Behavioral finance attempts to explain financial decision-making by considering how psychology impacts judgment and behavior. It bridges finance and psychology by recognizing individuals may make irrational decisions due to mental errors and emotional biases. Behavioral finance is significant because it helps define investors' biases and manage them, improving investment decisions and advising. It incorporates psychological concepts like prospect theory, loss aversion, and mental accounting to better understand investor behavior.
Behavioral finance and investment decisionaashima1806
Behavioral Finance is all related to the behavior of the investor at the time of investing in different market conditions.. same is exhibited in our presentation by compiling different questions related to investment for different investors on the basis of different age groups...
Behavioral finance and investment decisionaashima1806
Behavioral Finance is all related to the behavior of the investor at the time of investing in different market conditions.. same is exhibited in our presentation by compiling different questions related to investment for different investors on the basis of different age groups...
As an Investment Advisor, you will have to play an important role in enabling your clients to reach their financial goals without the emotions of fear or greed playing havoc. It is essential to understand Behavioural Finance, especially Heuristics and Biases that creep into financial decision making.
Behavioral Finance key notes for non financial managers. This help also the financial advisors discover the type of behavioral finance biases among their clients.
It also highlight the types of financial risks, and types of clients according to their risk capacity and risk tolerance.
It also add value to investors specially in the investment decision making process.
Abstract
The idea of an Efficient Market first came from the French mathematician Louis Bachelier in 1900: « The theory of speculation ».
Bachelier argued that there is no useful information in past stock prices that can help predicting future prices and proposed a theory for financial options’ valuation based on Fourier’s law and Brownian’s motions (time series).
Bachelier’s work get popular in the 60s during the computer’s era.
In 1965, Eugene Fama published a dissertation arguing for the random walk hypothesis (Stock market’s prices evolve randomly: prices cannot be predicted using past data).
In 1970, Fama published a review of the theory and empirical evidences
The EMH (Efficient Market Hypothesis): Financial markets are efficient at processing information. Consequently, the prices of securities is a correct representation of all information available at any time.
Weak:
Not possible to earn superior profits (risk adjusted) based on the knowledge of past prices and returns.
Semi-strong:
Not possible to earn superior profits using all information publicly available.
Strong:
Not possible to earn superior profit using all publicly and inside information.
The CAPM describes the relationship between market risks and expected return for a security i (also called cost of equity), E(Re_i):
Re_i = Rf – Bi(Rm – Rf)
With:
Rf = Risk free rate (typically government bond rate)
Rm = Expected return for the whole market
Bi = The volatility risk of the security i compared to the whole market
(Rm – Rf) is consequently the market risk premium
According to the EMH, for a well-diversified portfolio, expected returns can only reflect those of the market as a whole. Consequently, in the CAPM formula, It would involves that for a diversified-enough portfolio: β = 1 so Re = Rm
Investors want to value companies before making investment decisions.
A typical way to do so is to use the Discounted Cash Flow (DCF) method:
See also: Prospect theory, disposition effect, heuristic, framing, mental accounting, Home bias, representativeness, conservatism, availability, greater fool theory, self attribution theory, anchoring, ambiguity aversion, winner's curse, managerial miscalibration and misconception, Equity premium puzzle, market anomalies, excess volatility, Bubbles, herding, limited liabilities, Fama French three 3 factors model.
As an Investment Advisor, you will have to play an important role in enabling your clients to reach their financial goals without the emotions of fear or greed playing havoc. It is essential to understand Behavioural Finance, especially Heuristics and Biases that creep into financial decision making.
Behavioral Finance key notes for non financial managers. This help also the financial advisors discover the type of behavioral finance biases among their clients.
It also highlight the types of financial risks, and types of clients according to their risk capacity and risk tolerance.
It also add value to investors specially in the investment decision making process.
Abstract
The idea of an Efficient Market first came from the French mathematician Louis Bachelier in 1900: « The theory of speculation ».
Bachelier argued that there is no useful information in past stock prices that can help predicting future prices and proposed a theory for financial options’ valuation based on Fourier’s law and Brownian’s motions (time series).
Bachelier’s work get popular in the 60s during the computer’s era.
In 1965, Eugene Fama published a dissertation arguing for the random walk hypothesis (Stock market’s prices evolve randomly: prices cannot be predicted using past data).
In 1970, Fama published a review of the theory and empirical evidences
The EMH (Efficient Market Hypothesis): Financial markets are efficient at processing information. Consequently, the prices of securities is a correct representation of all information available at any time.
Weak:
Not possible to earn superior profits (risk adjusted) based on the knowledge of past prices and returns.
Semi-strong:
Not possible to earn superior profits using all information publicly available.
Strong:
Not possible to earn superior profit using all publicly and inside information.
The CAPM describes the relationship between market risks and expected return for a security i (also called cost of equity), E(Re_i):
Re_i = Rf – Bi(Rm – Rf)
With:
Rf = Risk free rate (typically government bond rate)
Rm = Expected return for the whole market
Bi = The volatility risk of the security i compared to the whole market
(Rm – Rf) is consequently the market risk premium
According to the EMH, for a well-diversified portfolio, expected returns can only reflect those of the market as a whole. Consequently, in the CAPM formula, It would involves that for a diversified-enough portfolio: β = 1 so Re = Rm
Investors want to value companies before making investment decisions.
A typical way to do so is to use the Discounted Cash Flow (DCF) method:
See also: Prospect theory, disposition effect, heuristic, framing, mental accounting, Home bias, representativeness, conservatism, availability, greater fool theory, self attribution theory, anchoring, ambiguity aversion, winner's curse, managerial miscalibration and misconception, Equity premium puzzle, market anomalies, excess volatility, Bubbles, herding, limited liabilities, Fama French three 3 factors model.
The Psychology of Investing Understanding Behavioral FinanceCOIN STREET
Using behavioral finance, one can understand the psychology of investing. This understanding can be shaped from different perspectives. This is a result of varying instances, as per Coinstreet. The investment advisory platform considers stock market returns to form one such instance. As stock prices increase or decrease, different behaviors get triggered. Accordingly, investors plan their moves.
Investor behaviour often deviates from logic and reason, and investors display many behaviour biases that influence their investment decision-making processes. The authors describe some common behavioural biases and suggest how to mitigate them.
Behavioural Finance - An Introspection Of Investor PsychologyTrading Game Pty Ltd
Investors always try to make rational decision while analyzing and interpreting information collected from various sources for different investment avenues to arrive at an optimal investment decision. But at the same time they are influenced by various psychological factors that influence them internally and bias their investment decision. Linter (1998) studied the various factors that influence internally the informed investment decision and included them under the discipline of behavioural finance. Behavioural finance studies how people make investment decision and influenced by internal factors and bias. The main purpose of the paper is to assess impact of behavioural factors over mutual fund investment decision made by investors in Raipur city.
How Investors Control their Psychology During Market Crashes.pptxunivestseo
Investors often face challenges in managing their psychology during market crashes, as market volatility can trigger emotional responses that may lead to irrational decision-making.
International Journal of Business and Management Invention (IJBMI)inventionjournals
International Journal of Business and Management Invention (IJBMI) is an international journal intended for professionals and researchers in all fields of Business and Management. IJBMI publishes research articles and reviews within the whole field Business and Management, new teaching methods, assessment, validation and the impact of new technologies and it will continue to provide information on the latest trends and developments in this ever-expanding subject. The publications of papers are selected through double peer reviewed to ensure originality, relevance, and readability. The articles published in our journal can be accessed online
Theories of entrepreneurship: Innovation theory by Schumpter, Theory of Achievement by McClelland, X-efficiency theory by Leibenstein, Theory of profit by Knight
2. INTRODUCTION TO BEHAVORIAL
FINANCE
A theory of finance that attempts to explain the decisions of investor
by viewing them as rational actors looking out for their self-
interest, given the sometimes inefficient nature of the market.
Combine behavioral and cognitive psychological theory with conventional
economics and finance to provide explanations for why people make
irrational financial decisions.
Combines social and psychological theory with financial theory as a means
of understanding how price movements in the securities markets occur
independent of any corporate actions.
3. NATURE OF BEHAVORIAL FINANCE
Bridge gap between finance and psychology
Two types:
1. Rational finance paradigm
2. Irrational finance paradigm
Rational finance paradigm: investors act rationally and consider all
available information in decision-making process
Irrational finance paradigm: behavior of an individual is determined by
own mind
Stimulating field of scholarship
4. SCOPE OF BEHAVORIAL FINANCE
Inflation and stock market
Underpricing of Initial Public Offering
Investors
Corporations
Markets
Regulations
Education
5. OBJECTIVES OF BEHAVORIAL FINANCE
Correct decision making
Provide knowledge to unaware investors
Identifies emotions and mental errors
Delivering what the client expects
Ensuring mutual benefits
Maintaining a consistent approach
Examining a consistent approach
6. SIGNIFICANCE OF BEHAVORIAL
FINANCE
Determining goals of investors
Defines investors’ biases
Manages behavioural biases
Helps in investment decisions
Helps for financial advisors’ and fund managers
Signifies that investors are emotional
8. PROSPECT THEORY
Developed by Kahneman and Tversky in 1979
Shows how people manage risk and uncertainty
Most central element of prospect theory is S-shaped value function
Value
GainLoss
9. LOSS AVERSION THEORY
People weigh all potential gains and losses in relation to some benchmark
reference point
Depicts tendency of people to show greater sensitivity to losses than gains
Types
1. Loss on the basis of “valence” or desirability
2. Loss on the basis of changes in possession
10. MENTAL ACCOUNTING
People’s tendency to code, categorise and evaluate economic outcomes
Primary reason is to enhance our understanding of the psychology of
choice
3 components
1. Perception of outcomes and the making and evaluation of decisions
2. Assignment of activities to specific accounts
3. Determination of time periods to which different mental accounts relates
11. INVESTORS DISPOSITION EFFECT
Disposition effect: notion of framing to the realization of losses
Refer to asymmetric risk aversion, according to which investors are risk-
averse when faced with gains and risk-seeking when faced with losses
13. NATURE OF PSYCHOLOGY
Study of experience
Study of mental processes
Study of behaviour
14. IMPORTANCE OF PSYCHOLOGY
Helps to identify goals
Helps to understand the investors attitude
Helpful in decision making
Helps to identify the financial market environment
15. PSYCHOLOGY OF FINANCIAL
MARKETS
Offers an understanding of financial market process which goes beyond
cognitive aspects alone
Provides insights into the connection between the subjective experience of
market participants and objective market processes
Offers insight into the difference between market participants
16. PSYCHOLOGY OF INVESTOR
BEHAVIOR
Incorporates both quantitative and qualitative aspect
Examines the mental processes and emotional issues
Different biases
1. Familiarity bias
2. Self-attribution bias
3. Trend-chasing bias
4. Behavorial bias