Module Directory

In this module it will be shown how allowing for common human traits such as overconfidence, fear of regret, pride, loss aversion, anchoring, framing, mental accounting, representativeness, etc., and limits to arbitrage enables a better understanding of financial markets and the trading strategies of investors.

The aims of this are to:

• Provide a plausible alternative to the neoclassical financial model that underlies the efficient market hypothesis.


• Identify key cognitive biases and heuristics that influence investment behaviour and asset prices.


• Present some latest research relating to both the theoretical developments in the field of behavioural finance along with the related empirical evidence.


• Build a bridge between academic research and investment practice.

By the end of this module, students will be expected to be able to:

1. Appreciate how prospect theory builds on and departs from expected utility theory.


2. Understand the role of heuristics and biases in influencing asset pricing and investment behaviour.


3. Understand the theoretical and empirical evidence for a variety of investment strategies based on the assumption of less than fully efficient markets.

Skills for your professional life (Transferable Skills)

The module will help you with the following transferable skills:

1. Good appreciation of the workings of financial markets when investors are less than 100% rational e.g. they are subject to loss aversion.


2. Ability to interpret empirical research results.


3. Understanding of recent developments in finance such as Fintech and equity crowdfunding.

For many years the Efficient Market Hypothesis (EMH) had been assumed to be valid within academic circles. Despite this, many practitioners choose active investment strategies that are premised on markets being inefficient; to take two examples, momentum investors buy stocks that have recently increased in value while value investors seek to buy grossly under-valued stocks.

In addition, there is increasing evidence of the existence of a wide variety of anomalies that represent an empirical challenge to the EMH. These include: stock market bubbles and crashes; abnormal returns to non-risk factors; delayed reaction to financial news such as earnings announcements; overreaction and eventual corrections; and the apparent profitability of momentum and value strategies.

During the past two decades a new paradigm has developed within finance. Behavioural finance rejects two crucial assumptions of mainstream finance: these are the assumptions of homogeneous, ultra-rational (utility maximising) agents and unlimited arbitrage. Drawing from cognitive psychology, behavioural finance examines ways in which common cognitive biases and heuristics together with and limits to arbitrage influence trading and stock prices.

This module will be delivered via:

• One 2-hour lecture per week.
• One seminar per week.

Problem sets will be given in advance for you to attempt before the class.