Principles of Behavioral Economics and Finance

Principles of Behavioral Economics and Finance

Instructions:  Answers must be typed.  You may work as a group with other classmates.  If you choose to work as a group, you should submit only one response for your whole group.  Every group member’s name should be listed on the top of the page.

Question 1

Daniel Kahneman (2002 Nobel laureate) and Richard Thaler (2017 Nobel laureate) co-authored an article in the Journal of Economic Perspectives.[1]  Read this article, and answer the following questions:

1. What distinction do these authors make between decision utility and experienced utility?
2. What are projection biases in the context of this paper? Provide an example of a projection bias, either from your life or from the paper.
3. How does the notion of a projection bias relate to whether and how much people choose to save for retirement when they are young?
4. Consider the examples of differences of experienced utility described in the paper, such as the shopper who receives higher experienced utility from food when he is hungry compared to when he is sated, or who enjoys warm clothes more when she is cold compared to when she is warm. Based on these examples, or similar observations of experienced utility you may have from your own life, what are the fundamental factor or factors that determine the experienced utility of any given good or scenario?

Principles of Behavioral Economics and Finance

Question 2

Stephen Ross was a financial economist who authored very well-regarded textbooks on Neoclassical Finance and Corporate Finance.  For this question, you’re going to read his keynote address to the European Financial Management Association in 2001 and answer the following questions.[2]

1. In Ross’s view, what does it mean for markets to be efficient? is it necessary for people to be completely rational in order for markets to be efficient?  Why or why not?
2. According to Ross, does the existence of efficient markets mean that there are no profitable arbitrage or trading opportunities?
3. What is the “closed-end fund puzzle”?
4. What is Ross’s solution to the closed-end fund puzzle? (Note:  You don’t need to show the math.  Just explain the intuition.)

[1] Kahneman, Daniel and Richard Thaler (2006).  “Utility Maximization and Experienced Utility.”  Journal of Economic Perspectives.  Vol. 20, No. 1, 221-234.

[2] Ross, Stephen.  “Neoclassical Finance, Alternative Finance and the Closed End Fund Puzzle.”  European Financial Management.  Vol. 8, No. 2, 129-137.

Principles of Behavioral Economics and Finance

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