Options and Corporate Finance: Basic Concepts

May 28th, 2015
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‘Behavioral finance argues that some financial phenomena can plausibly be understood using models in which some agents are not fully rational. The field has two building blocks: limits to arbitrage, which argues that it can be difficult for rational traders to undo the dislocations caused by less rational traders; and psychology, which catalogues the kinds of deviations from full rationality we might expect to see. (Barberis and Thaler, 2001)

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TOPIC:BEHAVIOURAL FINANCEINTRODUCTIONBehavioural finance is the study of the psychology influence on the behaviour of financial investor and subsequently the effects of the behaviour on financial marketsGraham and Dodd assert that; "The market's evaluation of the same data can vary over a wide range, dependent on bullish enthusiasm, concentrated speculative interest and similar influences, or bullish disillusionment. Knowledge is only one ingredient in arriving at a stock's price. The other ingredient, fully as important as information, is sound judgment." L.C. Gupta on other hand states; "Our findings suggest that the market's evaluation processes work haphazardly, almost like a blind man firing a gun rather than on the basis of informed beliefs about the long-term prospects of individual firms.In essence, the views expressed by Graham and Dodd and Gupta above imply that the market may at times display high irrationality causing substantial discrepancy between intrinsic values and market prices.Behavioural finance began as an attempt to understand why financial markets react inefficiently to public information. One stream of behavioural finance examines how psychological forces induce traders and managers to make suboptimal decisions, and how these decisions affect market behaviour. Another stream examines how economic forces might keep rational traders from exploiting apparent opportunities for profit Behavioural finance remains controversial, but will become

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