2. Learning Objectives
ā¢ Introduction to behavioral finance
ā¢ History of behavioral finance
ā¢ Heuristic- driven biases
ā¢ Need and Scope of Behavioral Finance
ā¢ Objectives of Behavioral Finance
ā¢ Significance of behavioral finance
ā¢ Market strategies
ā¢ Various theories of behavioral finance
ā¢ Limitations of behavioral finance
3. Introduction
āŖ Dr. Meir provides one of the best explanations of
why the world needs behavioral finance:
āŖ āPeople in standard finance are rational. They are
not confused by frames, they are not affected by
cognitive errors, they do not know the pain of
regret, and they have no lapses of self control.
People in behavioral finance may not always be
rational but they are always normal. Normal
people are often confused by frames, affected by
cognitive errors and know the pain of regret, and
the difficulty of self control.ā
4. ā¢Behavioral Finance is a concept developed with
the inputs taken from the field of psychology and
finance, which tries to understand various
puzzling observations in stock markets with better
explanations.
ā¢The main theme of the traditional finance is to
avoid all the possible effects of individualās
personality and mindset.
ā¢Behavioral Finance is just not a pure of finance. It
is something which is much broader and wider
and includes the insights from behavioral
economics, psychology and microeconomic
theory.
5. History of Behavioral Finance
ā¢Key proposition of traditional finance believed
that the financial markets are efficient and highly
analytical. They defined that efficient markets are
those markets in which security prices always
fully reflect the available information.
ā¢Global financial crisis in 2007, it was identified
that traditional financial models always
disappoint in predicting market.
6. HEURISTICāDRIVEN BIASES
ā¢ The important heuristic ā driven biases and cognitive errors that
impair judgement are:-
ā¢ REPRESENTATIVENESS
ā¢ OVERCONFIDENCE
ā¢ ANCHORING
ā¢ AVERSION TO AMBIGUITY
ā¢ INNUMERACY
8. Scope of Behavioral Finance
ā¢investors
ā¢Helps to identify the risks and their hedging
strategies
ā¢Provides an explanation to various corporate
activities.
ā¢inflation and stock market
ā¢Underpricing of initial public offering (IPO)
ā¢regulations
9. Need of Behavioral Finance
ā¢It covers āindividual and group emotion, and
behavior in markets.
ā¢The field brings together specialists in personality,
social, cognitive and clinical psychology,
psychiatry, organizational behavior, accounting,
marketing, sociology, anthropology, behavioral
economics, finance and the multidisciplinary study
of judgment and decision making.
10. Objective of Behavioral Finance
ā¢To review debatable issues in Standard
Finance and the interest of stakeholders.
ā¢To discuss emerging issues in the financial
world.
ā¢To discuss the development of new
financial instruments.
ā¢To examine the relationship between
theories of Standard Finance and
Behavioral Finance.
11. ā¢ Correct decision making
ā¢ Provide knowledge to unaware investors
ā¢ Identify emotions and mental error
ā¢ Delivering what the client expects
ā¢ Ensuring mutual benefits
ā¢ Maintaining consistent approach
ā¢ Examining a consistent approach
12. SIGNIFICANCE OF
BEHAVIOURAL FINANCE
ā¢ Determining goal of investors
ā¢ Defining investors biases
ā¢ Manages behavioral biases
ā¢ Cognitive biases
ā¢ Emotional biases
ā¢ Helps in investment decision
ā¢ Helps for financial advisors and fund managers
ā¢ Signifies that investors are emotional
14. Theories of behavioral finance
ā¢ PROSPECT THEORY
ā¢ Developed by Kahneman and Tversky in 1979
ā¢ Shows how people manage risk and uncertainty
ā¢ Most central element of prospect theory is S shaped value
function
16. LOSS AVERSION THEORY
ā¢ People weigh all potential gains and losses in
relations to some benchmark reference point
ā¢ Depicts tendency of people to show greater
sensitivity to losses than gains
ā¢ Types:-
ā¢ Loss on the basis of ā valenceā or desirability
ā¢ Loss on the basis of changes in possession
17. MENTAL ACCOUNTING
ā¢ Peoples tendency to code, categories and evaluate economic
outcomes
ā¢ Primary reason is to enhance our understanding of the psychology
of choice
ā¢ 3 components
ā¢ Perception of outcomes and the making and evaluation of
decisions
ā¢ Assignments of activities to specific accounts
ā¢ Determination of time periods to which different mental accounts
relates.
18. INVESTORS DISPOSITION
EFFECT
ā¢ Notion of framing realization of losses
ā¢ Refers to asymmetric risk aversion, according to
which investors are risk- averse when faced with
gains and risk-seeking when faced with losses.