Behavioural Finance

Topics: Daniel Kahneman, Prospect theory, Amos Tversky Pages: 7 (2024 words) Published: April 2, 2013
Behavioural Finance: How Investor Reacts in Decision Involving Risk?

Behavioral finance is a new field in economics that has recently become a subject of significant interest to investors. This article provides a general discussion of behavioral Finance .In this article survey is made between two different groups of investors. This article shows how we behave or the psychology when we make decisions involving risk, or in the possibility of loss .This article also throw some light on economists who stress psychological and behavioral elements of stock-price determination challenge efficient market theory. Investors behave irrationally during risk decisions such as: Losing Money - Individuals typically measure risk by money that has been lost. These losses are measured against the original cost of the stock or bond. Individuals sometimes feel money has been lost only when the security is sold.

Unfamiliar Instruments - Unknown or complex securities may seem riskier Previous Losses in Familiar Instruments- a stock that has lost money for the individual in the past is considered unattractive.

Contrary Investing - Not "following the crowd" may appear risky to an individual Historical v Potential Levels of Risk - Many individuals regard past levels of volatility as more important than projected levels of risk.

Behavioral finance is the integration of classical economics and finance with Psychology and the decision-making sciences. This study is related to the fact that how investors give different weight age to investment under similar situation. Some people systematically make errors in judgment or mental mistakes. Much of the economic theory available today is based on the belief that individuals behave in a rational manner and that all existing information is embedded in the investment process or no attention being given to the influence of human behaviour on the investment process. In fact, researchers have uncovered evidence that rational behavior is not often the case. Behavioral finance attempts to understand and explain how human emotions influence investors in their decision making process. These mental mistakes can cause investors to form biased expectations regarding the future that, in turn, can cause securities to be mispriced. Behavioral finance is based on the psychology of investors. Psychology primarily deals with human fallibility, systematic mistakes and biased judgment. HOW INVESTOR BEHAVE WHILE INVESTING & WHY?

Behaviour Finance field is so new, most professionals responsible for large portfolios were not exposed to the principles of behavioral finance in their college curricula and these principles have significant practical implications for investment management. Consequently, this article provides an overview of behavioral finance. No matter how much investor is well informed, have done research, studied deeply about the stock before investing then also he behave irrational with the fear of loss in the future. For instance the loss of `100 twice as painful as the pleasure received from a 100 gain. It consider the Idea that people are Irrational & make investment decision from many reasons for instance some while investing wants to behave like professional & are over confident, some follow the past trends followed by others. Tversky and Kahneman originally described "Prospect Theory" in 1979. They found that contrary to expected utility theory, people placed different weights on gains and losses and on different ranges of probability. They found that individuals are much more distressed by prospective losses than they are happy by equivalent gains. Following Question was asked to the two groups of investors 'A' & 'B' (Identification is not disclosed due to secrecy reason) When you invest in a new stock issue, what effect do you expect? INVESTOR'S GROUPS| (I)

Investment will give sure gain of 50% of your investment| (II) Probability of .5 to gain 100%...

References: 3. Barber, B. and T. Odean (2000), Trading is Hazardous to Your Wealth: The Common Stock Investment Performance of Individual Investors, Journal of Finance 55, pp. 773-806 
6. DeBondt, Werner F. M. and Richard H. Thaler, 1990, "Do Security Analysts Overreact?"
8. Jegadeesh, Narasimhan and Sheridan Titman, 1993, "Returns to Buying Winners and Selling Losers: Implications for Stock Market Efficiency," Journal of Finance 48, 65-92.
10. Lakonishok, Josef, Andrei Shleifer and Robert W. Vishny, 1994, "Contrarian Investment, Extrapolation, and Risk," Journal of Finance 49, 1541-1578.
15. Statman, Meir, 1995, "A Behavioral Framework for Dollar Cost Averaging," Journal of Portfolio Management 22 (Fall), 70-78.
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