Chapter 12 - Behavioral Finance and Technical Analysis

Chapter 12
Behavioral Finance and Technical Analysis

Multiple Choice Questions

1. Conventional theories presume that investors ____________ and behavioral finance
presumes that they ____________.
A. are irrational; are irrational
B. are rational; may not be rational
C. are rational; are rational
. may not be rational; may not be rational
!. may not be rational; are rational
Conventional theories presume that investors are rational and behavioral finance presumes
that they may not be rational.

Difficulty: Easy

2. The premise of behavioral finance is that
A. conventional financial theory i"nores ho# real people ma$e decisions and that people
ma$e a difference.
B. conventional financial theory considers ho# emotional people ma$e decisions but the
mar$et is driven by rational utility ma%imi&in" investors.
C. conventional financial theory should i"nore ho# the avera"e person ma$es decisions
because the mar$et is driven by investors that are much more sophisticated than the avera"e
person.
. B and C
!. none of the above
The premise of behavioral finance is that conventional financial theory i"nores ho# real
people ma$e decisions and that people ma$e a difference.

Difficulty: Easy

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Chapter 12 - Behavioral Finance and Technical Analysis
'. (ome economists believe that the anomalies literature is consistent #ith investors
____________ and ____________.
A. ability to al#ays process information correctly and therefore they infer correct probability
distributions about future rates of return; "iven a probability distribution of returns) they
al#ays ma$e consistent and optimal decisions
B. inability to al#ays process information correctly and therefore they infer incorrect
probability distributions about future rates of return; "iven a probability distribution of
returns) they al#ays ma$e consistent and optimal decisions
C. ability to al#ays process information correctly and therefore they infer correct probability
distributions about future rates of return; "iven a probability distribution of returns) they often
ma$e inconsistent or suboptimal decisions
D. inability to al#ays process information correctly and therefore they infer incorrect
probability distributions about future rates of return; "iven a probability distribution of
returns) they often ma$e inconsistent or suboptimal decisions
!. none of the above
(ome economists believe that the anomalies literature is consistent #ith investors inability to
al#ays process information correctly and therefore they infer incorrect probability
distributions about future rates of return and "iven a probability distribution of returns) they
often ma$e inconsistent or suboptimal decisions.

Difficulty: Moderate

*. +nformation processin" errors consist of
+, forecastin" errors
++, overconfidence
+++, conservatism
+-, framin"
A. + and ++
B. + and +++
C. +++ and +-
. +- only
E. +) ++ and +++
+nformation processin" errors consist of forecastin" errors) overconfidence) and conservatism.

Difficulty: Moderate

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Chapter 12 - Behavioral Finance and Technical Analysis
.. Forecastin" errors are potentially important because
A. research su""ests that people under#ei"ht recent information.
B. research su""ests that people over#ei"ht recent information.
C. research su""ests that people correctly #ei"ht recent information.
. either A or B dependin" on #hether the information #as "ood or bad.
!. none of the above.
Forecastin" errors are potentially important because research su""ests that people over#ei"ht
recent information.

Difficulty: Moderate

/. eBondt and Thaler believe that hi"h 01! result from investors
A. earnin"s e%pectations that are too e%treme.
B. earnin"s e%pectations that are not e%treme enou"h.
C. stoc$ price e%pectations that are too e%treme.
. stoc$ price e%pectations that are not e%treme enou"h.
!. none of the above.
eBondt and Thaler believe that hi"h 01! result from investors earnin"s e%pectations that are
too e%treme.

Difficulty: Moderate

2. +f a person "ives too much #ei"ht to recent information compared to prior beliefs) they
#ould ma$e ________ errors.
A. framin"
B. selection bias
C. overconfidence
. conservatism
E. forecastin"
+f a person "ives too much #ei"ht to recent information compared to prior beliefs) they #ould
ma$e forecastin" errors.

Difficulty: Moderate

12-'
Chapter 12 - Behavioral Finance and Technical Analysis
3. (in"le men trade far more often than #omen. This is due to "reater ________ amon" men.
A. framin"
B. re"ret avoidance
C. overconfidence
. conservatism
!. none of the above
(in"le men trade far more often than #omen. This is due to "reater overconfidence amon"
men.

Difficulty: Moderate

4. ____________ may be responsible for the prevalence of active versus passive investments
mana"ement.
A. Forecastin" errors
B. 5verconfidence
C. 6ental accountin"
. Conservatism
!. 7e"ret avoidance
5verconfidence may be responsible for the prevalence of active versus passive investments
mana"ement.

Difficulty: Moderate

18. Barber and 5dean 92888, ran$ed portfolios by turnover and report that the difference in
return bet#een the hi"hest and lo#est turnover portfolios is 2: per year. They attribute this
to
A. overconfidence
B. framin"
C. re"ret avoidance
. sample ne"lect
!. all of the above
They attribute this to overconfidence.
Difficulty: Moderate

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Chapter 12 - Behavioral Finance and Technical Analysis
11. ________ bias means that investors are too slo# in updatin" their beliefs in response to
evidence.
A. framin"
B. re"ret avoidance
C. overconfidence
D. conservatism
!. none of the above
12-.
Chapter 12 - Behavioral Finance and Technical Analysis
Conservatism bias means that investors are too slo# in updatin" their beliefs in response to
evidence.

Difficulty: Moderate

12. 0sycholo"ists have found that people #ho ma$e decisions that turn out badly blame
themselves more #hen that decision #as unconventional. The name for this phenomenon is
A. re"ret avoidance
B. framin"
C. mental accountin"
. overconfidence
!. obno%icity
An investments e%ample "iven in the te%t is buyin" the stoc$ of a star-up firm that sho#s
subse;uent poor performance) versus buyin" blue chip stoc$s that perform poorly. +nvestors
tend to have more re"ret if they chose the less conventional start-up stoc$. eBondt and
Thaler say that such re"ret theory is consistent #ith the si&e effect and the boo$-to-mar$et
effect.

Difficulty: Moderate

1'. An e%ample of ________ is that a person may re<ect an investment #hen it is posed in
terms of ris$ surroundin" potential "ains but may accept the same investment if it is posed in
terms of ris$ surroundin" potential losses.
A. framin"
B. re"ret avoidance
C. overconfidence
. conservatism
!. none of the above
An e%ample of framin" is that a person may re<ect an investment #hen it is posed in terms of
ris$ surroundin" potential "ains but may accept the same investment if it is posed in terms of
ris$ surroundin" potential losses.

Difficulty: Moderate

12-/
Chapter 12 - Behavioral Finance and Technical Analysis
1*. (tatman 91422, ar"ues that ________ is consistent #ith some investors= irrational
preference for stoc$s #ith hi"h cash dividends and #ith a tendency to hold losin" positions
too lon".
A. mental accountin"
B. re"ret avoidance
C. overconfidence
. conservatism
!. none of the above
(tatman 91422, ar"ues that mental accountin" is consistent #ith some investors= irrational
preference for stoc$s #ith hi"h cash dividends and #ith a tendency to hold losin" positions
too lon"

Difficulty: Moderate

1/. Arbitra"eurs may be unable to e%ploit behavioral biases due to ____________.
+, fundamental ris$
++, implementation costs
+++, model ris$
+-, conservatism
-, re"ret avoidance
A. + and ++ only
B. +) ++) and +++
C. +) ++) +++) and -
. ++) +++) and +-
!. +- and -
Arbitra"eurs may be unable to e%ploit behavioral biases due to fundamental ris$)
implementation costs) and model ris$.
Difficulty: Moderate

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Chapter 12 - Behavioral Finance and Technical Analysis
12. ____________ are "ood e%amples of the limits to arbitra"e because they sho# that the
la# of one price is violated.
+, (iamese T#in Companies
++, >nit trusts
+++, Closed end funds
+-, 5pen end funds
-, !;uity carve outs
A. + and ++
B. +) ++) and +++
C. +) +++) and -
. +- and -
!. -
(iamese T#in Companies) closed end funds) and e;uity carve outs are "ood e%amples of the
limits to arbitra"e because they sho# that the la# of one price is violated.

Difficulty: Moderate
13. __________ #as the "randfather of technical analysis.
A. ?arry 6ar$o#it&
B. @illiam (harpe
C. Charles o#
. Ben<amin Araham
!. none of the above
Charles o#) the ori"inator of the o# Theory) #as the "randfather of technical analysis.
Ben<amin Araham mi"ht be considered the "randfather of fundamental analysis. ?arry
6ar$o#it& and @illiam (harpe mi"ht be considered the "randfathers of modern portfolio
theory.

Difficulty: Easy

14. The "oal of the o# theory is to
A. identify head and shoulder patterns.
B. identify brea$a#ay points.
C. identify resistance levels.
. identify support levels.
E. identify lon"-term trends.
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Chapter 12 - Behavioral Finance and Technical Analysis
The o# theory uses the o# Bones +ndustrial Avera"e as an indicator of lon"-term trends in
mar$et prices.

Difficulty: Easy

2'. The o# theory posits that the three forces that simultaneously affect stoc$ prices are
____________.
+, primary trend
++, intermediate trend
+++, momentum trend
+-, minor trend
-, contrarian trend
A. +) ++) and +++
B. ++) +++) and +-
C. +++) +- and -
D. +) ++) and +-
!. +) +++) and -
The o# theory posits that the three forces that simultaneously affect stoc$ prices are primary
trend) intermediate trend) and minor trend.

Difficulty: Moderate

2*. The !lliot @ave Theory ____________.
A. is a recent variation of the o# Theory
B. su""ests that stoc$ prices can be described by a set of #ave patterns
C. is similar to the Condratieff @ave theory
. A and B
E. A) B) and C
Both the !lliot @ave Theory and the Condratieff @ave Theory are recent variations on the
o# Theory) #hich su""ests that stoc$ prices move in identifiable #ave patterns.

Difficulty: Easy
2.. A trin ratio of less than 1.8 is considered as a _________.
A. bearish si"nal
B. bullish si"nal
C. bearish si"nal by some technical analysts and a bullish si"nal by other technical analysts
. bullish si"nal by some fundamentalists
!. C and
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Chapter 12 - Behavioral Finance and Technical Analysis
A trin ratio of less than 1.8 is considered bullish because the declinin" stoc$s have lo#er
avera"e volume than the advancin" stoc$s) indicatin" net buyin" pressure.
Difficulty: Easy

2/. 5n 5ctober 24) 1441 there #ere 1)8'1 stoc$s that advanced on the DE(! and /18 that
declined. The volume in advancin" issues #as 112)3//)888 and the volume in declinin" issues
#as .3)133)888. The trin ratio for that day #as ________ and technical analysts #ere li$ely to
be ________.
A. 8.32) bullish
B. 8.32) bearish
C. 1.1.) bullish
. 1.1.) bearish
!. none of the above
91)8'11/18, 1 9112)3//)8881.3)'33)888, F 8.32. A trin ratio less than 1 is considered bullish
because advancin" stoc$s have a hi"her volume than declinin" stoc$s) indicatin" a buyin"
pressure.

Difficulty: Moderate
22. +n re"ard to movin" avera"es) it is considered to be a ____________ si"nal #hen mar$et
price brea$s throu"h the movin" avera"e from ____________.
A. bearish; belo#
B. bullishG belo#
C. bearish; above
. bullish above
E. B and C
+n re"ard to movin" avera"es) it is considered to be a bullish si"nal #hen mar$et price brea$s
throu"h the movin" avera"e from belo#. +n addition) it is considered to be a bearish si"nal
#hen mar$et price brea$s throu"h the movin" avera"e from above.

Difficulty: Moderate

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Chapter 12 - Behavioral Finance and Technical Analysis
24. ____________ is a measure of the e%tent to #hich a movement in the mar$et inde% is
reflected in the price movements of all stoc$s in the mar$et.
A. put-call ratio
B. trin ratio
C. Breadth
. confidence inde%
!. all of the above
Breadth is a measure of the e%tent to #hich a movement in the mar$et inde% is reflected in the
price movements of all stoc$s in the mar$et.

Difficulty: Moderate

'8. Then confidence inde% is computed from ____________ and hi"her values are considered
____________ si"nals.
A. bond yields; bearish
B. odd lot trades; bearish
C. odd lot trades; bullish
. put1call ratios; bullish
E. bond yields; bullish
Then confidence inde% is computed from bond yields and hi"her values are considered bullish
si"nals.

Difficulty: Moderate

'1. The put1call ratio is computed as ____________ and hi"her values are considered
____________ si"nals.
A. the number of outstandin" put options divided by outstandin" call options; bullish or
bearish
B. the number of outstandin" put options divided by outstandin" call options; bullish
C. the number of outstandin" put options divided by outstandin" call options; bearish
. the number of outstandin" call options divided by outstandin" put options; bullish
!. the number of outstandin" call options divided by outstandin" put options; bearish
The put1call ratio is computed as the number of outstandin" put options divided by
outstandin" call options and hi"her values are considered bullish or bearish si"nals.

Difficulty: Moderate

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Chapter 12 - Behavioral Finance and Technical Analysis
''. Tests of mar$et efficiency have focused on ____________.
A. the mean-variance efficiency of the selected mar$et pro%y
B. strate"ies that would have provided superior ris$-ad<usted returns
C. results of actual investments of professional mana"ers
D. B and C
!. A and B
Tests of mar$et efficiency have focused on strate"ies that would have provided superior ris$-
ad<usted returns and results of actual investments of professional mana"ers.

Difficulty: Moderate

'*. The anomalies literature ____________.
A. provides a conclusive re<ection of mar$et efficiency
B. provides a conclusive support of mar$et efficiency
C. su""ests that several strate"ies #ould have provided superior returns
. A and C
!. none of the above
The anomalies literature su""ests that several strate"ies #ould have provided superior returns.

Difficulty: Moderate

'.. Behavioral finance ar"ues that ____________.
A. even if security prices are #ron" it may be difficult to e%ploit them
B. the failure to uncover successful tradin" rules or traders cannot be ta$en as proof of mar$et
efficiency
C. investors are rational
D. A and B
!. all of the above
Behavioral finance ar"ues that even if security prices are #ron" it may be difficult to e%ploit
them and the failure to uncover successful tradin" rules or traders cannot be ta$en as proof of
mar$et efficiency.

Difficulty: Moderate

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Chapter 12 - Behavioral Finance and Technical Analysis
'/. 6ar$ets #ould be inefficient if irrational investors __________ and actions of arbitra"ers
#ere __________.
A. e%isted; unlimited
B. did not e%ist; unlimited
C. e%isted; limited
. did not e%ist; limited
!. none of the above
6ar$ets #ould be inefficient if irrational investors e%isted and actions if arbitra"ers #ere
limited.

Difficulty: Moderate

'3. __________ can lead investors to misestimate the true probabilities of possible events or
associated rates of return.
A. +nformation processin" errors
B. Framin" errors
C. 6ental accountin" errors
. 7e"ret avoidance
!. all of the above
+nformation processin" errors can lead investors to misestimate the true probabilities of
possible events or associated rates of return.

Difficulty: Moderate

'4. Cahneman and Tvers$y 9142', report that __________ and __________.
A. people "ive too little #ei"ht to recent e%perience compared to prior beliefs; tend to ma$e
forecasts that are too e%treme "iven the uncertainty of their information
B. people "ive too much #ei"ht to recent e%perience compared to prior beliefs; tend to ma$e
forecasts that are too e%treme "iven the uncertainty of their information
C. people "ive too little #ei"ht to recent e%perience compared to prior beliefs; tend to ma$e
forecasts that are not e%treme enou"h "iven the uncertainty of their information
. people "ive too much #ei"ht to recent e%perience compared to prior beliefs; tend to ma$e
forecasts that are not e%treme enou"h "iven the uncertainty of their information
!. none of the above
Cahneman and Tvers$y 9142', report that people "ive too much #ei"ht to recent e%perience
compared to prior beliefs and tend to ma$e forecasts that are too e%treme "iven the
uncertainty of their information.

Difficulty: Moderate

12-1'
Chapter 12 - Behavioral Finance and Technical Analysis
*.. The assumptions concernin" the shape of utility functions of investors differ bet#een
conventional theory and prospect theory. Conventional theory assumes that utility functions
are __________ #hereas prospect theory assumes that utility functions are __________.
A. concave and defined in terms of #ealth; s-shaped 9conve% to losses and concave to "ains,
and defined in terms of loses relative to current #ealth
B. conve% and defined loses relative to current #ealth; s-shaped 9conve% to losses and
concave to "ains, and defined in terms of loses relative to current #ealth
C. s-shaped 9conve% to losses and concave to "ains, and defined in terms of loses relative to
current #ealth; concave and defined in terms of #ealth
. s-shaped 9conve% to losses and concave to "ains, and defined in terms of #ealth; concave
and defined in terms of loses relative to current #ealth
!. conve% and defined in terms of #ealth; concave and defined in terms of "ains relative to
current #ealth
The assumptions concernin" the shape of utility functions of investors differ bet#een
conventional theory and prospect theory. Conventional theory assumes that utility functions
are concave and defined in terms of #ealth #hereas prospect theory assumes that utility
functions are s-shaped 9conve% to losses and concave to "ains, and defined in terms of loses
relative to current #ealth.

Difficulty: Difficult

*/. The la#-of-one-price posits that ability to arbitra"e #ould force prices of identical "oods
to trade at e;ual prices. ?o#ever) empirical evidence su""ests that __________ are often
mispriced.
A. (iamese T#in Companies
B. e;uity carve outs
C. closed-end funds
. A and C
E. all of the above
The la#-of-one-price posits that ability to arbitra"e #ould force prices of identical "oods to
trade at e;ual prices. ?o#ever) empirical evidence su""ests that all of the above are often
mispriced.

Difficulty: Difficult
12-1*
Chapter 12 - Behavioral Finance and Technical Analysis
.*. (tudies of (iamese t#in companies find __________ #hich __________ the !6?.
A. correct relative pricin"; supports
B. correct relative pricin"; does not support
C. incorrect relative pricin"; supports
D. incorrect relative pricin"; does not support
!. none of the above
(tudies of (iamese t#in companies find incorrect relative pricin" #hich does not support the
!6?.

Difficulty: Moderate

... (tudies of e;uity carve-outs find __________ #hich __________ the !6?.
A. stron" support for the Ha# of 5ne 0rice; supports
B. stron" support for the Ha# of 5ne 0rice; violates
C. evidence a"ainst the Ha# of 5ne 0rice; violates
. evidence a"ainst the Ha# of 5ne 0rice; supports
!. none of the above
(tudies of e;uity carve-outs find evidence a"ainst the Ha# of 5ne 0rice #hich violates the
!6?.

Difficulty: Moderate

./. (tudies of closed-end funds find __________ #hich __________ the !6?.
A. prices at a premium to DA-; is consistent #ith
B. prices at a premium to DA-; is inconsistent #ith
C. prices at a discount to DA-; is consistent #ith
. prices at a discount to DA-; is inconsistent #ith
E. B and
(tudies of closed-end funds find prices at premiums and discounts to DA- #hich is
inconsistent #ith the !6?.

Difficulty: Moderate


12-1.