Outline of Efficient Market View and Behavioral Finance View

Efficient Market View
- financial markets are efficiently taking account of all information, market prices reflect data
- "security prices reflect the true underlying value of assets"
- little room to capitolize on markets

Technical Analysis
- looking at charts to identify patterns in movements in markets
- Head and shoulder pattern, indicates great potential future loss (1% of cases)
- stock prices have to do a random walk through time (99% of cases)
- random walk:
x(t) = x(t-1) - E
E = random number
random walk negates trends
random walk states there is no regressing mean
- AR1 (first order autoregressive)
x(t) = 100 + p(x(t-1) - 100) + E
if (p = 1) AR1 = random walk
the larger the value of p (as p approached 1), the more random it is

** strategy
if below trend line => buy
if above trend line => sell
** prices will revert back to trend


Behavioral Finance/Economics
Adam Smith (1759) Theory of Moral Sentiments
(1776) Wealth of Nations

"praise is a fundamental human desire"
"humans make a transition from a desire for praise to a desire for praise worthiness"

Prospect Theory (Kahneman & Tversky)
value function = how people value items
reference point is subject to manipulation
wealth
framing (verbal manipulation/spin)
weighting function = how people deal with probabilities
probability
value between 1 and 100

others:
regret
overconfidence
cognitive dissonance
ego holding to false beliefs
assembling evidence that supports false theory
social contagion
herd behavior
collective consciousness (Emile Durkheim)
zeitgeist = collective set of facts/collective memory



Investments
1) Investment Allocations
- architectural makeup of investments
2) Market Timing Portfolios
- decisions over time
3) Security Selection
- risks vs reward