Chapter Questions
Explain how some of the behavioral biases discussed in the chapter might contribute to the success of technical trading rules.
Why would an advocate of the efficient market hypothesis believe that even if many investors exhibit the behavioral biases discussed in the chapter, security prices might still be set efficiently?
What sorts of factors might limit the ability of rational investors to take advantage of any "pricing errors" that result from the actions of "behavioral investors"?
Even if behavioral biases do not affect equilibrium asset prices, why might it still be important for investors to be aware of them?
Some advocates of behavioral finance agree with efficient market advocates that indexing is the optimal investment strategy for most investors. But their reasons for this conclusion differ greatly. Compare and contrast the rationale for indexing according to both of these schools of thought.
Jill Davis tells her broker that she does not want to sell her stocks that are below the price she paid for them. She believes that if she just holds on to them a little longer they will recover, at which time she will sell them. Which behavioral characteristic is the basis for Davis's decision making?a. Disposition effect.b. Conservatism.c. Representativeness.
After Polly Shrum sells a stock, she avoids following it in the media. She is afraid that it may subsequently increase in price. Which behavioral characteristic is the basis for Shrum's decision making?a. Fear of regret.b. Representativeness.c. Mental accounting.
All of the following actions are consistent with feelings of regret except:a. Selling losers quickly.b. Hiring a full-service broker.c. Holding on to losers too long.
Match each example to one of the following behavioral characteristics.
What do we mean by fundamental risk, and why may such risk allow behavioral biases to persist for long periods of time?
What is meant by data mining, and why must technical analysts be careful not to engage in it?
Even if prices follow a random walk, they still may not be informationally efficient. Explain why this may be true and why it matters for the efficient allocation of capital.
Use the data from The Wall Strect Journal in Figure 12.5 to calculate the trin ratio for the NASDAQ. Is the trin ratio bullish or bearish?
Calculate breadth for the NASDAQ using the data in Figure 12.5. Is the signal bullish or bearish?
Collect data on the S\&P 500 for a period covering a few months. Try to identify primary trends. Can you tell whether the market currently is in an upward or downward trend?
Baa-rated bonds currently yield $6 \%$, while Aa-rated bonds yield $5 \%$. Suppose that due to an increase in the expected inflation rate, the yields on both bonds increase by $1 \%$.a. What would happen to the confidence index?b. Would this be interpreted as bullish or bearish by a technical analys?c. Does this make sense to you?
Table 12A presents price data for Computers, Inc., and a computer industry index. Does Computers, Inc., show relative strength over this period?
Using the data in Table 12A, compute a five-day moving average for Computers, Inc. Can you identify any buy or sell signals?
Yesterday, the S\&P 500 rose by $.48 \%$. However, 1,704 issues on the NYSE declined in price while 1,367 advanced. Why might a technical analyst be concerned even though the market index rose on this day?
Table 12B contains data on market advances and declines. Calculate cumulative breadth and decide whether this technical signal is bullish or bearish.
In Table 12B, if the trading volume in advancing shares on day 1 was 530 million shares, while the volume in declining issues was 440 million shares, what was the trin statistic for that day? Was the trin bullish or bearish?
Using the following data, calculate the change in the confidence index from last ycar to this year. What besides a change in confidence might explain the pattern of yield changes?$$\begin{array}{lcc} & \text { This Year } & \text { Last Year } \\\hline \text { Yield on top-rated comorate bonds } & 4 \% & 7 \% \\\text { Yield on intermediate-grade corporate bonds } & 6 & 9\end{array}$$
Log in to Connect and link to the material for Chapter 12, where you will find five years of weekly returns for the S\&P S00.a. Set up a spreadsheet to calculate the 26 -week moving average of the index. Set the value of the index at the beginning of the sample period equal to 100 . The index value in each week is then updated by multiplying the previous week's level by $(1+$ Rate of return over previous week).b. Identify every instance in which the index crosses through its moving average from below. In how many of the weeks following a cross-through does the index increase? Decrease?c. Identify every instance in which the index crosses through its moving average from above. In how many of the weeks following a cross-through does the index increase? Decrease?d. How well does the moving average rule perform in identifying buy or sell opportunities?
Log in to Connect and link to the material for Chapter 12, where you will find five years of weekly returns for the S\&P 500 and Fidelity's Select Banking Fund (ticker FSRBX).a. Set up a spreadsheet to calculate the relative strength of the banking sector compared to the broad market. b. Identify every instance in which the relative strength ratio increases by at least $5 \%$ from its value five weeks earlier. In how many of the weeks following a substantial increase in relative strength does the banking sector outperform the S\&P 500? In how many of those weeks does the banking sector underperform the S\&P 500?c. Identify every instance in which the relative strength ratio decreases by at least $5 \%$ from its value five weeks earlier. In how many of the weeks following a substantial decrease in relative strength does the banking sector underperform the S\&P 500? In how many of those weeks does the banking sector outperform the S\&P 500?d. How well does the relative strength rule perform in identifying buy or sell opportunities?
One seeming violation of the Law of One Price is the pervasive discrepancy of closed-end fund prices from their net asset values. Would you expect to observe greater discrepancies on diversified or less-diversified funds? Why?