Investing Lesson Idea: Here’s A Class Simulation to Demonstrate Elements of Behavioral Finance

In my search for in-class activities to demonstrate behavioral aspects of investing, I came across this one on the Stirling Behavioral Finance blog.  Keep in mind as you read it, that it is designed from a college-level Economics class.

Here is the basic dynamics of the game:

  • Students pick stocks (they suggest 12, I might recommend just five) that they think will be excellent performers over the next month.
    • To make his more manageable for students, here is a spreadsheet (see Popular Stocks) with 90+ large companies with brands that students should be familiar with: PopularStocks

  • Send them to Yahoo Finance or Google Finance to find out the prices for these stocks.  The tickers are provided in the PopularStocks file above and by inputting these tickers they will get current prices.
  • Next, they need to decide how to allocate $1,000 among these stocks.  I have created a spreadsheet (see Investing Simulation) that they can use for this purpose or you can have them develop one on their own: InvestingSimulation
    • Step 1:  Input company name and ticker into the spreadsheet.
    • Step 2:  Decide how many dollars they want to invest in each stock.  Remember that they have $1,000 to invest among one to five stocks.  I have included one index fund, SPY (S&P500) on the list.  They can choose whether or not they want to invest in this.  The change in SPY over the next month will be the market return that students results can be compared against.  Ask them to write a few sentences about why they selected the stocks.
    • Step 3:  Input stock prices for each company into the spreadsheet.  I have a formula that will show students how many shares of each stock they will own.  In this case, they will be able to own partial shares of stock.
    • Step 4:  On a scale of 1 to 10, how confident are they in the success of their picks.  Input that number on the spreadsheet.
    • Step 5 (one month later):  Have students input “Ending Stock Prices” and calculate their percentage return.

Discussion:

  • Plot student returns and compare to average market return.
    • What was average return for class vs. market return?
    • What percentage of students outperformed?
    • What strategies did top performers utilize?  Do they think these are good long-term strategies?
    • For those who invested heavily in the S&P500, what was their rationale?
  • Plot student returns to level of confidence in picking their stocks
    • Is there a relationship between confidence level and return?
    • Is there a relationship between gender and confidence level?
  • Have students read this short article about overconfidence and its impact on financial markets and reflect on what they learned from this experience.

Good luck!

———————

Behavioural Finance Class Experiment

Note: Below is intended to get some ideas going on good class-room experiments and not intended as a protocol for doing one. I will post at a later time on some existing experiments and also potential on some protocols if I can work some out. Suggestions welcome. 

Thinking of the following simple class experiment to illustrate both the efficient market hypothesis and the extent of overconfidence of being able to beat indices by lay people. Basic idea of the set up is below. Everything will be recorded anonymously though students will be able to identify themselves in the results session if they remember the stocks they picked.  Could potentially be conducted as a web survey, with the advantage that students would be able to look at the stock index in their own time and not have to remember the stocks.

1. Email the class a link to google finance and some simple instructions for how to look up prices of stocks on the NYSE.

2. Tell them that they will be asked to pick stocks on the NYSE in class as part of a classroom exercise. Tell them to write down the names of 12 stocks they would like to pick. (Hard to think of how to enforce this part without using online).

3. At start of class, hand each student a paper survey asking them to allocate a hypothetical 1000 dollars across 12 stocks in any proportion they wish. Tell them that they will hold this portfolio for one month at which stage it will be evaluated in terms of rate of return (excluding any dividends). Later these can be keyed into separate portfolios on the google finance toolbar.

4. Ask them how confident they are that they will outperform the overall market index for the NYSE

5. Ask them how confident they are that they will outperform the class average return

6. Elicit a few simple financial capability questions (and gender)

7. One month later:

– plot average rates of return across the class
– show correlation with degree of confidence of beating market; beating class average; gender and financial sophistication.

8. Basic prior is that picking 12 random stocks on the index should yield a normal distribution of average returns that are unrelated to any of the personal factors measured.