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ECON 412/452 – Behavioural Finance

1. In addition to limits to arbitrage, behavioural ﬁnance presupposes widespread prevalence of decision-making psychology among investors, conceived as deviations from normative ratio- nality.

(a) Present and explain the criteria for normative rationality in choice under risk and un-

certainty. Also provide a detailed example of t w o diﬀerent experiments in which the modal response is a violation of these criteria for normative rationality.

(20 marks)

(b) Present and explain the criteria for normative rationality in the incorporation of new

information. Also provide a detailed example of an experiment in which the modal response is a violation of normative rationality in the incorporation of new information.

(20 marks)

(c) Present and explain the criteria for normative rationality in intertemporal choice. Also give an illustration of the kind of between-task consistency test that can distinguish between those individuals who are consistent with normative rationality in intertemporal choice, and those who are not.

(10 marks)

2. Noise trader risk is a central concept within behavioural ﬁ nance.

(a) State and explain noise trader risk (De Long, Shleifer, Summers and Waldmann, 1990).

Be sure to explain the diﬀerent factors contributing to the expected return spread of noise traders over informed traders, and how these factors interact in doing so.

(15 marks)

(b) Please present and explain an example to illustrate how noise traders’ sentiment can

drive the comovement of asset prices.

(10 marks)

(c) Discuss why the noise trader risk could aﬀect rational arbitrageurs’ decisions to bet against a speculative bubble.

(15 marks)

(d) Explain how noise trader risk contributes to an explanation of the closed-end fund puzzle.

(10 marks)

3. (a) Grayscale Bitcoin Investment Trust (GBTC) holds Bitcoin, and sells shares in this holding. Those shares can be traded on Over-The-Counter (OTC) secondary markets. As the following graphs show, GBTC shares have consistently traded at a premium to the underlying Net Asset Value (NAV) of its Bitcoin holding.

(i) Analyse this from the standpoint of behavioural ﬁnance .

(ii) Can this premium over NAV be explained without recourse to behavioural ﬁnance? If so, please explain.

(a) GBTC premium over NAV (%)

(b) GBTC price per share (USD)

(c) GBTC total return (%)

(d) Bitcoin price (USD)

(25 marks)

(b) Canada legalised the recreational use of cannabis in 2018. In January 2019, the Cana-

dian Securities Exchange held a lottery among 40 interested companies to determine which one of them would receive the (non-transferable) right to use the “POT” stock- ticker symbol. Notice that pot is a slang term for cannabis. On the day that it was pub- licly announced that Weekend Unlimited Industries Inc., a Vancouver-based cannabis products company, had won the “POT” stock-ticker lottery, its share price surged 135%. Weekend Unlimited Industries made no other substantive announcements on that day, nor did any other new information about the company came into the public domain from other sources.

Analyse this from the standpoint of behavioural ﬁnance .

(25 marks)