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Beyond Greed and FearUnderstanding Behavioral Finance and the Psychology of Investing$
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Hersh Shefrin

Print publication date: 2002

Print ISBN-13: 9780195161212

Published to Oxford Scholarship Online: November 2003

DOI: 10.1093/0195161211.001.0001

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Inefficient Markets: The Third Theme

Inefficient Markets: The Third Theme

(p.33) Chapter 4 Inefficient Markets: The Third Theme
Beyond Greed and Fear

Hersh Shefrin (Contributor Webpage)

Oxford University Press

Markets are efficient when prices coincide with intrinsic value. Heuristic‐driven bias and frame dependence combine to render markets inefficient. Representativeness leads to the winner–loser effect, whereby investor overreaction causes prior long‐term winners to become future long‐term losers, and prior long‐term losers to become future short‐term winners. Conservatism leads security analysts to underreact to earnings surprises, thereby generating short‐term momentum in stock prices. Frame dependence leads investors to frame stock returns in terms of short horizons instead of long horizons. As a result, investors require a larger equity premium than they would if they framed returns using longer horizons. Prices can deviate from fundamental value for long periods, with excess volatility the result.

Keywords:   equity premium puzzle, irrational exuberance, Long‐term Capital Management, overconfidence, overreaction, post‐earnings announcement drift, representativeness, winner–loser effect

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