Two behavioural finance problem sets related to Temporal Discounting Assignment

Two behavioural finance problem sets related to Temporal Discounting and Bayesian Learning vs Reinforcement Learning in Financial Decision making - Assignment Example The exponential discounting graph has a positive slope due to its positivity index. This person should sign an agreement in period zero due to income effect and substitution effect. The high interest rate increases income a certain amount of time. Therefore, increase in consumption during the first and second period makes the income effect of the borrower to be negative in the period. Additionally, due to substitution effect, the gross interest rate is relative to consumption price during period zero compared to period 1 and 2 (Nielsen, 2005). Hence, it will be more expensive in the first and second period compared to period zero. As such, for a person, a rise in interest rate in the first or second period may rise or reduce the rate during period zero. Assuming that Mr. Spout has an expected payout of $1 when he invests in stock A, Mr. Spout will not choose the guaranteed stock A. Stock has an expected uncertainty of 1/3; therefore, Mr. Spout will take his chances and invest in stock B. He will not have preference between investing in either stock A or investing in stock B (Forbes, 2009). To state this in a different way, Mr. Spout will later select the investment that has a higher expected return. Mr. Spout, will invest in stock B in future, since he does not consider taking into account the investment risk in his decision. As a Bayesian learner, Mr. Spout decision will be influenced by uncertainty knowledge and the time is linked through the process of learning of the stocks. As a risk neutral investor, Mr. Spout will be indifferent between investing in stock A or in Stock B. Since he has an experience in stock A, Mr. Spout will invest in stock B. As a Bayesian investor, Mr. Spout experimented in the first period and observed the results. Therefore, he will invest in stock B due to its uncertainty element attached to the stock. He will not have preference between