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Behavioural finance b.v.raghunandan

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  • 1. Behavioural Finance -B.V.Raghunandan, SVS College, Bantwal MBA Department, Alva’s College of Engineering, Moodbidri August 20, 2013
  • 2. Bi-Polar World • Physical Sciences like Physics, Chemistry, Mathema tics-Precision and Quantitative • Non-Physical Sciences like Botany, Zoology, Medicines and Social Sciences- Imprecise and Qualitative
  • 3. Bi-Polar Finance • Standard Finance -Adding Precision to the Art of Investment-Homo Economicus • Behavioural Finance- The Imprecise Art and the Heuristic Attitude
  • 4. Standard Finance • Modigliani and Miller’s Arbitrage Theory • Markowitz’s Diversified Portfolio • Asset Allocation of Sharpe • Black-Schole’s Option Pricing
  • 5. Miller-Modigliani Arbitrage Arbitrage Theory of Franco Modigliani & Merton Miller
  • 6. Harry Max Markowitz • Modern Portfolio Theory- Risk, Return, Correlation and Diversification
  • 7. William Forsyth Sharpe • Capital Asset Pricing Model • Sharpe Ratio for risk adjusted performance analysis • Binomial Method of Option Valuation • Returns Based Style Analysis
  • 8. Fischer Black-Myron S.Scholes • Valuation of Options • Hedging • Wide Usage • Option Price Calculator
  • 9. Efficient Market Hypothesis • People behave rationally (Homo Economicus) • Maximise the expected profit or utility • Trying to predict future value of individual securities • Important current information is freely available to all the participants (Weak, Semi-Strong and Strong Markets) • Free Availability of information means there is no cost involved in getting the information
  • 10. Behavioural Finance • BF is the study of the impact created by psychological factor on the activities of the investing public, traders, companies and the financial intermediaries
  • 11. Why Psychology? • Crowd Mentality • Childishness • Tension • Need to be Praised • Prove Smartness • Short Term View • Intolerance • Moody • Refusing to Take Decision • Acting on Tips • Escaping from Reality • TV/Internet • Individualistic • Creating a Virtual World • Destruction of Family • Diplomacy inside the House • Self-Centered Parents • Nuclear Personalities • Failing Health • Blinkers on the Eyes
  • 12. Authorities on Behavioural Finance • 1896- Gustave le Bon-’A Study of Popular Mind’ • 1912- Seldon-’Psychology of the Stock Market’-price changes depend upon mental attitude of the investing and trading public • 1956- Leon Festinger introduced Theory of Cognitive Dissonance in social psychology
  • 13. Prospect Theory • 1974-Amos Tversky & Daniel Kahneman described three heuristics when making judgement under uncertainty: • Representativeness • Availability: occurrences • anchoring and adjustment • Risk Aversion
  • 14. Import of the Theory – Explaining the apparent regularity in human behaviors when assessing risk under uncertainty. – People respond differently to equivalent situations depending on whether it is presented in the context of a loss or a gain. – Computation is based on losses and gains rather than final asset values – Investors are risk hesitant when chasing gains but become risk lovers when trying to avoid a loss
  • 15. Risk Aversion & Risk Seeking• Situation 1 Option a) A sure gain of Rs.2,000 Option b) 25% Chance to gain Rs.10,000 and 75% chance to gain nothing • Situation 2 a) A sure loss of Rs.5000 b) 75% chance to loss Rs.10,000 and 25% chance to lose nothing
  • 16. Richard Thaler: Regret Theory • Mental Accounting-1980 a) underweighting of opportunity costs b) failure to ignore sunk costs c) search behaviour, choosing not to choose and regret d) precommitment and self- control.
  • 17. Further Theories • 1980- Tversky and Kahneman- Problem Framing and preferences • 1981-Shiller- Volatility is too high for the future dividend • 1985- F.M.De Pont and Thaler-Overreaction of Stcok Market • 1988- Samuelson and Zeckhauser- Status Quo Bias • Many other Theories like Overconfidence etc
  • 18. Changes in Stock Market • Mutual Funds & Other Institutions • HNI • FII Activity • F & O Market • Regulation by SEBI • Monetary Policy of RBI • Government Policies • Scams • Consultants, Advisors and Media • Investment Trusts • Disinvestment • Technology • Many Players • Dominant Financial Services • Free Pricing of IPOs • Technical Analysis • Irrelevance of PE Ratios • Tips and Sentiments • Interim Financial Reporting
  • 19. THANK YOU