BEHAVIOURIAL FINANCE PRESENTED BY SIMRAN KAUR MBA 2 ND YEAR
BEHAVIOURIAL FINANCE
PRESENTED BYSIMRAN KAURMBA 2ND YEAR
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.
NATURE OF BEHAVORIAL FINANCE
Bridge gap between finance and psychology Two types: 1. Rational finance paradigm2. 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
SCOPE OF BEHAVORIAL FINANCE
Inflation and stock market Underpricing of Initial Public Offering Investors Corporations Markets Regulations Education
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
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
MARKET STRATEGIES
Market timing Technical analysis Financial fraud Pyramid scheme Efficient market hypothesis
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
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
Types1. Loss on the basis of “valence” or desirability2. Loss on the basis of changes in possession
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 components1. Perception of outcomes and the making and evaluation of
decisions2. Assignment of activities to specific accounts3. Determination of time periods to which different mental
accounts relates
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
CONCEPT OF PSYCHOLOGY
Behaviour Personality Motivation intelligence
NATURE OF PSYCHOLOGY
Study of experience Study of mental processes Study of behaviour
IMPORTANCE OF PSYCHOLOGY
Helps to identify goals Helps to understand the investors attitude Helpful in decision making Helps to identify the financial market environment
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
PSYCHOLOGY OF INVESTOR BEHAVIOR
Incorporates both quantitative and qualitative aspect Examines the mental processes and emotional issues Different biases1. Familiarity bias2. Self-attribution bias3. Trend-chasing bias4. Behavorial bias
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