5.1

Question 1

Bayes rule

Answer 1

Probability of an event, based on prior knowledge of conditions that might be related to the event

Question 2

Does the stock market overreact?

Answer 2

Yes. They overreact ti unexpected and dramatic news.

They overweight recent info and underweight prior data.

They use the representative heuristic = while making decisions under uncertainty

Question 3

2 examples of overreaction in stock market

Answer 3

1. Excess volatility of security prices

2. P/E ratio anomaly = if its low the firm is undervalued. And otherwise overvalued

Question 4

Overreaction hypothesis

Answer 4

1. Subsequent price reversals will be more pronounced for stocks with more extreme returns
   - L outperform W. Asymmetric overreaction.
2. If you want to generate extreme observations, lengthen the portfolio formation period (2y)
   - overreaction shows more in 2&3 period

Question 5

2 main hypothesis

Answer 5

1. Extreme movements in SP’s will lead to subsequent price movement in the opposite direction
2. The more extreme the initial price movement - the more the subsequent adjustment = magnitude