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Sruthy

Behavioural finance examines how psychological factors influence investor behavior and market outcomes, highlighting that investors are not always rational and are affected by biases. Key theories include Prospect Theory, which emphasizes loss aversion, and concepts like overconfidence and heuristics that impact decision-making. The field has evolved since the 1980s, with significant contributions from figures like Daniel Kahneman and Robert Shiller, who have received Nobel Prizes for their work.

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6 views10 pages

Sruthy

Behavioural finance examines how psychological factors influence investor behavior and market outcomes, highlighting that investors are not always rational and are affected by biases. Key theories include Prospect Theory, which emphasizes loss aversion, and concepts like overconfidence and heuristics that impact decision-making. The field has evolved since the 1980s, with significant contributions from figures like Daniel Kahneman and Robert Shiller, who have received Nobel Prizes for their work.

Uploaded by

Pramod P
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© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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INTRODUCTION TO

BEHAVIOURAL FINANCE
PRESENTED BY
SRUTHY. S.
SUNIL
Behavioural Finance

• Behavioural finance is the study of the influence of


psychology on the behaviour 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.
Traditional Financial Theory

• In order to better understand behavioural finance, let’s


first look at traditional financial theory.

• Traditional finance includes the following beliefs:

• Both the market and investors are perfectly rational

• Investors truly care about utilitarian(practical)


characteristics

• Investors have perfect self-control

• They are not confused by cognitive errors or information processing errors


Traits of behavioural finance are:

• Investors are treated as “normal” not


“rational”

• They actually have limits to their self-


control

• Investors are influenced by their own biases

• Investors make cognitive errors that can


lead to wrong decisions.
Major theories used :

1. Prospect Theory :

• Prospect theory assumes that losses and gains are


valued differently, and thus individuals make decisions
based on perceived gains instead of perceived losses.

• Also known as the “loss-aversion” theory

• The general concept is that if two choices are put


before an individual, both equal, with one presented in
terms of potential gains and the other in terms of
possible losses, the former option will be chosen.
2. Judgement under uncertainty

(a) Overconfidence:

Overconfidence investors may overestimate their ability to


identify and winning investments. They may not be aware that the
available information is not adequate to develop an accurate
forecast in uncertain situations.

• Too little diversification, because tendency to invest too much in


which what one is familiar with.

(b) Fear of Regret:

To avoid the pain of regret, people tend to alter their behaviour,


which may end up being irrational at times.
3. Human Heuristics

• A heuristic is a mental shortcut that allows people to solve


problems and make judgments quickly and efficiently.

• People often use heuristics that reduce complex problem


solving to more simple judgmental operations.
EVOLUTION OF

BEHAVIOURAL SCIENCE
Evolution of Behavioural Finance: The origin of behavioral finance can
be traced back to 1980. Daniel Kanheman is the father of behavioural
finance. He along with Amos Tversky propounded the theory in the
prospect theory in the year 1979, He received Nobel prize for the same
in the year 2002.

Another important contributor to the field is Robert J Schiller who


received Nobel prize in the year 2013. He predicted the global financial
crisis of 2007 and warned the world. Coincidently he shares his Nobel
Prize with Eugene Fama who is an eminent standard finance economist.

The early theories in the field are provided by Kahneman and Taversky.
This field got for the award by contributions of economists Richard
Thaler. He got Nobel prize in 2017 for his contribution in the field for
concepts such as mental accounting theory.

Others who have contributed in this area are Dan Ariely, Werner D
Bondt, Hersh Shefrin, Meir Statman et al.

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