Behavioural Finance

Topics: Capital asset pricing model, Financial markets, Financial economics Pages: 3 (992 words) Published: November 11, 2010
“The contribution of behavioural finance theory is said to be of critical importance in understanding investor behaviour in modern finance” INTRODUCTION
According to Gregory Curtis (2004, pg 16), Sometime we behave like perfect economic beings. But other times we behave like, well, human beings. We make decisions on the basis of biases that don't reflect real world facts. We allow our responses to decisions to depend on how the questions are framed. We engage in complex mental accounting, ignoring the fact that our various asset baskets are all interrelated. We allow ourselves to be driven by hopes and fears, rather than facts. So which is better—modern portfolio theory, which describes how markets work, or behavioural finance, which describes how people work? The answer, of course, is that we need both. Modern portfolio theory and behavioural finance are both important tools in helping us design and manage successful investment portfolios. Both have advantages and disadvantages...” According to Martin Sewell (2008, pg 1), “Behavioural finance is the study of the influence of psychology on the behaviour of financial practitioners and the subsequent effect on markets. Behavioural finance is of interest because it helps explain why and how markets might be Inefficient”. Emery D. et al (2007, pg434) states that Unlike the “traditional finance which embraces much of what is thought of as finance theory that people behave rationally, behavioural finance often allows that psychology and culture can cause investors and decision makers to behave irrationally, and market to be inefficient”. “Behavioural finance assumes investors are not rational. The easiest way of seeing this is through the psychology of buying and selling. Investors tend to buy when the market is high and sell when it is low” Alice Ross (2009 Pg. 3).According to Pike R. And Neale B. (2009, pg 705), “this assumes that people have the same preferences, perfect knowledge of all alternatives and...
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