TITLE:
Can Financial Education Extend the Border of Bounded Rationality?
AUTHORS:
Doron Greenberg, Ze’ev Shtudiner
KEYWORDS:
Experiment, Affect Heuristic, Familiarity Effect, CAPM
JOURNAL NAME:
Modern Economy,
Vol.7 No.2,
February
15,
2016
ABSTRACT: When choosing a
particular alternative from a number of financial assets, risk is an important
feature. According to the classic Capital Assets Pricing Model (CAPM), we would
expect to receive a positive correlation between risk and return of financial
assets. However, studies show that investors judge financial assets in terms of
“good” or “bad”. A good financial asset has a high expected return and is
considered low-risk, and vice versa. This type of thinking is biased, as it is
both irrational and contradicts the classical theory of finance. One
explanation for this bias is the affect heuristic. According to this heuristic,
the investor forms her attitude about the asset in the first stage, and then
links all of her subsequent judgments to this attitude. The aim of this study
is to examine how this bias is affected by studying the CAPM in Finance entry
courses. An experiment was conducted in which each subject made both risk
judgments and return judgments in regard to 25 domestic stocks chosen randomly
from the Tel Aviv 100 stock index. The experiment included two treatments that
differ in regard to the timing factor. Some of the subjects were asked to judge
the return and risk ratings before learning about the CAPM in class; the others
were asked after studying the CAPM material. Finance education reduced the
bias, but did not prevent it. The results show that in the teaching of
Economics, there should be a balance between providing a coherent theoretical
framework together with behavioral aspects. Moreover, given that finance education
did not prevent the bias among students with background in quantitative
analysis, it is reasonable to assume that other agents without this background
would have more difficulties to apply the principles of investments under
uncertainty.