Although, behavioral finance and market efficiency are topics that may seem separate and different, they both work conjointly. Finance has always been imagined to be a subject of numbers, calculations, spreadsheets and everything that encompasses investing. By glancing over the title of this paper, one could assume that the topic is related to a psychology or behavioral class more than finance. However, by researching the topic, it is clear that finance relies on behavioral sciences and psychological understanding more than expected. In the following paper, behavioral finance will be explained properly and the different examples of behavioral finance will be listed along with some examples to illustrate the significance of behavioral finance. Following the explanation, a correlation between the topic and market efficiency will be presented to show the importance of behavioral finance.
Behavioral Finance and Market Efficiency:
Behavioral finance is a topic that is of great importance in the investment community that can be of great use for investors and corporations seeking to draw in more investors. Behavioral finance is a topic that builds a bridge that connects two different fields together and enables one field, finance, to evolve and expand into the world of psychology to enable a more efficient and stable market. To simply explain behavioral finance, it is a psychological method to better understand how individuals choose their investment outlets and make decisions financially (Qawi, 2010). With such information, a better financial environment can be created to simplify the way individuals invest their savings or spend their monies.
Behavioral finance and market efficiency are two issues that are c...
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...of the ways to identify overconfidence in an individual is lack of diversification (Jain, 2012). To recall, diversification was discussed in a previous topic that relates to the idea of including different outlets of investments within one portfolio to maximize profit with risk reduction (What is diversification, 2011). Overconfidence can be dangerous as it increases the risk factor of the investment in general and can negatively affect the investment portfolio value.
Finally, the disjunction effect is a model that can shed light and explain the market price changes and disturbance before and after presidential elections or important announcements that can be either political or economical in nature. Disjunction effect occurs when an investor decides to not take any action until the individual knows all the information regardless of its importance (Jain, 2012).
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