Alan Greenspan coined the phrase “irrational exuberance” in late 1996 to describe the rapid growth in the stock market. Professor Robert Shiller, an economist at Yale, has written a book by the same title (should I say he’s a bear?). Actually, exuberance, rational or otherwise, is a characteristic of behavioral economics and finance. Daniel Kahneman shared the 2002 Nobel Prize in Economics for his work in the area. Start by reading a short piece from CFO.com ( http://www.cfo.com/printable/article.cfm/3014027?f=options ) and look elsewhere as you are interested. My question is: how do behavioral considerations impact the way we are doing valuation? Economic recession of 2008-2009 had several causes, one of which was so called “subprime crisis.” Financial institutions used sophisticated models and simulation techniques to price mortgage-backed securities (MBS) and these securities ended up being severely overpriced. What lessons for the future can we learn from this mispricing of MBS? What precautionary mechanisms would you suggest to avoid the repetition of this crisis in the future?
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