Intuitive Forecasts of Financial Risk and Return - Essay Example

? De Bondt, W.F.M (1993). Betting on trends: Intuitive forecasts of financial risk and return. A Critical Appraisal Emily Giblin of Newcastle Article sourced from a bibliography of behavioural finance by Mike Cox Introduction This exploration seeks to critically analyze the article “Betting on trends: Intuitive forecasts of financial risk and return” by De Bondt W.F.M (1993)1, with a view to determining both the strengths and weaknesses of the article. Particular reference will be paid to the study design applied, the statistical methodology pertained, and both the findings and conclusions reached by the article. In addition suppositions regarding the suitability of each of these study features will be made. Furthermore, the analysis will delve deeper into assessing the practical applicability of the study findings in a real world financial setting, while recommending prospective research into the topic based on the limitations discovered. Article Summary The study first sought to assess the observable trends in stock share prices, followed by the aspiration to empirically test whether such trends in stock share prices are a predictable value-a notion coagulated by previous research.The study exercised a sample of twenty-seven students, all of whom were MBA scholars, within a class setting. With an average age of 22 years, 25 males and 2 females, all of whom had previously taken at least two courses in finance, and were completely aware of the efficient market hypothesis1, completed the study. The study reconnoitered a hypothesis that; changes in prices are somewhat predictable, with major stock market indices being mean-reverting over a 3-5 years horizon, where after a long bull market; an index decline is more likely than an upward movement1. The study also hypothesized that after a period of fall in prices, the chances of a turnaround are higher than the chances of a further decline. The methodology involved playing a ‘technical analysis game’, where an overhead projector was used to present 6 graphs; each graph encompassed the prices of 48 undisclosed stocks1. The graphs exhibited a plot of the S&P index on the vertical side of three bull markets for the different years (1967, 1980 and 1986), and three bear markets for the different years (1970, 1974 and 1982), against the prices of such stocks in months, where the subjects were required to predict (to the best of their ability), the prices of month 7, and the prices 13 months later. Additionally, subjects were required to give interval estimates of: 1) when they would expect the prices of the stock share to have a one-in-ten chance of the actual prices of the stock turning higher, and 2) an estimate at which there would be a one-in-ten chance that the actual prices of the stock would turn lower. The prediction errors for each forecast were then squared, and the individual with the least sum of squared errors was named the prize winner. The results indicated that on average, participants showed more optimism in bull markets than in bear markets, where the participants who saw an upward trend in the bull markets were classified as ‘followers’, while those who saw an opposite trend were classified as ‘contrarians’1. In the bull markets category of the graphs, 50.6% of the participants were ‘followers’, while only 11.1% were ‘contrarians’, giving a difference that is statistically significant, where p Read More