Term
| (4) Information Processing Errors |
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Definition
- Forecasting Errors - People give too much weight to recent evidence and produce extreme forecasts. could cause high P/E stocks to subsequently underperform
- Overconfidence - People tend to overestimate their own abilities
- Conservatism - Investors are often slow to update beliefs due to new information
- Sample size neglect and Representiveness - People tend to infer patterns from limited information
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Term
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Definition
- Framing - reference point matters. People tend to be risk adverse for gains, risk seeking for losses.
- Mental Accounting - specific type of framing when people segregate certain decisions. Playing with house money vs own funds.
- Regret Avoidance - unusual choices cause people to blame themselves more, tend to stick to more convential stocks. => Higher returns required to lure investors to buy firms with high book to market ratios.
- Prospect Theory - Instead of assuming people become less risk adverse as their wealth increases, prospect theory assumes people are loss adverse and evalute based on changes in wealth. Convex with losses =>risk seeking regarding losses.
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Term
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Definition
- Fundamental Risk - mispricing may get worse, causing severe losses, even if right eventually
- Implementation Cost - transaction costs limit
- Model Risk - What if your model is wrong? Still some risk
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Term
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Definition
- Siamese Twin Companies - When the same company is traded/split in multiple ways, prices should be set. Still Fundamental Risk.
- Equity Carve Outs - Selling a stake in a division should be worth less than entire company. Might be limited by lack of shares available to trade.
- Closed-End Funds - Mutual funds where shares cannot be redeemed at will trade at less than share value. Might be accounting for expenses - any alpha.
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