Learning outcomes After studying this course, you should be able to: make an informed judgement about whether or to what extent a financial market satisfies the conditions of an efficient market identify the main factors that could detract from that efficiency.
4.2 Discounted cash flow Any investment gives rise to a stream of future expected cash flows. DCF converts all of these to an equivalent amount of present-day money (or present value) by discounting each future cash flow for the appropriate number of periods (for example, years) by the periodic discount rate. The periodic discount rate is the investor's required rate of return including the time preference rate, a premium for risk and an adjustment for inflation. Having established the present values<
3.7 Interest rate risk This has to be seen in conjunction with the previous comments about the secondary market in shares and debt instruments. An efficient secondary market can ensure that there is always a ready buyer for an investment, but the price at which the investment can actually be sold will depend entirely on market conditions at the time of sale. The secondary market price will not necessarily bear any relation to the price originally paid by the investor. The following example illustrates the general p
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7.3 What is an effective decision? To improve decision making it is first important to have a clear idea of how we should judge an effective decision. While in this course we have suggested that decisions often stray from formal rationality, this does not always mean those decisions are less effective. Sometimes it is smart to take mental shortcuts: drawing on hunches and intuition can allow us to tap our tacit knowledge and experience and can reduce the costs of decision making. It can be smart to ask what is ‘legitimate’
6.6 The social construction of unknown risk While some risks can be quantified, many are unknown. In the face of such uncertainty our approach to risk depends on fundamental assumptions about the way the world works which cannot be readily subject to empirical test. Different social groups have different approaches to uncertainty. Schwarz and Thompson (1990) characterise these in terms of what they describe as four myths of nature. Adams (1995) has conceptualised these in terms of a ball on a surface (
6.4.1 Implications What does this all imply for decision making? First, the importance of control perceptions to decision makers' perceptions of risk suggests an important source of bias. In a study of managers' risk taking, Zur Shapira (1995) found that managers would often discount risks on the basis that they felt they could control them. In my own research on traders' decision making, I found traders to suffer from control illusions and their risk judgement and performance to suffer in consequence: illusory
6.2 A rational-economic perspective on risk A rational-economic perspective generally represents risk as a combination of the expected magnitude of a gain or loss, combined with some probability distribution of anticipated outcomes. Economic ideas of risk behaviour are founded largely on expected utility theory. Expected utility theory predicts that investors will always be risk averse. The shape of the utility curve (utility plotted against increasing wealth) is such that utility increases with wealth, but at a declining rate. This is
6.1 Introduction An important aspect of decision making which crosses all three perspectives is making decisions about risks. Risk is all-pervasive in organisational life and many decisions require us to weigh up and choose between different kinds of risk. Thus any account of decision making would be incomplete without examining how our perceptions of risk affect our decisions. In this section we will examine risk from the three different perspectives we have identified: rational-economic, psychological and s
5.5.3 Normative pressures
Normative pressures concern what we think we ‘should’ do. They concern our values and the broader social values to which we subscribe. Some organisations make explicit attempts to foster particular kinds of value (for example, in relation to customer service), but normative pressures also come from outside the organisation, such as from a particular professional or religious affiliation. Institutional pressures are important for both private and public-sector organisations.
5.5.1 Coercive pressures
Coercive pressures come from the social sanctions that can be applied if we do not act in socially legitimate ways. The law is one source of coercive pressure, but so too is the knowledge that you will get promoted only if you act in ways which fit accepted ways of doing things in your organisation.
5.4 The pursuit of legitimacy Social institutions affect which actions are seen as legitimate. As we make decisions in organisations it is common to be concerned not just with economic outcomes but also with ‘legitimacy ’: ‘How will this decision be seen by X ’?; ‘Does this fit the way things are done around here?’; ‘What would happen if the press got hold of this?’; and so on. Some of this can be quite unconscious; the conceptual frameworks and notions of cause and effect that are available to decis
5.3 Social institutions Of course, the extent of agreement about meaning can be highly variable: from the ephemeral (a certain style of clothing may come to stand for a shared attitude among a small group of teenagers for a short period) to the more profound (such as the idea of ‘a market’ or ‘marriage’). Sociologists refer to these more profound shared meanings as institutions. In this sense, an institution is a persistently reproduced social pattern that is relatively self-sustaining. However, to sa
4.5.2 Anchoring adjustment Many decisions need revisiting and updating as new information comes available. However, most of us make insufficient anchoring adjustment: this is the tendency to fail to update one's targets as the environment changes (Rutledge, 1993). Once a manager has made an initial decision or judgement then this provides a mental anchor which acts as a source of resistance to reaching a significantly different conclusion as new information becomes available. It is what happens when one has made
4.5 Deciding: problems of judgement We are constantly bombarded by information. Simply walking though a room risks flooding us with more sensory information that we can possibly process. Stop for a moment and consider all the different things you can see, hear, smell, or feel. 4.2 Bounded rationality and the use of heuristics As decision makers, none of us has infinite resources or time to devote to gathering and analysing information. In addition, we all have significant limitations to the amount of complexity we can cope with. Thus, even where we make conscious efforts to make decisions according to a formally rational process, we often need to make simplifying assumptions and accept limits on the availability of information and the thoroughness of our analysis. As noted above, we constantly use heuristics 3.3 Limitations of the rational-economic perspective As an approach to understanding economic life, the assumption of formal rationality has been very successful. For example, there is great deal of evidence that, on average, prices in financial markets behave as if investors were formally rational. However, there is also a great deal of evidence that individuals do not behave in this way (e.g. de Bondt, 1998). Even within the field of financial economics, there is increasing interest in developing theories of market behaviour which take better 2.2 Different approaches to decision making Think of a major decision you have recently been involved in making at work. For each of the following statements about your decision-making process make a note of the number which shows your level of agreem Conclusion This course has focused on managing projects through people and how important this is in relation to: managing the relationship with stakeholders; motivating the project team to get results; dealing with senior management; building relationships across the organisation in order to encourage co-operation; satisfying the client and end user. Recapping on the learning ob 8 Satisfying the client and end user Most projects have an identifiable client or customer group which will benefit from or use the outcome of the project. The client may be external to the organisation which is implementing the project, for example, the customer for whom a new building is being constructed. Or the clients may be internal, for example, the users of a new IT system. As we have already seen, it is important that the client or end user shares and endorses the project's objectives and is actively involved in its dev
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Activity 2
