the firms and workers in alpha form expectations adaptively. the firms and worke
ID: 1244996 • Letter: T
Question
the firms and workers in alpha form expectations adaptively. the firms and workers in omega form expectations rationally. their otherwise identical economies are initially in equilibrium at the natural level of output with 10 percent inflation. the central banks of both alpha and omega make credible commitments to reduce the growth of money until they achieve 2 per cent inflation. compare and contrast the adjustment process to the new equilibrium at the lower rate of inflation in both countries.Explanation / Answer
Behavioural finance and behavioural corporate finance analyse the effects of psychological biases, heuristics, and emotions on investors’ and
managers’ decision-making and performance. A major paradigm shift has been recently established by introducing a new field of research, namely
Emotional Finance. This ground-breaking approach employs Freud’s theory of phantastic objects to analyse the effect of unconscious, infantile
emotions on investors’ decisions. That work is extended by proposing a new development, namely, emotional corporate finance. We argue that, just
as investors may view investments as phantastic objects, managers may view their projects similarly. We develop a formal approach that considers
the effects of managerial phantasy on the investment appraisal decision, project performance, and managerial entrapment in a losing project. Our
main results are as follows: a) Managerial project-phantasy may induce a manager to mistakenly invest in value-reducing projects. b) Phantasy
may lead to volatility of managerial emotions, and hence volatility of project performance. c) Phantasy may lead to project entrapment, but may
result in project abandonment if the manager’s project-phantasy turns to project hatred. We conclude by considering whether managerial phantasy
could explain management’s entrapment in the Concorde project.
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