behavioral finance

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An entire King of Queens episode devoted to behavioral finance and economics. Doug gets a Christmas bonus. He and Carrie decide not to spend their windfall (mental accounting). Doug wants to put it in the bank, while Carrie pushes for a high-flying internet stock (herd behavior). The stock goes up for one day, but quickly falls. They don’t sell because it’s too painful. They hold out, hoping the stock will recover (loss aversion). The stock continues to fall and they finally sell at the bottom. Then they notice news about government approval, the stock rallies, and they buy back in (availability bias). It’s all wrapped up in a syrupy sitcom message about the meaning of Christmas.

Hat tip: Rodrigo Sanchez.

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In thinking about how to apply mental accounting to public policy, George Loewenstein writes:

The process of mentally bucketing money in multiple accounts is often combined with earmarking the accounts for specific goals…While it seems like an inconsequential process, earmarking can have a dramatic effect on retirement saving. Cheema and Soman (2009) found that earmarking savings in an envelope labeled with a picture of a couple’s children nearly doubled the savings rate of very low income parents.

The results by Cheema and Soman could explain why some US financial institutions offer clients the opportunity to label college savings accounts with a child’s name. Saving becomes easier because the money is earmarked for the education of a specific child.

From a recent report on how behavioral economics and finance can improve retirement policies. Hat tip: Dan Goldstein.

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The target company’s 52-week high exhibits a strong anchoring effect on merger and acquisition decisions, according to three economists in the working paper, “The Psychology of Pricing in Mergers and Acquisitions.” A Wall Street Journal article on the paper is gated. The full paper can be downloaded here. A summary is below:

The 52-week high stock price is widely available and represents a salient price level to investors and managers. Empirically, we show that the target’s 52-week high exercises a strong effect on the bidder’s offer price. A number of bidders offer exactly this price, demonstrating its unique salience. The effect is difficult to square with alternative explanations and appears best explained in terms of the use of the 52-week high as a reference point by the target’s shareholders or as an anchor in negotiations with the bidder.

Our evidence suggests that bidders’ shareholders view bids driven by the target’s 52-week high as overpaying: They react especially negatively to the component of the offer price driven by the target’s 52-week high. Most important, perhaps, is the fact that psychological pricing has real effects. Bids that exceed the 52-week high discontinuously increase the probability of deal success and thus the distribution of capital across firms’ alternative investment policies.

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Robert Shiller, who has organized a behavioral finance workshop with Richard Thaler since 1991, lectures on the subject in his Financial Markets class. Runs about an hour.

[youtube="http://www.youtube.com/watch?v=0ZLNbxWH8Lc"]

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