariah- compliant bonds) defaults, including those of Investment Dar, Saad Group and Dubai World’s Nakheel. Until then it was widely thought that sukuk—the very public face of Islamic finance—were more secure than conventional bonds, given their use of tangible assets. But the defaults triggered a wider debate about sukuk holder and investor protection. That was in 2009. Fast forward to today and you could be forgiven for thinking that the defaults had never shaken investor confidence in sukuk. Although sukuk value and volume fell in 2013, the international sukuk market is as vibrant as ever. Issuance is set to enjoy another record year, building on 2012’s record $18.5 billion in total international sukuk issuance (Global Finance Nov 2014).

10. 5.1010 Gemach Gemach (an abbreviation for gemilut chasadim "acts of kindness") is a Jewish free-loan fund which subscribes to both the positive Torah commandment of lending money and the Torah prohibition against charging interest on a loan. Establishing gemachs, or free-loan societies, is an old Jewish custom. When Jews arrived in America from Europe, one of the first institutions to arise in each community was a Hebrew Free Loan society. Today, there are hundreds of such organisations functioning as parts of synagogues, yeshivas, and other Jewish institutions. People donate money to the society as charity, and the society in turn lends money without interest to anyone requesting a loan (Katz 2001).

11. 5.1111 RAOP– Random Acts of Pizza An online community devoted to giving away free pizza to strangers that ask for one. It is a community within the social news and entertainment website Reddit.com. Users can submit requests for free pizza and if their story is compelling enough a fellow user might decide to send them one, “because... who doesn’t like helping out a stranger? The purpose is to have fun, eat pizza and help each other out. Together, we aim to restore faith in humanity, one slice at a time.” A typical post might sound something like this: “It’s been a long time since my mother and I have had proper food. I’ve been struggling to find any kind of work so I can supplement my mom’s social security... A real pizza would certainly lift our spirits.” See Althoff et al. 2014 (paper slides), for a fascinating study.Reddit.compaperslides

12. 5.1212 What About The U.K.? Charity coffee scheme launches in UK which lets drinkers donate lattes to those in need - Daily Mail - 31 March 2013 It doesn't sound as enticing as a cappuccino, flat white or latte, but a new beverage called the 'suspended coffee' is set to take cafés across the country by storm. In a concept born in Naples, Italy, caffeine drinkers not only place their own regular order, they also request a second drink for someone who cannot afford to pay for their own.

13. 5.1313 What About The U.K.? The idea, which is not just aimed at helping the homeless but those who simply find themselves out of work and broke, for example, spread to Bulgaria and, thanks to the power of social networking sites, is beginning to take off in Britain and around the world. So far, about 150 British cafes have signed up to what has become a formal scheme, while big chains like Starbucks and Costa are making positive noises about getting involved.

14. 5.1414 What About The U.K.? Bankers should behave at work as they do at home, says Archbishop Vincent NicholsBankers should behave at work as they do at home, says Archbishop Vincent Nichols, Telegraph 18-9-2012. Business leaders including Vodafone’s chief executive Vittorio Colao and Unilever’s Paul Polman joined the Archbishop of Westminster in a drive to restore business’s battered reputation for ethical behaviour. Five years on from the start of the financial crisis, and after a series of initiatives to promote “moral capitalism”, executives are concerned that little progress has been made to restore public trust.

15. 5.1515 What About The U.K.? Archbishop warns Wonga that Church wants to force it out of businessArchbishop warns Wonga that Church wants to force it out of business, Telegraph 25-7-2013. The Archbishop of Canterbury (Most Rev. Justin Welby) has told the payday lender Wonga that he wants to force it out of business by competing with it. He has said he plans to expand the reach of credit unions, which provide small loans to their members, as part of a long- term campaign to boost competition in the banking sector. The Church of England has plans to encourage congregation members with relevant skills to volunteer at credit unions. Small, local lenders could also be invited to use church buildings and other community locations with the help of church members. The church, which claims to have a strong ethical investment policy that explicitly bans companies involved in payday lending, invests in Accel Partners, the US venture capital firm that led Wonga’s 2009 fundraising.

16. 5.1616 What About The U.K.? Bankers have tendency to lie for financial gain, say scientists - FT - 20 Nov 2014 Swiss researchers have come up with what they say is compelling scientific evidence that bankers lie for financial gain. The team at the University of Zurich (Cohn et al., 2014) used game playing experiments to show “that the prevailing culture in the banking industry weakens and undermines the honesty norm, implying that measures to re-establish an honest culture are very important”.Cohn et al., 2014 The study, published in the leading journal Nature, probes the psychology behind what the researchers call “a dramatic loss of reputation and a crisis of trust in the financial sector”, as a result of rogue trading, rigged interest rates such as Libor and tax evasion scandals.

17. 5.1717 What About The U.K.? Trust in others’ honesty is a key component of the long-term performance of firms, industries, and even whole countries. However, in recent years, numerous scandals involving fraud have undermined confidence in the financial industry. Contemporary commentators have attributed these scandals to the financial sector’s business culture, but no scientific evidence supports this claim. The authors show that employees of a large, international bank behave, on average, honestly in a control condition. However, when their professional identity as bank employees is rendered salient, a significant proportion of them become dishonest. This effect is specific to bank employees because control experiments with employees from other industries and with students show that they do not become more dishonest when their professional identity or bank- related items are rendered salient. Their results thus suggest that the prevailing business culture in the banking industry weakens and undermines the honesty norm, implying that measures to re-establish an honest culture are very important (Cohn et al., 2014).Cohn et al., 2014 salient - most noticeable or important

18. 5.1818 What About The U.K.? Faith, hope and hedge funds for Church of England By Miles Johnson, Hedge Fund Correspondent, Financial Times March 4, 2014 The Church of England is ramping up the exposure of its £6bn endowment to alternative investments such as hedge funds and private equity in a move that will cement its position as one of the UK’s largest single investors in these types of assets. The ethical investment policy was called into question last year when it was revealed that the endowment had an indirect holding in Wonga, the payday lender that had been publicly attacked by Justin Welby, Archbishop of Canterbury. Mr. Welby had said he wanted to put Wonga “out of existence” by championing credit unions.

19. 5.1919 What About The U.K.? The Telegraph – 28 July 2013

20. 5.2020 What About The U.K.? Welby vs Wonga - FT - 12 Dec 2014 An early Christmas present may be en route to Archbishop Justin Welby. Word has it that the Financial Conduct Authority has finally found the time — in among the regulator’s embarrassing gaffes, cancelled bonuses and the rest — to grant approval to the Church of England’s big sally into financial services. The Churches’ Mutual Credit Union is set to get regulatory approval before the end of the year, City Insider gathers. About time. The church has wanted to create its own credit union — a mutual not-for- profit savings and loans institution — since 2008. Approval for the CMCU had been due by this summer but apparently something more important came up at the FCA.

21. 5.2121 More From the Church.? A new paper published by Theos, a London-based religious think-tank, will raise hackles on the right and left alike, if only because of its title: "Just Money: How Catholic Social Teaching can Redeem Capitalism". Advocates of capitalism will certainly retort that the system has no need of redemption. The core meaning of the word redemption is something like "to secure the freedom, or the very existence, of someone or something at a price...." And as a supremely efficient instrument for resource allocation and price discovery, so the argument would go, capitalism should have no need of any external agency to purchase its right to exist. It just needs to be allowed to do its job. At the other extreme, critics on the left will retort that capitalism is so wicked that it cannot be redeemed by anything, least of all the doctrines of Catholicism.paper Catholicism and capitalism: Redeeming the system - The Economist - 20 Oct 2014

22. 5.2222 What About The U.K.? BBC News - Comic Relief money invested in arms and tobacco shares 10 December 2013 Millions of pounds donated to Comic Relief have been invested in funds with shares in tobacco, alcohol and arms firms, BBC Panorama has learned. The BBC has also seen evidence which suggests Save the Children censored criticism of energy firms, to avoid upsetting corporate partners. Comic Relief said it used its funds to "deliver the greatest benefits to the most vulnerable people". Save the Children said its campaigns were unaffected by any partnerships.

23. 5.2323 What About The U.K.? Capitalism is at risk of destroying itself unless bankers realise they have an obligation to create a fairer society, the Bank of England governor has warned. Mark Carney, governor of the Bank of England, said bankers had operated a “heads-I-win-tails-you-lose” system. He questioned whether traders met ethical standards and said that those who failed to meet high professional standards should face ostracism. Bank of England governor: capitalism doomed if ethics vanish | The Guardian | 28/5/2014

24. 5.2424 What About The U.K.? UK study in call to unleash $1tn for social investments - FT - 14-9-2014 A study by the international Social Impact Investment Taskforce, set up by the UK government and led by Sir Ronald Cohen, the venture capitalist, calls on governments to view “impact investment” as a vital stream of financing for domestic social programmes, as well as international development projects.Social Impact Investment Taskforce Global governments need to do more to ease the way for private-sector investments that link financial returns to social benefits, with $1tn in capital waiting to be set free on the world’s problems, according to the report published on Monday (15-9-2014).report

25. 5.2525 What Else? There is the scandal over banks’ attempted manipulation of the Libor (London Interbank Offered Rate) benchmark borrowing rate and mis-selling of interest rate swaps to small businesses. Currently under review (26-10-2012) are the following 16 banks; Bank of America, Bank of Tokyo Mitsubishi UFJ, Barclays, Citigroup, Credit Suisse, Deutsche Bank, HSBC, JPMorgan Chase, Lloyds Banking Group, Norinchukin Bank, Rabobank, Royal Bank of Canada, Royal Bank of Scotland, Société Générale, UBS and West LB.

26. 5.2626 What Else? Several banks have already admitted wrongdoing over the scandal, and have settled with regulators. Libor refers to the London interbank offered rate, which is an interest rate used by many banks, mortgage lenders, and others to set the price of borrowing on trillions of dollars of financial contracts. Several banks have indicated that they colluded to set the rate artificially low, which could have deprived lenders like Fannie Mae of higher profits.

27. 5.2727 What Else? BBC News - Fannie Mae sues banks for $800m over Libor - 31 October 2013 US mortgage giant Fannie Mae is suing nine banks including Barclays and Royal Bank of Scotland (RBS) over losses relating to the Libor scandal. The mortgage financer is seeking more than $800m (£499m) in damages. "Fannie Mae filed this action to recover losses it suffered as a result of the defendants' manipulation of Libor," a spokesman said.

28. 5.2828 What Else? The nine banks being sued by Fannie Mae are Barclays, RBS, Rabobank, UBS, Bank of America, Citigroup, Credit Suisse, Deutsche Bank and JP Morgan Chase. Of those, Barclays, RBS, Rabobank and UBS have previously settled with regulators over similar allegations. Barclays was fined £290m by UK and US authorities in 2012, while RBS was fined £390m earlier this year.

29. 5.2929 What Else? Rabobank received a fine of £662m from regulators earlier this week. A string of international banks have been implicated in the affair and several criminal charges have been brought against traders. It is also not the first time banks have been sued over Libor manipulation. In March, the other major US mortgage financer Freddie Mac sued more than a dozen banks. BBC News - Fannie Mae sues banks for $800m over Libor - 31 October 2013

30. 5.3030 What Else? FDIC sues banks over Libor manipulation - FT - 15 March 2014 The US Federal Deposit Insurance Corporation (FDIC) sued more than a dozen banks from Barclays to Citigroup over losses attributed to manipulation of the London interbank offered rate.FDIC The FDIC said it was acting on behalf of 38 failed banks, which it said lost money because of the way the largest international banks are alleged to have distorted the benchmark interest rate to hide their weak financial position during the crisis or to make money on derivatives trades. It is only the latest in a series of private and government lawsuits against the panel of banks, which were supposed to submit a realistic rate at which they could borrow money. Fannie Mae and Freddie Mac, the government-controlled mortgage companies, have previously sued nearly a dozen banks and the British Bankers’ Association for allegedly causing them to suffer hundreds of millions of dollars in losses.

31. 5.3131 What Else? ‘Reprehensible’ Lloyds under fire from Carney - FT - 29/7/2014 Lloyds Banking Group has been criticised for “highly reprehensible” behaviour by the Bank of England after it became the first lender to be fined for rigging rates to cut the cost of a financial crisis rescue scheme, effectively costing the taxpayer millions of pounds The state-backed bank was on Monday ordered to pay £226m as part of a settlement with US and UK authorities, including £218m of fines for manipulating key benchmark interest rates and £7.8m in compensation to the BoE for cutting the fees it paid to use the central bank’s liquidity lifeline. The total fine is less than the amounts paid by UK rivals Royal Bank of Scotland and Barclays, but the revelation the bank rigged rates to cut the cost of taxpayer-funded life support is a set back for the bank, which is trying to repair its reputation following the PPI mis-selling scandal. It is the seventh financial institution to settle as part of the global investigation into manipulation of Libor and other interbank lending rates.

32. 5.3232 What Else? Senior British banker pleads guilty to Libor rigging - Telegraph - 7 Oct 2013 Southwark Crown Court hears guilty plea from banker who cannot be named for legal reasons. A senior banker from a leading British bank has become the first person in the UK to plead guilty to criminal charges related to manipulating Libor. The person appeared at Southwark Crown Court on Friday and was released on bail pending sentencing. The court has ordered that neither the name of the individual or the bank can be disclosed. The banker, who has since left his former employer, pleaded guilty to a charge of conspiracy to defraud related to the crucial interest rate benchmark, which influences the price of hundreds of trillions of pounds of financial contracts around the world.

33. 5.3333 What Else? The acronyms proliferate! A Japanese lawmaker is querying “unnatural movements” in Tibor, the rates that underpin trillions of Yen of loans in Japan, challenging the financial regulator to get a better grip on the rate-submission process. Banks and brokerages have been investigated by regulators and watchdogs around the world for attempting to rig benchmark rates such as Libor and Euribor and Tibor. Japan’s Tibor rate comes under scrutiny - FT – 19/5/2014

34. 5.3434 What Else? Swiss and UK watchdogs step up forex investigations - FT 31/3/2014 Switzerlands competition commission has launched an investigation into eight domestic and international banks after it found indications that they co-operated to manipulate a pivotal foreign exchange rate. The fresh probe by the Wettbewerbskommission (Weko) marks the first time a regulator has publicly confirmed that it has uncovered signs of possible competition law breaches.Wettbewerbskommission Weko is looking at whether banks including Barclays and UBS co-operated in fixing several important currencies. This widens the number of banks under investigation, with Weko saying it is probing domestic lenders Credit Suisse, Julius Baer and Zcher Kantonalbank as well as foreign banks JPMorgan, Citigroup and Royal Bank of Scotland. Barclays makes £500m provision on forex investigation - FT - 30 Oct 2014 The bank disclosed it has set aside the sum in relation to ongoing investigations into the foreign exchange market by regulators as it reported third quarter results.

35. 5.3535 What Else? Currency-Rigging Fines Could Hit $41 Billion Globally, Citi Says - Global Association Of Risk Professionals - 20 Oct 2014 Oct. 20 (Bloomberg) - Banks could have to pay as much as $41 billion globally to settle probes into allegations traders rigged benchmarks in the currency markets, Citigroup Inc. (Citi) said today.BloombergCitigroup Inc. Deutsche Bank AG is seen as probably the most impacted with a fine of as much as 5.1 billion euros ($6.5 billion), Citigroup analysts led by Kinner Lakhani (Managing Director at Citi) calculated, estimating the Frankfurt-based banks settlements could reach 10 percent of its tangible book value, or its assets worth. Using similar calculations, Barclays Plc could face as much as 3 billion pounds ($4.8 billion) in fines and UBS AG penalties of 4.3 billion Swiss francs ($4.6 billion), they wrote in a note first sent to clients on Oct. 3. The Citigroup analysts made their calculations using a Sept. 26 Reuters report.Reuters report

36. 5.3636 What Else? Regulators slap $3.2bn fines on five banks in global forex probe - FT - 12 Nov 2014 US, UK and Swiss regulators on Wednesday slapped $3.2bn in fines on five banks including UBS and Royal Bank of Scotland in the first cases to come out of a global probe into allegations of rate-rigging in the foreign exchange markets. It did not settle with Barclays but said it was continuing its investigations into the bank to cover its spot forex trading business of developed economy currencies and also wider forex business areas.

37. 5.3737 What Else? Under-fire FCA spells out its targets for the year ahead - The Guardian - 31-3-2014 A review of how firms can prevent traders manipulating key benchmarks in a bid to stop a new Libor scandal and an investigation into how lenders treat borrowers who have fallen behind on repayments are among the City regulator's plans for the year ahead. The Financial Conduct Authority (FCA) takes over regulation of the consumer credit sector on Tuesday, and it also outlined plans for a review of how struggling borrowers are treated by the industry, and how loans are advertised.FCA It has already signalled that it plans to get tough on the payday lenders that offer short-term loans at high interest rates, with new restrictions set to come into force in July, and it said it planned to visit the top five firms to check they are following the rules. Wheatley said: "Taking on the regulation of consumer credit is an enormous task which effectively doubles the number of firms we regulate. "Using our new power we want to tackle harm to consumers who are most at risk and our work will focus on protecting vulnerable consumers."

38. 5.3838 What Else? Wonga to pay £2.6m compensation for fake debt firm letters | The Guardian | 26-6-2014 Financial Conduct Authority (FCA) orders payday lender to compensate 45,000 customers after it sent threatening letters.FCA Britain's best-known payday lender, Wonga, has been ordered to pay more than £2.6m compensation after it was found to have sent threatening letters to customers from non-existent law firms. The FCA said Wonga had been guilty of “unfair and misleading debt collection practices” after it emerged the lender had created fake law firms using the names of employees who in some cases still work for the company. The regulator said the firm would be compensating around 45,000 customers who received the letters, which threatened legal action over outstanding debts.

39. 5.3939 What Else? Banks look to replace payday lenders - FT - 15 July 2014 Some of Britain’s biggest banks are examining ways to launch payday-style loans as a new cap on the cost of credit is expected to drive many smaller operators out of the market. The UK’s financial regulator on Tuesday outlined the details of a proposed new price cap that will prevent the overall cost of a payday loan ever exceeding 100 per cent of the amount borrowed. The move is aimed at cleaning up an industry famed for its four-figure annual percentage rates and hefty default charges. The Financial Conduct Authority (FCA) said that from January next year, interest and fees on short-term loans must not exceed 0.8 per cent a day of the amount borrowed. That means someone borrowing £100 from a payday lender for 30 days would pay a maximum of £24 in charges. Currently the typical charge would be about £30, according to the FCA.FCA Fees for late payment would be capped at £15 and there will be a total price limit of 100 per cent of the original loan. The FCA estimated the cap would cause payday companies to lose £420m a year – approximately 42 per cent of their £1bn combined annual revenues – and save the average consumer £193 a year.

40. 5.4040 What Else? Payday loans shaken up by competition regulator - The Guardian - 9 Oct 2014 Payday lenders will be forced to give details of their products on price comparison websites to help potential borrowers shop around under new competition rules for the sector. The Competition and Markets Authority (CMA) said payday lenders’ customers find it hard to get clear information on the cost of borrowing. Letting them compare deals online will increase competition and make it easier for new lenders to offer better prices, the CMA said.CMA The regulator will also require payday lenders to be clearer about their fees and charges, make it easier for borrowers to shop around without hurting their credit record, improve data sharing between lenders and oblige them to give borrowers a summary of charges.

41. 5.4141 What Else? Wonga to write off £220m of loans owed by customers - FT - 2 Oct 2014 Wonga, the UK’s biggest payday lender, is looking at changing its name as part of efforts to rehabilitate its reputation after agreeing with the regulator to write off the debt of 330,000 customers. The group admitted on Thursday that under tighter lending criteria, it would not have provided loans to these people. It plans to write off £220m and eradicate interest charges for 45,000 more in a bold attempt to rehabilitate its reputation with regulators and the British public.

42. 5.4242 What Else? This has been accompanied by controversies elsewhere, such as accusations that traders and speculators are rigging the oil price. In July 2012, GlaxoSmithKline was fined $3bn for abusive practices in marketing drugs in the US. GlaxoSmithKline fined $3bn after bribing doctors to increase drugs sales - The Guardian - 3 July 2012

43. 5.4343 What Else? EU’s Amazon probe steps up pressure over tax deals - FT - 7 Oct 2014 The move by Brussels to open a formal investigation into Amazon’s tax arrangements in Luxembourg, confirmed on Tuesday, is the latest step in a far-reaching crackdown on alleged “sweetheart” tax deals between governments and large companies. The online retail giant is now embroiled in a probe that has already drawn in Apple, Starbucks and Fiat’s financial arm. The European Commission is investigating whether they received “hidden subsidies” from governments through preferential tax treatment that amount to illicit state aid. Other companies could also be drawn into the net, according to tax advisers.

44. 5.4444 What Else? Leak reveals scale of corporate tax deals with Luxembourg - FT - 6 Nov 2014 Leaked documents describing the Luxembourg tax arrangements of more than 340 multinationals were published on Wednesday, stoking the debate over the allegedly favourable tax deals offered by the Grand Duchy. The International Consortium of Investigative Journalists, a global network based in the US, said it had examined nearly 28,000 pages of leaked documents that laid out special tax deals granted by the Luxembourg tax authorities to some of the world’s largest corporations.International Consortium of Investigative Journalists

45. 5.4545 What Else? Which firms have tax deals with Luxembourg? - Management Today - 6 Nov 2014 Documents detailing cosy tax-saving arrangements between Luxembourg and no less than 340 companies have been leaked to the International Consortium of Investigative Journalists (ICIJ), showing PwC helping the likes of Pepsi, Fedex and Ikea obtain tax rulings from the tiny duchy that helped them save billions.ICIJPwC The documents appear to show how the firms used complex financial structures (when are they ever simple?) to reduce their bills, in some cases to less than 1% - somewhat below Luxembourg’s official corporate tax rate of 29%. Jean-Claude Juncker has been President of the European Commission since 2014. Juncker was Prime Minister of Luxembourg from 1995 to 2013! Luxembourg tax scandal not my fault says EU chief: Jean-Claude Junker launches bizarre defence saying he is not to blame despite being country's PM for 18 years - Daily Mail - 12 Nov 2014

46. 5.4646 What Else? How Juncker and Luxembourg landed Silicon Valley’s biggest catch - FT - 11 Dec 2014 Jean-Claude Juncker had a mischievous look. It was shortly before the 2004 election and Luxembourg’s premier at the time just could not keep the secret that his tiny Grand Duchy was reeling in another big corporate catch. AOL and Amazon were already moving to Luxembourg amid a flurry of interest from US internet companies. Jeannot Krecké, a rival politician, recalls Mr Juncker furtively hinting at more to come. After a pause, Mr Juncker cracked: “I like apples.” The EU is now investigating whether sweetheart tax deals Luxembourg granted to two foreign companies — Amazon and Fiat — were too sweet. Thousands of pages of leaked Luxembourg tax rulings have revealed how hundreds of others that moved to the Grand Duchy also managed to pay negligible taxes. Even some allies fear Mr Juncker’s role in his nation’s unlikely rise to the top of Europe’s per capita rich list — a 40-year journey from clapped-out steel producer to booming financial centre, satellite pioneer and ecommerce hub — could prove his undoing.

47. 5.4747 What Else? There is also (of course) a personal element to these events. Snorradóttir et al. (2013) considered psychological distress among surviving bank employees differently entangled in downsizing and restructuring following the financial crisis of 2008. In the banks, where all employees experienced rapid and unpredictable organizational changes, psychological distress was higher among employees most entangled in the downsizing and restructuring process. Being subjected to downsizing within their own department, salary cut, and transfer to another department, were directly related to increased psychological distress. Employees most entangled in organizational changes are the most vulnerable and should be prioritized in workplace interventions during organizational changes.

48. 5.4848 On The Other Hand Why do rich celebrities steal groceries? Why do students risk their academic careers by cheating for just a few extra marks? Ruedy et al. (2013) may have the answer: because it feels good. Many theories of moral behaviour assume that unethical behaviour triggers negative affect. They challenge this assumption and demonstrate that unethical behaviour can trigger positive affect, which they term a “cheater’s high.”

49. 5.4949 On The Other Hand Across 6 studies, they found that even though individuals predict they will feel guilty and have increased levels of negative affect after engaging in unethical behaviour (Studies 1a and 1b), individuals who cheat on different problem-solving tasks consistently experience a more positive affect than those who do not (Studies 2–5). They find that this heightened positive affect does not depend on self- selection (Studies 3 and 4), and it is not due to the accrual of undeserved financial rewards (Study 4).

50. 5.5050 On The Other Hand Cheating is associated with feelings of self- satisfaction, and the boost in positive affect from cheating persists even when prospects for self- deception about unethical behaviour are reduced (Study 5). Their results have important implications for models of ethical decision making, moral behaviour, and self-regulatory theory. The Cheater's High - How Being Bad Feels Good - BPS Research Digest Ruedy N.E., Moore C., Gino F. and Schweitzer M.E. 2013 “The cheater's high: the unexpected affective benefits of unethical behavior” J. Pers. Soc. Psychol. 105(4) 531-548. Abstract PreprintAbstractPreprint

51. 5.5151 On The Other Hand Having less, giving more, the influence of social class on prosocial behaviour is investigated. Lower social class (or socio-economic status) is associated with fewer resources, greater exposure to threat, and a reduced sense of personal control. Given these life circumstances, one might expect lower class individuals to engage in less prosocial behaviour, prioritising self-interest over the welfare of others. It was hypothesized, by contrast, that lower class individuals orient to the welfare of others as a means to adapt to their more hostile environments and that this orientation gives rise to greater prosocial behaviour (Piff et al. 2010).

52. 5.5252 On The Other Hand Across 4 studies, lower class individuals proved to be more generous (Study 1), charitable (Study 2), trusting (Study 3), and helpful (Study 4) compared with their upper class counterparts. Mediator and moderator data showed that lower class individuals acted in a more prosocial fashion because of a greater commitment to egalitarian values and feelings of compassion (Piff et al. 2010).

53. 5.5353 On The Other Hand Social class exerts unique and pervasive psychological effects, shaping in fundamental ways how people construe the social environment and behave prosocially toward others. By behaving generously and helping those in need, lower class individuals may promote trust and cooperation from others, thus ensuring that in times of hardship, their needs will, too, be met (Piff et al. 2010).

54. 5.5454 On The Other Hand Similarly, higher social class predicts increased unethical behaviour. Seven studies using experimental and naturalistic methods reveal that upper-class individuals behave more unethically than lower- class individuals. In studies 1 and 2, upper-class individuals were more likely to break the law while driving, relative to lower-class individuals. In follow-up laboratory studies, upper-class individuals were more likely to exhibit unethical decision-making tendencies (study 3), take valued goods from others (study 4), lie in a negotiation (study 5), cheat to increase their chances of winning a prize (study 6), and endorse unethical behaviour at work (study 7) than were lower-class individuals. Mediator and moderator data demonstrated those upper-class individuals’ unethical tendencies are accounted for, in part, by their more favourable attitudes toward greed (Piff et al. 2012).

55. 5.5555 On The Other Hand In studies 1 and 2, upper- class individuals were more likely to break the law while driving, relative to lower- class individuals. These American studies equates class with affluence! Piff et al. 2012

56. 5.5656 On The Other Hand Since the recent financial crisis, regulators and the general public have focused on financial speculation as one of its potential causes. In addition to the rôles played by rating agencies and complicated financial engineering, speculative short sales have been put into question. Laypeople's moral judgments about this type of financial speculation have been investigated. short sales -The sale of a security that is not owned by the seller, or that the seller has borrowed.

57. 5.5757 On The Other Hand Sometimes cheaters do get caught. New York financier Bernie Madoff received a life sentence after pleading guilty to 11 felony counts in one of history's largest investment frauds. He admitted to a Ponzi scheme dating from the early 1990s. Federal investigators believe the fraud began as early as the mid-1980s and may have begun as far back as 1970. On 29 June 2009, 71 year old Madoff was sentenced to 150 years in prison, the maximum allowed. Unfortunately, this is just one of many stories about captains of industry and finance behaving badly with other people's money. So why do some people cheat and others don't? The classical explanation is that it's a rational choice, a cold calculation of cost and benefit. Can I get away with it, and how much can I get away with before I risk getting caught?

58. 5.5858 On The Other Hand Some scientists have begun questioning this cynical view of human ethics and suggest that the decision is much more complex than this simple calculation. Gino et al. (2009) set up an elaborate hoax to see if they could actually make people cheat - in order to illuminate the psychological forces at work in the dishonest mind. In the experiment they asked a large group of university students to solve a set of complex mathematical problems in a very short time. They made it hard enough that none could realistically solve all the problems, and they paid them for whatever ones they did solve.

59. 5.5959 On The Other Hand The mathematical exercise was just pretence for the real experiment: shortly after the students began on the mathematical problems, one of them (actually a paid actor) loudly announced to the room: “I've solved everything. What should I do?” Everyone in the room knew this was impossible, so the student-actor was a clear example of blatant cheating. He also took all of the cash, as if he had a perfect score and - very important - left without any consequences. The idea was to see how many of the students followed the cheater's example - to see if blatant dishonesty boosted cheating among students generally. And it did, dramatically.

60. 5.6060 On The Other Hand But the psychologists added another twist to the experiment: sometimes they had the actor wear the T-shirt of a rival university, other times not. They wanted to see if the cheater's group identity - classmate or outsider - influenced the level of copycat cheating. That is, would students cheat more (or less) when they saw a rival cheat, as compared to seeing a compatriot cheat? The results were unambiguous. As reported by Gino et al. (2009) fellow classmates had much more influence than outsiders. Indeed, seeing a rival cheat actually lowered the level of overall cheating slightly - compared to students who simply cheated on their own initiative, without any prodding.

61. 5.6161 On The Other Hand These findings argue against the “cold calculation” theory of cheating. After all, if the students only weighed the “can I get away with it” factor, then they would have been influenced equally by the successful cheating of both compatriot and outsider. And they weren't. The psychologists decided to double-check these findings with another small experiment. It was basically the same set-up, but in this scenario the actor didn't do anything; he simply asked out loud of the invigilator: “Is it OK to cheat?” I know, stupid question.

62. 5.6262 On The Other Hand Nobody would really do that. But the idea was simply to nudge the inner moralist in the students' minds, to bring the issues of cheating and dishonesty front and centre. And when they did this, the students cheated noticeably less. No role models, good or bad, just priming the idea of unethical behaviour - that was enough to keep the students honest.

63. 5.6363 On The Other Hand So it appears our inner moralist doesn't really want to cheat. Yet it also appears that dishonesty can be contagious - if we witness one of our own committing the public act of dishonesty. These findings point to a possible strategy for preventing a wave of unethical contagion. If cheating in general declines when cheaters are perceived as outlaws, then it should help to stigmatise public cheaters as just that - outlaws, bad apples. Of course, Bernie Madoff and the rest of Wall Street's alleged fraudsters have already done a lot of that work for us.

64. 5.6464 On The Other Hand Across four studies (Lotz and Fix 2013), found that laypeople's moral judgments of short selling are significantly harsher than their judgments of long positions. Both successful (Study 1) and unsuccessful (Study 2) short selling receives harsher moral judgments. In addition, studies which manipulate the moral character of the shorted asset (Study 3) or the time horizon of the investment strategy (Study 4) support the conclusion that short selling is considered less moral than taking a similar long position. The results present consistent support for a judgment bias of economic laypeople in the domain of financial economics. long positions - The buying of a security, with the expectation that the asset will rise in value.

65. 5.6565 On The Other Hand Interestingly Kouchaki and Smith (2013) have demonstrated that people are more moral in the morning than in the afternoon. They propose that the normal, unremarkable experiences associated with everyday living can deplete one’s capacity to resist moral temptations. In a series of four experiments, both undergraduate students and a sample of U.S. adults engaged in less unethical behaviour (e.g., less lying and cheating) on tasks performed in the morning than on the same tasks performed in the afternoon. This morning morality effect was mediated by decreases in moral awareness and self-control in the afternoon. Furthermore, the effect of time of day on unethical behaviour was found to be stronger for people with a lower propensity to morally disengage.

66. 5.6666 Asset Pricing Mehra and Prescott (1985) show that the combination of a high equity premium, a low risk-free rate, and smooth consumption cannot be reconciled with plausible levels of investors’ risk aversion within a standard paradigm of expected utility maximization. This has become known as the equity premium puzzle. And is clarified below.

67. 5.6767 Asset Pricing The equity premium puzzle. Put simply if real returns to investors from the purchases of U.S. government bonds have been estimated at 1% per year, while real returns from stock (“equity") in U.S. companies have been estimated at 7% per year (Kocherlakota, 1996). General utility- based theories of asset prices have difficulty explaining (or fitting, empirically) why the first rate is so low and the second rate so high, not only in the U.S. but in other countries too.

68. 5.6868 Asset Pricing Mehra and Prescott (1985) estimate that the coefficient of relative risk aversion (see definitions) should be higher than 30 to explain the historical equity premium, whereas previous estimates and theoretical arguments suggest that the actual figure should be close to 1. See explanation below. Definitions

69. 5.6969 Relative Risk Aversion S&P 500

70. 5.7070 Relative Risk Aversion First Derivative The slope

71. 5.7171 Relative Risk Aversion Second Derivative The slope of the slope

72. 5.7272 Relative Risk Aversion The ratio d2/d

73. 5.7373 Asset Pricing A coefficient of relative risk aversion close to 30 corresponds to a situation like the following one: Suppose that Primus is offered a 50–50 gamble between $100,000 and $50,000 (expected value of $75,000); then his certainty equivalent (the value he would accept) should be around $51,209 (Mankiw and Zeldes, 1991). This is an extreme risk aversion. Reitz (1988) has argued that the equity premium may be a rational response to a time-varying risk of economic catastrophe, as bonds protect capital investment better than equity. Is this explanation is not testable? Probably not.

74. 5.7474 Asset Pricing Moreover, since the data from 1926 contain the 1929 crash, the catastrophe in question must be of greater magnitude. Also, the hypothetical catastrophe should affect equity but not bonds: thus, hyperinflation would not qualify. A different line of research has managed to explain part of the equity premium introducing unexpected utility preferences. In particular, Constantinides (1990) suggested a habit- formation model in which the utility of consumption depends on past levels of consumption as well.

75. 5.7575 Asset Pricing People become averse to reductions in their consumption and this may be used to explain the equity risk premium.

76. 5.7676 Asset Pricing Equity Risk Premium What Does Equity Risk Premium Mean? It is the excess return that an individual stock or the overall stock market provides over a risk-free rate. This excess return compensates investors for taking on the relatively higher risk of the equity market. The size of the premium will vary as the risk in a particular stock, or in the stock market as a whole, changes; high-risk investments are compensated with a higher premium.

77. 5.7777 Asset Pricing Equity Risk Premium The reason behind this premium stems from the risk- return trade off, in which a higher rate of return is required to entice investors to take on riskier investments. The risk-free rate in the market is often quoted as the rate on longer-term government bonds, which are considered risk free because of the low chance that the government will default on its loans. On the other hand, an investment in stocks is far less guaranteed, as companies regularly suffer downturns or go out of business.

78. 5.7878 Asset Pricing Equity Risk Premium If the return on a stock is 15% and the risk-free rate over the same period is 7%, the equity-risk premium would be 8% (15%-7%) for this stock over that period of time.

79. 5.7979 Asset Pricing To explain the equity risk premium Campbell and Cochrane (1999) explain this intuition with a carefully crafted model. While this sort of model is probably on the right track, emphasising only consumption-based habit-forming, it neglects the weighty role of pension funds, endowments, and very wealthy individuals with long horizons.

80. 5.8080 Asset Pricing This leaves us with two questions that are still open: Why is the equity premium so large, and why is anyone willing to hold bonds? This lecture is meant to show you how this sort of question can be approached using insights from behavioural finance.

81. 5.8181 Asset Pricing - Myopic Loss Aversion Myopic loss aversion combines time horizon-based framing and loss aversion. Investors are more averse to risk when their time horizon is short than when it is long (Haigh and List, 2005). Benartzi and Thaler (1995) puts forth a behavioural explanation of the equity premium puzzle based on a partial equilibrium model. They exploit two ideas from the psychological evidence about decision making.

82. 5.8282 Asset Pricing - Myopic Loss Aversion The first notion is loss aversion, which refers to the tendency for individuals to be more sensitive to reductions in their levels of well being than to increases. This translates into a slope of the utility function, which is greater over wealth decrements than over increments.

83. 5.8383 Asset Pricing - Myopic Loss Aversion The second notion is mental accounting, which refers to the practice of implicitly earmarking financial outcomes as belonging to different accounts. This bears relevance on how outcomes are aggregated: because of loss aversion, aggregation rules may not be neutral.

84. 5.8484 Asset Pricing - Myopic Loss Aversion However a word of caution from Andersen et al. (2010). “For one celebrated example, consider Benartzi and Thaler (1995), who use laboratory-generated estimates from college students to calibrate a model of the behaviour of US bond and stock investors. Such exercises are fine as ‘finger mathematics’ exemplars, but are no substitute for estimation on the comparable samples.”

85. 5.8585 Asset Pricing - Myopic Loss Aversion Here is an example drawn from Barberis and Huang (2001). It compares the purchase of two shares as an entity, or as two separate purchases. An investor named Primus exhibits loss aversion, modelled by a utility function over wealth increments such as u(x) = x if x ≥ 0 and u(x) = 2x if x < 0.

86. 5.8686 Asset Pricing - Myopic Loss Aversion

87. 5.8787 Asset Pricing - Myopic Loss Aversion Primus is thinking about buying a portfolio of one share each of two stocks, which are currently trading at 100. Primus believes that their values one year from now will be either 70 or 150 with equal probability and that the two distributions are stochastically independent.

88. 5.8888 Asset Pricing - Myopic Loss Aversion Primus is thinking about buying a portfolio of one share each of two stocks, which are currently trading at 100. Primus believes that their values one year from now will be either 70 or 150 with equal probability and that the two distributions are stochastically independent. The probabilities are:- Both loose 30 with a probability of ½ × ½=¼ One looses 30 and one gains 50 with a probability of ½ × ½ + ½ × ½ (gains 20 with probability ½) Both gain 50 with a probability of ½ × ½=¼

89. 5.8989 Asset Pricing - Myopic Loss Aversion If Primus is loss averse over portfolio fluctuations, the expected utility of the investment is ¼ u(100) + ½ u(20)+ ¼ u(-60) = 5 Recall the possible events 2@150 ⇒ a profit of 100 150 and 70 ⇒ a profit of 20 70 and 150 ⇒ a profit of 20 2@70 ⇒ a loss of 60 and u(x) = x if x ≥ 0 and u(x) = 2x if x < 0 ¼ u(100) + ½ u(20)+ ¼ u(-60) = ¼ 100 + ½ 20 - ¼ 120 = 5

90. 5.9090 Asset Pricing - Myopic Loss Aversion While if he is loss averse over an individual stock fluctuation, it is 2( ½ u(50)+ ½ u(-30)) = -10 Because for a single stock 150 ⇒ a profit of 50 70 ⇒ a loss of 30 u(x) = x if x ≥ 0 and u(x) = 2x if x < 0 But there are two stocks 2( ½ u(50)+ ½ u(-30)) = 2( ½ 50 - ½ 60) = -10 which is obviously not as attractive.

91. 5.9191 Asset Pricing - Myopic Loss Aversion The relevance of mental accounting for the equity premium puzzle can be seen by confronting Primus with the choice between a risky asset paying an expected 7% per year with standard deviation of 20% and a safe asset yielding a sure 1%. The attractiveness of the risky asset depends on the time horizon of the investor, which is another form of mental accounting. The longer Primus’ investment horizon, the more attractive the risky asset, provided that the investment is not evaluated frequently.

92. 5.9292 Asset Pricing - Myopic Loss Aversion It is the combination of loss aversion and a short evaluation period (which we call myopic loss aversion) that makes the investor unwilling to bear the risks associated with holding equities.

93. 5.9393 Asset Pricing - A Partial Equilibrium Model Let us go back to the equity premium puzzle. Suppose that Primus’ preferences conform to prospect theory. With respect to the standard expected utility formulation, this requires three important modifications to take into account observed behaviour: 1.utility is defined over wealth increments; 2.it exhibits loss aversion; 3.the expected utility ∑ i w i u(x i ) is computed using decision weights w i which distort the actual probabilities.

94. 5.9494 Asset Pricing - A Partial Equilibrium Model The second element which is necessary to build a multi-period model is a specification of the length of time over which an investor aggregates returns; that is, his evaluation period. This is not his investment horizon.

95. 5.9595 Asset Pricing - A Partial Equilibrium Model Consider a young investor saving for retirement 30 years off in the future who gets a newsletter from his mutual fund every quarter. If he experiences the utility associated with his wealth increments every quarter (when he gets the newsletter), this agent has an evaluation period of three months and an investment horizon of thirty years. Accordingly, he will behave as someone whose investment horizon is just one quarter.

96. 5.9696 Asset Pricing - A Partial Equilibrium Model The Prince of Wales has warned the pensions industry to ditch its short-term outlook or risk condemning future generations to a "miserable future". In a speech to the National Association of Pension Funds' annual conference, Charles said: “With an ageing population, and pension fund liabilities that are therefore stretching out for many decades, surely the current focus on 'quarterly capitalism' is becoming increasingly unfit for purpose?” ITV News ITV News 17 Oct 2013

97. 5.9797 Asset Pricing - A Partial Equilibrium Model Mehra and Prescott (1985) investigate the equity premium by asking how risk averse should the representative investor be to explain historical evidence. Benartzi and Thaler (1995) approaches the puzzle by asking how long should the evaluation period of an investor be with prospect theory preferences to explain the equity premium. An answer is obtained using simulations based on the historical (1926–1990) monthly returns on stocks, bonds, and treasury bills.

98. 5.9898 Asset Pricing - A Partial Equilibrium Model The stock index is compared both with treasury bills returns and with five-year bond returns, and these comparisons are done both in real and nominal terms. It is argued that the use of bonds is preferable because they are more profitable substitutes for long-term investors. And it is argued that nominal terms (see next slide) are preferable because they are used in most annual reports (and because evaluation in real terms would yield negative prospective utility over most periods). However, the results remain robust under any of the four possible specifications.

99. 5.9999 Nominal –v- Real A nominal value refers to a value expressed in money terms (that is, in units of a currency) in a given year or series of years. By contrast, real value adjusts the nominal value to remove effects of price changes over time. Nominal means an unadjusted rate, value or change in value. This type of measure often reflects the current situation, such as the current price of a car, and doesn't make adjustments to reflect factors such as seasonality or inflation, which provide a more accurate measure in real terms. A real variable, such as the real interest rate, is one where the effects of inflation have been factored in.

100. 5.100100 Asset Pricing - A Partial Equilibrium Model It is found that the evaluation period that makes a portfolio of 100% stock indifferent to a portfolio of 100% bonds in nominal terms is about 13 months. If the comparison is made in real terms, the equilibrium period is between 10 and 11 months. If bills are used in place of bonds, this period is one month shorter. This suggests that an evaluation period of about 12 months may lead people to consider bonds as feasible alternative to stocks.

101. 5.101101 Asset Pricing - A Partial Equilibrium Model An obvious criticism to these findings is that most people prefer to invest in portfolios containing both stocks and bonds. A second simulation is thus run; checking (under 10% increments) which mix of bonds and stocks would maximize prospective utility. Portfolios carrying between 30% and 55% of stocks all yield approximately the same prospective value. This result is consistent with observed behaviour. For instance, the most frequent allocation in TIAA-CREF (a very large benefit retirement body in the U.S.) is 50-50.TIAA-CREF

102. 5.102102 Cult of equity killed off by pension funds UK pension funds are holding more bonds than equities for the first time since the so-called cult of equity in the 1950s, say leading City fund managers. The switch into bonds, which began in about 2002, is the most significant shift in market allocation since the late George Ross Goobey made a landmark speech praising equities as a way of generating inflation-linked growth in 1956. Cult of equity killed off by pension funds - Financial Times - 7 November 2012 ‘Equity’ A stock or any other security representing an ownership interest.

103. 5.103103 Asset Pricing - A Partial Equilibrium Model As the evaluation period lengthens, stocks become more attractive. The actual equity premium in the data used was 6.5% per year, and this is consistent with an evaluation period of one year. What happens if the evaluation period lengthens? With a two-year evaluation period, the premium falls to 4.65%; with a five-year period, it falls to 3.0%, and with 20 years to 1.4%. Therefore, assuming 20 years as the benchmark case, we can say that the price of excessive vigilance is about 5.1% (6.5% – 1.4%).

104. 5.104104 Asset Pricing - A Partial Equilibrium Model A common asset allocation for pension funds has about 60% in stocks and 40% in bonds. Given that it is reasonable to assume that pension funds have an infinite investment horizon, they should favour stocks much more. A possible explanation links myopic loss aversion with an agency problem. Although the pension fund has an infinite investment horizon, its managers must report annually on the performance of their investments and cannot afford negative returns over long periods. Their choice of a short horizon creates a conflict of interest between the manager and the stockholders.

105. 5.105105 Asset Pricing - A Partial Equilibrium Model Another source of a conflict of interest is the rule adopted in foundations and trusts that only a fixed percentage of an n-year moving average of the value of the endowment (usually, n = 5) can be spent every year. The goals of maximizing the present value of spending over an infinite horizon versus maintaining a steady operating budget compete against each other.

106. 5.106106 Asset Pricing - An Equilibrium Pricing Model Barberis et al. (2001) builds on Benartzi and Thaler (1995) to provide a behavioural explanation of the equity premium puzzle based on an equilibrium pricing model (Li Calzi 2002). The new twist they add is that prior outcomes influence the way gains and losses in wealth are experienced.

107. 5.107107 Asset Pricing - An Equilibrium Pricing Model Thaler and Johnson (1990) finds that a loss is less painful to people when it comes after substantial earlier increases in wealth: the earlier gains “cushion” the subsequent loss and make it more bearable. In financial markets, this translates into a behaviour such that investors care less for a market dip that follows substantial prior gains because they are “still up, relative to a year ago.”

108. 5.108108 Asset Pricing - An Equilibrium Pricing Model Starting from an underlying consumption growth process with low variance, the combination of prospect theory and the effect of prior outcomes can generate stock returns with high mean, high volatility and significant predictability, while maintaining a risk less interest rate with low mean and volatility.

109. 5.109109 Asset Pricing - An Equilibrium Pricing Model This is obtained in a consumption-based asset pricing model (Lucas 1987). Except for the modifications in investors’ preferences, the (representative) investor (named Primus) is fully rational and dynamically consistent.

110. 5.110110 Asset Pricing - An Equilibrium Pricing Model The driving force in the model is a story of changing risk aversion. After a run-up in prices, Primus is less risk averse because those gains will cushion any subsequent loss. After a fall in stock prices, he is more wary of further losses and hence more risk averse. This variation in risk aversion allows returns to be much more volatile than the underlying dividends: an unusually good dividend raises prices, but this price increase also makes Primus less risk averse, driving prices still higher.

111. 5.111111 Asset Pricing - An Equilibrium Pricing Model This process generates predictability in returns very similar to what is empirically observed: following a significant rise in price, the investor is less risk averse and subsequent returns are therefore on average lower. Moreover, since the high volatility of returns leads to frequent losses for stocks, the loss adverse investor requires a high equity premium to be willing to hold stocks. See Barberis et al. (2001) and other works by these authors.

112. 5.112112 A Biased Warning The following is credited toTerry Smith (Terry Smith puts money where his fund is Daily Telegraph, 2-11-2010), the view may be slightly biased since he was launching his own fund.Terry Smith puts money where his fund is An average fund manager charges a management fee of 3% annually. Smith has frequently lambasted the fund management industry for underperformance and overcharging customers. Turnover of shares at FundSmith (his fund) will be kept to a minimum.FundSmithFundSmith

113. 5.113113 A Biased Warning On the fund management industry Mr. Smith comments: “The reaction I find most amazing is from the individuals who disbelieve the simple arithmetic of the example of the impact of hedge fund style 2% and 20% fees on the division of the resulting fund between the investor and fund manager. If 2% and 20% were applied to Warren Buffett’s investment performance, over 90% of the eventual value of the fund would accrue not to the investor, but to the manager.”

114. 5.114114 A Biased Warning On the fund management industry Mr. Smith comments: “We have certainly seen people ripped off. Your average active fund manager is charging you 5% up front, 1.5% per annum and he probably adds about another 1.5% per annum for his dealings, so you pay about 3% per annum. You can go and buy an index fund for 25 basis points, a quarter of a percent. So for around about a twelfth of what he is charging you per annum you could just get the index, so you have clearly been ripped off.”

115. 5.115115 A Biased Warning Why Fundsmith boss Terry Smith takes the slow road - Daily Mail - 7 Nov 2014 Terry Smith thinks there are only 65 companies in the entire world worth investing in. But the share price of many of them is far too expensive, he grumbles. So he only has money in just 27. Since launch in 2010, his fund has leapt by more than 80 per cent – if you’d invested £1,000, your cash would now be worth £1,846.

116. 5.116116 A Biased Warning Always in demand: Fundsmith Equity Fund invests in companies that produce consumer staples like Reckitt Benckiser - which own Dettol - and Unilever, which own PG Tips.

117. 5.117117 A Biased Warning Mr. Smith intends to address the perennial criticism of fund managers as fickle custodians of clients’ money. If FundSmith serves the wider purpose of driving down fees and livening up some of the more indolent fund managers, investors everywhere will owe its founder a debt of gratitude. It is a sector congested with investment managers; from the mediocre to the downright bad with a mania for charging high fees, thereby eroding returns and seldom beating the index.

118. 5.118118 Circular Fees! FCA warns managers over in-house funds - FT - 26 Nov 2014 Many wealth managers and private banks have been failing to make clear when they are placing customer money into funds they run themselves, a review by the UK financial watchdog has found. Some of these firms also failed to monitor their use of in-house funds, the Financial Conduct Authority said in a report released on Monday.Financial Conduct Authorityreport Wealth managers and private banks have previously faced strong criticism from the regulator over their lack of clarity on fees.

119. 5.119119 You Are Not Alone! True and Fair Campaign The investment industry has been using smoke and mirrors to mislead consumers for far too long. Fees are hidden when investing your hard earned money in ISAS, pensions and other investments. This is a tragedy when 49% of the UK workforce is not saving enough for retirement. The British public faces a minefield of hidden charges with their investments and savings. Millions of ordinary savers and pensioners are being left seriously out of pocket through bad investment products, services and industry practices - the very people who most deserve to be told the truth about charges, and need greatest encouragement to build up adequate savings pots are being deceived.

120. 5.120120 You Are Not Alone! True and Fair Calculator The aim of the Calculator is to provide users with a reasoned estimate of the full effects of charges and other costs on their investments, in pounds and pence and as a percentage. The Calculator is the brainchild of Gina and Alan Miller, who have worked in the investment management industry for nearly 28 years they are passionate believers that consumers have a fundamental right to know the true cost of their investments, in one single number, before investing. This Calculator finally gives investors the chance to do this. Calculator

121. 5.121121 However The comic strip highlights the obstacle posed by the low financial literacy of many would-be investors. While the comic makes the exaggerated point that an investor facing a 10 percent per year fee would nevertheless blindly proceed with investing, this parody is not far from the truth. Many mutual fund and hedge fund investors pay 2 percent per year or more on the amount invested — whether the value of their investment goes up or down! Cartoon (Kramer 2014)Cartoon(Kramer 2014)

122. 5.122122 However Hidden fees will lead funds to their OK Corral Financial Times, February 3, 2013, Tom Stabile …dubious ways managers are allowed to disguise fund costs… The sad list includes mutual funds and their brokerage partners masking the cost of sales commissions or “loads” by stretching them for years into an “ongoing” charge, or trapping them at the back-end when investors exit the fund. There also are the ankle-biters – the purchase fee on investors buying in; redemption fee on investors selling off; account fee, often just for routine administration; and a shareholder service fee for pesky investors who call with questions. Then tack on sometimes hefty trading costs, which most managers hide deep in fund documents. Most account statements also have no clear summary of charges, because funds usually deduct these expenses from the pooled assets, forcing investors to consult a prospectus, calculator and abacus.

123. 5.123123 However For example the Sarasin Agrisar fund included in the Hargreaves Landsdown Wealth 150 list had gained only 9 per cent in the five years to 2014. It also has annual charges of 1.75 per cent!Hargreaves LandsdownWealth 150 list Sarasin & Partners LLP - Welcome to Sarasin & Partners. Fact sheet

124. 5.124124 However How to choose a financial adviser - FT - 31 Oct 2014 The authors view is that there is a substantial number of people being over-served and overcharged by financial services firms because the firm is providing an ongoing annual service that is not necessary or not good value for money. Betterment: ambitions of a robo adviser - FT - 16 Dec 2014 BettermentBetterment is an old word for a new idea: a website delivering personalised investment at lower cost than flesh-and-blood advisers can. But then paradox is intrinsic to the character of co-founder Jon Stein. The New York entrepreneur says he “loathes” the banking industry, yet plays down the assumption that “robo advisers” such as Betterment could put tens of thousands of US investment advisers out of their jobs.

125. 5.125125 Also Mortgage borrowers struggle to find cheapest deal - Which? - 3 Nov 2014 Which? research has found that homeowners could be paying over the odds because it's too hard for compare mortgage deals. Their research revealed that mortgage borrowers are being faced with over 40 different fees and charges from lenders, from set-up costs through to arrears fees and final repayment charges. Lenders also don't always make it clear whether fees are avoidable or not. When setting up a mortgage, borrowers may be charged multiple fees to cover administration costs. Arrangement fees have also become more expensive, doubling in the past five years from an average of £878 in 2009 to £1,588 in 2014. To add to the confusion, providers may use different names for the same or similar fees - for example booking fees might also be called reservation or application fees depending on which lender you're dealing with. How 'sneaky' banks hid a sharp rise in mortgage fees - Telegraph - 3 Nov 2014

126. 5.126126 Next Week Preferences In Prospect Theory