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Behavioral Finance - An Explanation

Behavioral finance argues that traditional finance assumptions do not fully capture how investors actually make decisions. Investors are influenced by emotions, mental errors, and psychological factors that can lead to irrational behavior. Behavioral finance incorporates psychological aspects to provide more realistic models of financial decision-making. Some biases that influence investors include heuristics, framing effects, emotions, and herd behavior.

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175 views13 pages

Behavioral Finance - An Explanation

Behavioral finance argues that traditional finance assumptions do not fully capture how investors actually make decisions. Investors are influenced by emotions, mental errors, and psychological factors that can lead to irrational behavior. Behavioral finance incorporates psychological aspects to provide more realistic models of financial decision-making. Some biases that influence investors include heuristics, framing effects, emotions, and herd behavior.

Uploaded by

smritipattnaik
Copyright
© Attribution Non-Commercial (BY-NC)
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PPT, PDF, TXT or read online on Scribd
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Behavioral Finance - An Explanation

to Irrational Investment Behaviour

Dr. MALABIKA DEO


Professor & Head of Commerce,
PONDICHERRY CENTRAL UNIVERSITY,
Kalapet
Puducherry – 605 014.
INDIA.
Behavioural Finance
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.

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.
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 Risk & Return – frames
factors for investors Decision Specific.
Rational, Logical, Herd instinct, Emotional and
Transparent & Objective Sentimental.
Arguments in favour of Behavioral
Finance
 More Realistic
Psychological Foundation
Increases Explanatory Power of Financial Models
Solves Empirical Puzzles of Traditional Finance
New approach to Traditional Finance
Basics of Theories of Behavioral Finance

 Heuristic – Driven Biases


 Frame Dependence
 Emotional Inefficiencies
 Market Inefficiencies
Heuristic – Driven Biases
It explains, how decision makers take decision
without systematic collection and evaluation of
information in the event of limited time

 Representativeness
 Over – Confidence
 Anchoring
 Gamblers Fallacy
 Availability Biases
 Aversion to Ambiguity
Frame Dependence
 Prospect Theory
 Mental Accounting
 Narrow Framing
 Shadow of Past
 Behavioural Portfolio
Prospect Theories
 Investors pay attention to change in each
transaction than the total value.
 People look at chances in terms of potential gain
and losses in relation to specific reference point
(Purchasing Power).
 Underweighing outcomes that are probable, in
comparisons to certain outcomes.
 Value function concave for gains and convex for
losses.
 More pain for losses less happiness in gains.
Mental Accounting
Division of current and future asset into
different groups are differently treated

Narrow framing
 Un Due attention to short – term gains
even in long horizon.
 Over estimation of risk
Shadow of Past
Gain prompts people to take more risk Loss Makes
people averse to take further risk.
Behavioral portfolio
Investors to hold their portfolio in a pyramid of
assets based on the goals like safety, income and
growth.
 Options
 Commercial Property
 Stocks
 Bonds
 Residential House
 Cash
Market Inefficiency
Investors trade on the basis of rumors,
sentiment or noise not on fundamentals.
 Buying Undervalued stocks - more risky
 Not Selling Over priced stocks - more
greedy
Emotional and Social Influence
 Risk tolerance affected by Emotions and
Sentiments

 Decision based on Herd Instinct than


Market Analyses

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