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Behavioural > fungibility and mental accounting > Flashcards

fungibility and mental accounting Flashcards

1
Q

standard theory of money being fungible

A
  • money is substitutable
  • no categorisations needed for consumption decisions
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2
Q

what is narrow bracketing

A

people ignore background information and narrowly focus on the decision and hand - dont consider a wider picture

  • choice bracketing has implications for reference points when people evaluate
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3
Q

what is mental accounting
why is it important

A

pschological process that individuals summarize and analyse thier finances in the head
- they budget
- and categorise wealth
- feel compelled to spend money as intended

  • how people do their mental accounting affects the decisions they make
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4
Q

what are the 3 components of mental accounting

A
  1. how outcomes are perceived
  2. categorisations into specific accounts
  3. frequency accounts are evaluated
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5
Q

what is loss aversion

A

focus on differences relative to a reference point when evaluating
- gain function is concave
- loss is convex
- the pyschological pain due to losing x is greater than the pleasure froming gaining x
- losses loom larger than equivalent size gains

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6
Q

mental accounting = how outcomes are perceived and how decisions are made

A
  1. peoples willingness to pay for goods changes depending on the reference point and context of the situation
  2. reference points matter because - fall prey to the sunk cost fallacy = pursuing an inferior option because of previously investing nonrecoverable resources in the option
  • standard econ = context doesnt change WTP
  • rational decision makers realise the cost is in the past - only compare OC of options available now
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7
Q

example of sunk costs

A
  • you will still attend the basketball game in bad weather when you have paid 200 for it
  • willing to make inferior choices so your losses dont seem like losses
  • most people will sunk the cost
  • compared to if someone else buys the ticket = less people go = evidence just becasue spent the money will force themselves to go
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8
Q

categorisation

A

budgets
separate accounts
expenditure / income categorised

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9
Q

what are the rational purposes of categorising

A
  • supports tradeoffs between categories
  • self control device - set yourself a budget for gambling
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10
Q

what are the 3 ways of framing an outcome

A
  1. comprehensive account = take wealth and future earnings into account
  2. minimal = examine differences between the two options - outweigh 5 difference and cost of driving
  3. topical account - compare consequences of choice relative to reference point = curvature of value function = discount of 5 off of 15 has more psychological value than from 125 - narrow bracketing = thinking about only the calculator
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11
Q

what is the psychological affect of narrow choice bracketing

A
  • depending on whether losses or gains fall into different accounts or the same, will affect evaluation and decision making
  • small loss and big gain in different account = little psychological value
  • small loss big gain in same account = integrated = big psychological value
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12
Q

example of narrow bracketing and graph

A

taxi drivers decisions on the day - narrow frame the time
- only consider decisions on the day rather than lifetime expeceted utility maximisation
- they would benefit more from working more hours on higher wage days
- but because of the bracketing they only consider todays wages
- fall into different accounts - affect evaluation
- separating off different parts of grand decision making process

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13
Q

observational data suggesting label effect

A

winter fuel payment:
- 250 to hh over 60
- you dont only have to spend it on fuel
- if no labelling effect = expect some of 250 will be spent on other things
- narrow bracketing = allowance increases expenditure on fuel after age of 60
- discontinuity
- compared to before policy = no jump at 60
- people bracketing around expenditure on fuel

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14
Q

natural field experiment
- Abeler 2017

gourmet beverages

A
  • restaurant = typical spend = 40
  • 8 voucher given = cash/gourmet beverage

result;
- labelling it gourmet bevergae gets more people to spend on drinks
- before voucher = average 16.60 on drinks
- label = 18.60
- cash = 14.7

not fully controlled - regression is positive and significant

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15
Q

Abeler
lab experiment to test label effect

A
  • induced value utility function for housing and clothing
  • generated a table of payoff functions from laboratory results
  • able to see where optimal consumption is at for baseline stage =
  • grant stage = cash only = 13, 20
  • label = 22,7 = max

results
- consumption of housing significantly higher
- consumption of housing marginally above optimum

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16
Q

conclusion

A
  • fungibility core of econ
  • evidence it is violated
  • becasue of mental accounting
  • loss aversion curve = mental accounting is important for decision making
  • context and history sunk costs matters
  • categorisation can be good
  • can lead to people not making optimal decisions because of narrow bracketing
  • bracketing affects how options are evaluated
17
Q

what is the equity premium puzzle

A

the puzzle as to why stocks historically outperform treasury bonds despite being riskier investments

  • equity premium = difference in equity returns and government bonds
  • the added premium is a risk premium = have to be rewarded for taking extra risk
18
Q

what is myopic loss aversion

A

is a combination of loss aversion and mental accounting
- greater sensitivity to losses than to gains and a tendency to evaluate outcomes frequently.

  • value function is steeper in loss domain
  • how someone brackets has implications for whether they evaluate set of transactions as portfolios or individually
  • how often they evaluate
19
Q

Benartzi 1995

  • loss aversion
A
  • loss from losing 100 looms larger than gaining 200 = because loss is like 250 minus utility
  • when they consider both games = they accept
  • when they consider both separately they reject
  • loss averse investors are more willing to task risks if they evaluate performance infrequently = widen their bracketing
20
Q

Benartzi
observational data
prospective utility functions

A

estimated prospective utility functions that incorporated MLA for stocks and bonds using data

  • for riskier portfolios length of evaluation has an impact on utility
  • in the short term utility slightly decreases
  • requires long evaluation before investors start preferring stocks over bonds
21
Q

Robert Metcalfe 2017

field experiment

A
  • used beta test of trading platform
  • to evaluate whether frequent access to price and value information would cause less investment in risky assets
  • how does it affect professional investors willingness to take risk
  • 2 groups = frequent and infrequent
  • frequent = second by second data
  • infrequent = every 4 hours
22
Q

results of robert Metcalfe
beta test

A
  • 53% more profits in low info group
  • 33% more investments made in risky assets
23
Q

how does MLA cause risk premium

A

loss averse investors take short term view on their investments
they overly react negatively to short term losses
because losses loom larger than gains, they demand high premiums to compensate for this risk
- when in reality if they had a longer term view, risk premiums would be smaller

24
Q

Gneezy

experimental test of MLA 1997

A
  • manipulating frequency of evaluation
  • when frequency is low individuals take more risks
  • subjects 9 rounds of indentical lottery
  • in each round given 200 and decide how many cents to bet on a lottery
  • 2/3 chance to lose X and 1/3 to win 2.5X
  • high frequency round = bet one round at a time and see outcome after each round
  • low frequency = make bets in rounds of 3 and see results at the end of the first round
25
Q

results of Gneezy 1997

  • coins high and low frequency students
A
  • students invest more in Treatment L compared to H
26
Q

Haigh 2005

  • do professional traders exhibit myopic loss aversion
A
  • similar to Gneezy experiment
  • professional traders exhibit even more MLA than students
  • bigger difference between high and low frequency groups
27
Q

what is the efficient market hypothesis

A

asset prices include all of the relevant information available in the market
under EMH the current price is the optimal forecast because it is based on all public information available at the time
- future price = current price plus forecast error
- movements in pt caused by new info about expected prices

28
Q

what is wrong with the efficient market hypothesis

A

observational data is not consistent with this hypothesis
- real stock price is very volatile compared to snp500
- what are the reasons for this volatility.
- assumes its due to investors showing countercyclical risk aversion = more risk averse in busts
- need to test experimentally because too many other factors to control for

29
Q

Cohn et al 2015

testing for countercyclical risk aversion

A
  • 162 finance professionals in switzerland
  • treatments = primed with a animated chart showing either a boom or bust - primes are subconcious shoves in particlar directions
  • asked how much fear they feel before making investments
  • endowed with 200 decide how much to invest in risky asset
  • ## make risk - picking yellow ball = good = prob 50%
30
Q

results from
boom bust ball

A
  • investment in risky asset is lower under bust compared to boom
  • holds under risk and ambiguity
  • lower investment when ambiguity = probability unknown
  • significant in regression
31
Q

boom bust ball
- does experience in trading matter

A
  • split group outcomes by low and high lieracy and low and high trading frequency
  • low literacy = invest less in risky asset
  • high experience = invested more in booms and invested same amount in busts
  • evidence of countercylcical risk aversion = lower willingness to buy same risky asset in a bust to a boom everyone
  • testing if bust = fear = those that are primed with bust feel sadder and more fearful

Behavioural (10 decks)

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