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Behaviourial finance
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.
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Behaviourial finance
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- 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 BEHAVORIALFINANCE 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 BEHAVORIALFINANCE Inflation and stock market Underpricing of Initial Public Offering Investors Corporations Markets Regulations Education
- 5. OBJECTIVES OF BEHAVORIALFINANCE 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
- 7. MARKET STRATEGIES Markettiming Technical analysis Financial fraud Pyramid scheme Efficient market hypothesis
- 8. PROSPECT THEORY Developedby 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’stendency 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
- 12. CONCEPT OF PSYCHOLOGY Behaviour Personality Motivation intelligence
- 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
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