Behavioral Finance theory has been emerged based on the limitations of traditional finance theory I-e investors behave rationally (Statman, 1995). Barberis & Thaler (2003) noted that behavioral finance theory explains irrationality and decision making process by drawing evidence from the cognitive psychology and biases associated by, the way people make believes and preferences.
Behavioral biases have been considered as a main driving force in investment portfolio choice. People are subject to behavioral biases when they make decision making. These biases prevent people from making rational and normal decisions. Many researchers in the field of behavioral finance conducted research and suggest that investors do not always behave rationally when making investment decisions (Babajide & Adetiloye, 2012).
Many behavioral Finance models motivate irrational investment behavior using overconfident investors. Overconfidence refers to the habit of overestimating own ability to perform in given tasks. Barner & Odean (2000) submits that overconfidence causes excess trading which can be risky to financial well-being. Some of the key biases that affect financial decisions include investing with overconfidence, which can lead to inappropriate or risky investments. Loss aversion is, investing to avoid loss or regret, at all costs, which can mean we don’t invest in way that will truly help us reach our investment objectives. Loss aversion is also acknowledged as risk aversion. Investing with self-attribution bias refers to a tendency to overestimate the degree which leads to risky investments. Ofir and Wiener (2008) study show the result that even professional investors are not really protected to behavioral biases and there are certain personal...
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...that which type of decision they will take and through their responses to the questions study judged the behavioral biases prevalent among their decision.
Data analysis technique
After data collection, questionnaires will be coded and checked for coding errors and omissions and coded data will process in the SPSS software Package. Statistical techniques, which are used for the data to achieve the research objectives, include Descriptive Statistics, Correlation coefficient. Descriptive Statistics (mode, median, mean, variance, standard deviation) are used to describe respondents’ personal information. Correlation coefficient was used to find out the relationship between over confidence bias, self-attribution and loss aversion bias and investment. Using linear regression, independent variables that demonstrated to explain better the affects over the dependent ones.
If you have formed a conclusion from the facts and if you know your judgment is sound, act on it- even though others may hesitate or differ”. The investor is not wrong if the crowd disagrees, and the other way around. It is also I important for the investor in both Enterprising and Defensive Investor to diversify with the amount of different Stocks and bonds.
The greatest investors in the world all understand one common theme when it comes to successful investing, “markets are volatile and they fluctuate.” Whether it is real estate investing or investing in stocks, there is an inherent risk. Therefore, new investors who are trying to decide whether to invest their available capital in real estate or stocks must learn to understand their own risk tolerance. To understand risk successfully, new investors must first learn some of the pros and cons of both real estate investing and stock market investing.
According to Thaler and Sunstein, people do not always make rational choices and those choices would present themselves quite differently if they had unlimited and cognitive abilities and unlimited will power. The two argue against the notion of the perfectly rational individual that exists in economics textbooks (Nudge 6-7). They reject that individuals most of the time make terrific choices, and if not terrific certainly better than any third party could do (Nudge 7). Real people suffer from a variety of cognitive biases and errors. People have trouble with long division when they don’t have a calculator and often forget their spouse’s birthday (Nudge 6). To be blunt, individuals are bad at calculating risk and are mentally lazy.
This study recognizes and acknowledges that movements of money into the stock market through mutual funds are linked to general business conditions. Clearly, company earnings and revenues and the external economic environment in which firms operate will influence investor decisions. However, that linkage between business performance and commitment of money to stocks is not rigid. Over short-term periods and even over extended lengths of time, masses of investors may be afflicted with either “irrational exuberance,” or they may be descending down a “wall of worry”.
when making in decisions in markets because they will try to predict how an different outcomes
The efficient market hypothesis has been one of the main topics of academic finance research. The efficient market hypotheses also know as the joint hypothesis problem, asserts that financial markets lack solid hard information in making decisions. Efficient market hypothesis claims it is impossible to beat the market because stock market efficiency causes existing share prices to always incorporate and reflect all relevant information . According to efficient market hypothesis stocks always trade at their fair value on stock exchanges, making it impossible for investors to either purchase undervalued stocks or sell stocks for inflated prices. As such, it should be impossible to outperform the overall market through expert stock selection or market timing, and that the only way an investor can possibly obtain higher returns is by purchasing riskier investments . In reality once cannot always achieve returns in excess of average market return on a risk-adjusted basis. They have been numerous arguments against the efficient market hypothesis. Some researches point out the fact financial theories are subjective, in other words they are ideas that try to explain how markets work and behave.
The efficient market, as one of the pillars of neoclassical finance, asserts that financial markets are efficient on information. The efficient market hypothesis suggests that there is no trading system based on currently available information that could be expected to generate excess risk-adjusted returns consistently as this information is already reflected in current prices. However, EMH has been the most controversial subject of research in the fields of financial economics during the last 40 years. “Behavioural finance, however, is now seriously challenging this premise by arguing that people are clearly not rational” (Ross, (2002)). Behavioral finance uses facts from psychology and other human sciences in order to explain human investors’ behaviors.
There is a sense of complexity today that has led many to believe the individual investor has little chance of competing with professional brokers and investment firms. However, Malkiel states this is a major misconception as he explains in his book “A Random Walk Down Wall Street”. What does a random walk mean? The random walk means in terms of the stock market that, “short term changes in stock prices cannot be predicted”. So how does a rational investor determine which stocks to purchase to maximize returns? Chapter 1 begins by defining and determining the difference in investing and speculating. Investing defined by Malkiel is the method of “purchasing assets to gain profit in the form of reasonably predictable income or appreciation over the long term”. Speculating in a sense is predicting, but without sufficient data to support any kind of conclusion. What is investing? Investing in its simplest form is the expectation to receive greater value in the future than you have today by saving income rather than spending. For example a savings account will earn a particular interest rate as will a corporate bond. Investment returns therefore depend on the allocation of funds and future events. Traditionally there have been two approaches used by the investment community to determine asset valuation: “the firm-foundation theory” and the “castle in the air theory”. The firm foundation theory argues that each investment instrument has something called intrinsic value, which can be determined analyzing securities present conditions and future growth. The basis of this theory is to buy securities when they are temporarily undervalued and sell them when they are temporarily overvalued in comparison to there intrinsic value One of the main variables used in this theory is dividend income. A stocks intrinsic value is said to be “equal to the present value of all its future dividends”. This is done using a method called discounting. Another variable to consider is the growth rate of the dividends. The greater the growth rate the more valuable the stock. However it is difficult to determine how long growth rates will last. Other factors are risk and interest rates, which will be discussed later. Warren Buffet, the great investor of our time, used this technique in making his fortune.
A crucial reason in favour of mental accounting and overconfidence is decision efficiency. Real-life investing scenario changes every moment Time-consuming and systematic thinking process seldom is allowed during the intense decision-making (Stewart Jr et al., 1999, Busenitz and Barney, 1997). Additionally, the ‘small world’ used by the economic theory, which only applied to strict condition, is not necessarily applicable in the practical investment decision. As the assumption in those analysis approach may not conform with real life well and for most of times, cognitive heuristics is more suitable for the uncertainty(Gigerenzer and Gaissmaier, 2011). However, there is also a few argument against them, for it may hinder people from examining their investment choice thoroughly. Research shows that they did not perceive themselves as risk taker, but in fact, they are more likely to take relatively low return alternatives as ‘opportunities’, indicating that they are risk-taking to a great extent(Palich and Ray Bagby, 1995). As a result of the illusion created by such factors, decision makers tend to be narrow-minded in composing strategies and unable to bring enough information into thought(Schwenk, 1988). It was demonstrated by several researches that decisions made by means of biases and heuristics impose
performance of average investors; however the seasoned investors do not get complete freedom to get
There is a lot of research work going on in this particular field, more so since the crisis of 2008. The purpose of this article was to make readers aware of the subject .Behavioral finance is an interesting mix of logics, psychology and economics. Budding investors and management students should look into this in more detail so that they are better equipped to make financial decisions.
Psychologists found that human beings do not behave as rationally as economists suppose. The occurring of stock market anomalies and empirical researches conducted by Babajide & Adetiloye (2012) and Bashir et al. (2013) revealed that investors are not always as rational as they are portrayed to be. These anomalies can be explained by, a new emerging area of finance, behavioral finance. To better understand investment intention, whether rational or not, psychological factors are necessary to be considered. One of the main purpose of this research is to investigate how psychological factors, particularly the motivation, mentality could possibly affect investment financial intention. The motivation will be measured in terms of the degree of risk the investor is willing to take.
...s go about making judgments and choices. Both theories play an intrinsic role with behavioral decision making and have proven to be successful approaches for management (Shanteau, 2001).
This paper will define and discuss five financial theories and how they impact business decisions made by financial managers. The theories will be the Modern Portfolio Theory, Tobin Separation Theorem, Equilibrium Theory, Arbitrage Pricing Theory (APT), and the Efficient Markets Hypothesis.
Our understanding and the concept of investment in behavioural finance combines economics and psychology to analyse how and why investors make final decision. As an investor one’s decision to invest is fully influence by different type of attitudes of behavioural and psychological ( Ricciardi & Simon, 2000). Yet, in order to maximize their financial goal, investors must have a good investment planning. Furthermore , to gain a good investment planning , there must be a good decision making among investors. They have to choose the right investment plan I order to manage the resources for different type of investments not only to gain profit wise but also to avoid the risk that occur from investment.