Behavioral finance -_an_explanation

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Behavioral finance -_an_explanation

  1. 1. Behavioral Finance - An Explanation to Irrational Investment Behaviour Dr. MALABIKA DEO Professor & Head of Commerce, PONDICHERRY CENTRAL UNIVERSITY, Kalapet Puducherry – 605 014. INDIA.
  2. 2. <ul><li>Behavioural Finance </li></ul><ul><li>Behavioural Finance is the study of influence of psychology on the financial decision making and it argues that the emotions of and mental errors cause the Mispricing. </li></ul><ul><li>Behavioural finance argues that emotions and sentiment play a crucial role in determining the behaviour of investors in the market place and very offen they act irrationally due to influence of psychological factor . </li></ul>
  3. 3. Assumption of Behavioural Investors Traditional Finance Behavioural Finance Rational & Correct Heuristic (Rule of Thumb) Price reflects intrinsic value Frame dependence, social influence causes Mispricing Risk & Return – prime factors for investors Decision Risk & Return – frames Specific. Rational, Logical, Transparent & Objective Herd instinct, Emotional and Sentimental.
  4. 4. <ul><li>Arguments in favour of Behavioral Finance </li></ul><ul><ul><li>More Realistic </li></ul></ul><ul><ul><li>Psychological Foundation </li></ul></ul><ul><ul><li>Increases Explanatory Power of Financial Models </li></ul></ul><ul><ul><li>Solves Empirical Puzzles of Traditional Finance </li></ul></ul><ul><ul><li>New approach to Traditional Finance </li></ul></ul>
  5. 5. <ul><li>Basics of Theories of Behavioral Finance </li></ul><ul><ul><li>Heuristic – Driven Biases </li></ul></ul><ul><ul><li>Frame Dependence </li></ul></ul><ul><ul><li>Emotional Inefficiencies </li></ul></ul><ul><ul><li>Market Inefficiencies </li></ul></ul>
  6. 6. <ul><li>Heuristic – Driven Biases </li></ul><ul><li>It explains, how decision makers take decision without systematic collection and evaluation of information in the event of limited time </li></ul><ul><ul><li>Representativeness </li></ul></ul><ul><ul><li>Over – Confidence </li></ul></ul><ul><ul><li>Anchoring </li></ul></ul><ul><ul><li>Gamblers Fallacy </li></ul></ul><ul><ul><li>Availability Biases </li></ul></ul><ul><ul><li>Aversion to Ambiguity </li></ul></ul>
  7. 7. <ul><li>Frame Dependence </li></ul><ul><ul><li>Prospect Theory </li></ul></ul><ul><ul><li>Mental Accounting </li></ul></ul><ul><ul><li>Narrow Framing </li></ul></ul><ul><ul><li>Shadow of Past </li></ul></ul><ul><ul><li>Behavioural Portfolio </li></ul></ul>
  8. 8. <ul><li>Prospect Theories </li></ul><ul><ul><li>Investors pay attention to change in each transaction than the total value. </li></ul></ul><ul><ul><li>People look at chances in terms of potential gain and losses in relation to specific reference point (Purchasing Power). </li></ul></ul><ul><ul><li>Underweighing outcomes that are probable, in comparisons to certain outcomes. </li></ul></ul><ul><ul><li>Value function concave for gains and convex for losses. </li></ul></ul><ul><ul><li>More pain for losses less happiness in gains. </li></ul></ul>
  9. 9. <ul><li>Mental Accounting </li></ul><ul><li>Division of current and future asset into different groups are differently treated </li></ul><ul><li>Narrow framing </li></ul><ul><ul><li>Un Due attention to short – term gains even in long horizon. </li></ul></ul><ul><ul><li>Over estimation of risk </li></ul></ul>
  10. 10. <ul><li>Shadow of Past </li></ul><ul><li>Gain prompts people to take more risk Loss Makes people averse to take further risk . </li></ul><ul><li>Behavioral portfolio </li></ul><ul><li>Investors to hold their portfolio in a pyramid of assets based on the goals like safety, income and growth. </li></ul><ul><ul><li>Options </li></ul></ul><ul><ul><li>Commercial Property </li></ul></ul><ul><ul><li>Stocks </li></ul></ul><ul><ul><li>Bonds </li></ul></ul><ul><ul><li>Residential House </li></ul></ul><ul><ul><li>Cash </li></ul></ul>
  11. 11. <ul><li>Market Inefficiency </li></ul><ul><li>Investors trade on the basis of rumors, sentiment or noise not on fundamentals. </li></ul><ul><ul><li>Buying Undervalued stocks - more risky </li></ul></ul><ul><ul><li>Not Selling Over priced stocks - more greedy </li></ul></ul>
  12. 12. <ul><li>Emotional and Social Influence </li></ul><ul><ul><li>Risk tolerance affected by Emotions and </li></ul></ul><ul><ul><li>Sentiments </li></ul></ul><ul><ul><li>Decision based on Herd Instinct than </li></ul></ul><ul><ul><li>Market Analyses </li></ul></ul>
  13. 13. THANK YOU

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