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Lecture Financial markets - Lecture 8: Human foibles, fraud, and regulation

Regulation of financial and securities markets is intended to protect investors while still enabling them to make personal investment decisions. Psychological phenomena, such as magical thinking, overconfidence, and representativeness heuristic can cause deviations from rational behavior and distort financial decision-making. | Lecture 8: Human Foibles, Fraud, and Regulation “Millionaire in the Making” money.cnn.com Dave Farley earns $120k as manager at Ford plant Saves $1600 per month Net worth $270,000 Plans to retire in 10 years age 45with $1 million (at r=3.5% this gives annuity income of $54k for 30 years, half what he consumes now) Calculations imply he expects return of 10%/year. Human Nature and Workings of Markets Gambling behavior Loyalty to friends transcends loyalty to society Salesmanship, spamming Fraud, near-fraud Green Stamps & Human Foibles 1896 Thomas Sperry & Shelly Hutchinson started first trading stamp business. Zero interest bonds. 1913 Two members of the Beinecke family, who had married into Sperry family, bought the company. Beinecke Library. In 1950s, S&H discovered stamps were better received if paid in merchandise, rather than cash. By 1956, almost half US households were pasting stamps into books. S&H Green Stamps Today Public interest waned in 1970s, exists only in backward areas of US today. Beinecke family sold S&H to a conglomerate, which kept the stamps barely alive. 1999 Walter Beinecke III buys S&H back from conglomerate to do trading stamps on the web. “Greenpoints” replace Green Stamps. Purposes of Regulation Enforce rules of the game Protect the weak from exploitation by cynical operators. Property and Society Karl Marx believed human societies used to practice “primitive communism,” with no private property. In fact, concepts of property exist across diverse cultures, though nature of rights varies. Rights to fruits of one’s own labor Property law Complexities of Property Definition in Modern Economy Information has value, but producer of information is hard to define. Property rights can be entangled in maze of intersecting contracts. French law allows an artist to sell works subject to contract that it never be altered. Trust law in common law countries allows trustee to act on behalf of owner without intermingling own assets. Countries with poorly | Lecture 8: Human Foibles, Fraud, and Regulation “Millionaire in the Making” money.cnn.com Dave Farley earns $120k as manager at Ford plant Saves $1600 per month Net worth $270,000 Plans to retire in 10 years age 45with $1 million (at r=3.5% this gives annuity income of $54k for 30 years, half what he consumes now) Calculations imply he expects return of 10%/year. Human Nature and Workings of Markets Gambling behavior Loyalty to friends transcends loyalty to society Salesmanship, spamming Fraud, near-fraud Green Stamps & Human Foibles 1896 Thomas Sperry & Shelly Hutchinson started first trading stamp business. Zero interest bonds. 1913 Two members of the Beinecke family, who had married into Sperry family, bought the company. Beinecke Library. In 1950s, S&H discovered stamps were better received if paid in merchandise, rather than cash. By 1956, almost half US households were pasting stamps into books. S&H Green Stamps Today Public interest waned in 1970s, exists only in backward areas