Behavioral finance -_an_explanation
- 1. Behavioral Finance - An Explanation to Irrational Investment Behaviour Dr. MALABIKA DEO Professor & Head of Commerce, PONDICHERRY CENTRAL UNIVERSITY, Kalapet Puducherry – 605 014. INDIA.
- 2. 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 .
- 3. 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 factors for investors Decision Risk & Return – frames Specific. Rational, Logical, Transparent & Objective Herd instinct, Emotional and Sentimental.
- 4. 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
- 5. Basics of Theories of Behavioral Finance Heuristic – Driven Biases Frame Dependence Emotional Inefficiencies Market Inefficiencies
- 6. 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
- 7. Frame Dependence Prospect Theory Mental Accounting Narrow Framing Shadow of Past Behavioural Portfolio
- 8. 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.
- 9. 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
- 10. 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
- 11. 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
- 12. Emotional and Social Influence Risk tolerance affected by Emotions and Sentiments Decision based on Herd Instinct than Market Analyses
- 13. THANK YOU