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behavioral finance.pptx
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- 2. Lorem ipsum dolorsit amet, consectetur adipiscing elit 2 BEHAVIORAL FINANCE Presenting by: Anjan kavya Manoj Murali Santosh
- 3. 3 Aspects of BehavioralFinance Definition Structure Traditional vs Behavioral finance Theories of Behavioral Finance C O N T E N T S Introduction 01 02 03 04 05 06
- 4. 4 Introduction 1. Since 1950s,the field of finance has been dominated by traditional finance model. 2. Key assumption- people are rational. 3. However, Behaviorists/Psychologists challenged this assumption. 4. People often suffer from cognitive and emotion biases and act in a seemingly irrational manner. 5. The finance field was reluctant to accept this view of psychologist who proposed behavioral finance model. 6. As this evidence of the influence of psychology and emotions on decisions became more convincing. Behavioral finance has received greater acceptance. 2002 Nobel prize in Economics to Psychologists Daniel Kahneman and experimental economists Vernon Smith – vindication of Behavioral Finance
- 5. Definition Behavioral finance isthe study of the influence of psychology on the behavior of investors or financial analysts. It also includes the subsequent effects on the markets. It focuses on the fact that investors are not always rational, have limits to their self-control, and are influenced by their own biases. Behavioral 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 5
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- 7. Personal finance: Asset pricing: 7 BehavioralFinance • Price Anomalies • IPO underperformance • Value Anomaly • Sentiment • Equity premium • PEA drift • Momentum • Bubbles • IPO timing • Winner’s curse • Cash-flow sensitivity • Overconfidence • Superstar CEO’s • Procrastination • Emotional choice • Loss aversion • Narrow Framing • Return chasing • Passivity • Financial illiteracy • Home bias • Overconfidence • Wishful thinking Use psychology and economics to understand finance: Corporate finance:
- 8. 8 TRADITIONAL FINANCE BEHAVIORALFINANCE People process data appropriately and correctly People employ imperfect rules of thumb(heuristics) to process data which includes biases in their beliefs and predisposes them to commit errors. People view all decisions through the transparent and objective lens of risk and return( inconsequential frame definition) Perception of risk and return are significantly influenced by how decision problems are framed People are guided by reason and logic and independent judgement Emotions and herd instincts play important role influencing decisions. Market are efficient. Market price of each an unbiased estimate of an intrinsic value. Heuristic-driven biases and errors, frame dependence, and effects of emotions and social influence often lead to discrepancy between market price and fundamental value.
- 9. 9 Anchoring Prospect theory Regret theory Overand under reactions Theories of Behavioral finance 1 2 3 4
- 10. 10 Tversky andKanheman (1979) developed the theory showing how people manage risk. Explaining the apparent regularity in human behaviours 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. Investors are risk hesitant when chasing gains but become risk lovers when trying to avoid a loss Prospect theory Regret theory Emotional reaction to having made an error of judgement. Investors avoid selling stocks that have gone down in order to avoid the regret of having made a bad investment and the embarrassment of reporting the loss. They find it easier to follow the crowd and buy a popular stock : if it subsequently goes down, it can be rationalized as everyone else owned it. Investors defer selling stock that have gone down in value and accelerate the selling of stock that have gone up.
- 11. 11 Anchoring isa phenomenon in which in the absence of better information, investors assume current prices are about right. Anchoring describes how individuals tend to focus on recent behavior and give less weight to longer time trends. People tend to give too much weight to recent experience, extrapolating recent experience, extrapolating recent trends that are often at odds with long run average and probabilities. In the absence of any better information, past prices are likely to be important determinants of prices today. Therefore, the anchor is the most recently remembered price. Anchoring theory Over and Under reactions The most robust finding in the psychology of judgement needed to understand market anomalies is overconfidence. People tend to exaggerate their talents and underestimate the likelihood of bad outcomes over which they have no control. The greater confidence a person has in himself, the more risk there is of overconfidence. Manager overestimate the probability of success in particular when they think of themselves as experts. People tend to become more optimistic when the market goes up and more pessimistic when the market goes down.
- 12. 12 Aspects of BehavioralFinance Behavior of the Investor Behavior of the Market • Behavioral finance is an important subfield of finance which combines psychology and economics to explain why and how investors act and to analyze how that behavior affects the market. • Indeed, It attempts to explain the decisions of investors by viewing them as a rational actor looking out of their self- interest, given the sometimes inefficient nature of the market. • Behavioral finance is an important subfield of finance which combines psychology and economics to explain why and how investors act and to analyze how that behavior affects the market. • Indeed, It attempts to explain the decisions of investors by viewing them as a rational actor looking out of their self- interest, given the sometimes inefficient nature of the market.
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