ABSTRACT
Behavioural finance is part of finance that seeks to understand and explain the systematic financial market implications of psychological decision processes. It utilizes knowledge of cognitive psychology, social sciences and anthropology to explain irrational investor behavior that is not being captured by the traditional rational based models.

INTRODUCTION

Classical investment theories are based on the assumption that investors always act in a manner that maximizes their return. Yet a number of research show that investors are not always so rational. Human become puzzled when the uncertainty regarding investment decision engulfs them. People are not always rational and markets are not always efficient. Behavioral finance explains why individual do not always make the decisions they are expected to make and why markets do not reliably behave as they are expected to behave. Recent research shows that the average investors make decisions based on emotion, not logic; most investor’s buy high on speculations and sale low on panic mood.
Psychological studies reveal that the pain of losing money from investment is really three times greater than the joy of earning money. Emotions such as fear and greed often play a pivotal role in investor’s decision; there are also other causes of irrational behavior. It is observed that stock price moves up and down on a daily basis without any change in fundamental of economies. It is also observed that people in the stock market move in herds and this influence stock price.
Theoretically markets are efficient but in practice, they never move efficiently. For example, a reputed company announces a mega investment in an emerging area over next few years, the stock price of the company starts moving up immediately without looking into the prospects, return or the amount of investment to be made in this project. That is how the behavior of investor moves the stock price.

BEHAVIOURAL FINANCE

Behavioral finance is a new concept in a financial market. Behavioral finance is not one of several branches of standard finance, but it replaces traditional finance and offers a better model of humanity. Even though Modern Portfolio Theory (MPT) and Efficient Market Hypothesis (EMH) theories have been considered successful in a financial market, behavioral finance has developed to stand out as one of the alternative theories of standard finance.

Behavioral finance is a research of the impact of psychology on the market participants’ behavior and the following effects or outcomes on markets. Behavioral finance focuses on the way how individual investors make decisions, in particular, how people interpret and act on specific information. Investors do not always show rational and predictable reactions supported by the quantitative models, and this means that the decision-making process of investors considers cognitive biases and the affective (emotional) aspects. Behavioral finance emphasizes on investors’ behavior leading to various market anomalies and inefficiencies. This new concept of finance explains individual behavior, group behavior by integrating the field of sociology, psychology, and other behavioral sciences and predicts financial markets.

Behavioral finance is a relatively new field that seeks to combine behavioral and cognitive psychological theory with conventional economic and finance to provide explanations for why people make irrational financial decisions. It is very popular in stock market across the world for investment decisions.

Behavioral finance is the study of psychology and economics to explain why and how people make seemingly irrational or illogical decisions, why they save, invest, spend and borrow money.

Shefrin (2001) says behavioral finance is the study of how psychology affects financial decision making and financial markets.

Verma (2004) has defined “Behavioral finance tries to understand how people forget fundamentals and make investment based on emotions.”

Swell (2005) asserts that behavioral finance is the study of the influence of psychology on the behavior of financial practitioners and the subsequent effect on markets. Further in 2007, he has stated that behavioral finance challenges the theory of market efficiency by providing insights into why and how market can be inefficient due to irrationality in human behavior.

Forbes (2009) has defined behavioral finance as a science regarding how psychology influences financial market. This view emphasizes that the individuals are affected by psychological factors like cognitive biases in their decision making, rather than being rational and wealth maximizing.

Thus, behavioral finance is the application of scientific research on the psychological, social and emotional contributions to market participants and market price trends. It also studies the psychological and sociological factors that influence the financial decision making process of individual groups and entities.

LITERATURE REVIEW

Though the literature of behavioral finance is very large, it is proposed to present some empirical case studies to focus light insight to behavioral finance and its application in decision making.
Tversky and Kahneman who were recognized as the father of behavioral finance can be best explained in different phases by their works. In 1979, they presented a paper regarding critique of Expected Utility Theory which found out empirically that people underweight outcomes that are merely probable in comparison with outcomes that are obtained with certainty; also that the people generally discard components that are shared by all prospects under consideration.
Under prospect theory, value is assigned to gain and losses rather than to final assets: also probabilities are replaced by decision weights. The theory which they confirmed by experiment predicts a distinctive fourfold pattern of risk attitudes, risk aversion for gains of moderate to high probability and losses of low probability and risk seeking for gains of low probability and losses of moderate of high probability. In 1981, they introduced the concept of framing. They showed that the psychological principles that govern the perception of decision problems and to evaluation of probabilities and outcomes produced predictable shifts of preference when the same problem is framed in different ways.

De Bondt and Thaler (1985) published article: “Does the Stock Market Over-react?” in a Journal of Finance. They propounded that the people are systematically over-reacting to unexpected and dramatic news results in substantially weak form inefficiencies in the stock market. Mental accounting is a set of cognitive operations used by individuals and households to organize evaluate and keep track of financial activities.

Jay R Ritter (2003) has given a brief introduction of behavioral finance published in Pacific Basin Finance Journal. In his research article, he rejected the traditional assumption of expected utility maximization with rational investors in efficient market. The two building blocks of behavioral finance are cognitive psychology (How People Think) and the limit of arbitrage (when market will be inefficient). The article further highlights many empirical patterns like stock market bubbles in Japan, Taiwan and the US.

Simon Gervais (2009) in “Behavioral Finance; Capital Budgeting and Other Investment Decision”, he has made a survey of literature on the effects of behavioral biases on capital budgeting. In this paper, a large body of psychological literature finds that the people tend to be overconfident and overly optimistic. This literature find that the biased managers over-invest their firms cash flows, initiate too many mergers, start more firms and more noval projects and tend to stick with unproductive investment policies longer. Corrective measures to reduce the effect of manager biases include learning, inflated discount rate and contractual incentives but their effectiveness in curbing over investment appears to be limited.

OBJECTIVE OF THE STUDY

* To understand the basic perception of individuals towards finance and investment. * To analyze the impact of external factors on investors’ decision making. * To understand the generic behavior of investors. * To understand the relationship between rationality in thinking and investing. * To understand the impact of others’ financial growth on an individual.

METHODOLOGY

* The research was mainly based on primary data. * The primary data was collected through questionnaire. * The size of the sample selected was 40. * The simple consisted of MBA students across 3 different institutions. * The research also made use of secondary data from various reports for literature review. * Variables used Dependent Variables: This study consists of Dependent Variable, namely, Investors’ Participation which consists of two statements, namely,
a. Presently, I am trading on stock market.
b. I do have a fair bit of knowledge about stock market. Independent Variables: The questionnaire tried to understand the specific factors that possibly influenced investors’ attitude towards investing.

ANALYSIS

The respondents were enquired with questions on various factors to evaluate: * Their understanding of the stock market. * The confidence level when it comes to decision making. * The effect of ‘herd follow’ phenomenon. * Impact of other investors’ financial well-being personally, and other such factors.

* The analysis is basically done by giving emphasis on personal perception towards investment and behavioral changes based on external changes. * The analysis involves understanding how an individual behaves in the stock market and also how his/her personal behavior has an impact on their investments. * The study also tries to understand the perception differences among both the genders. * The study also analyses the perception of those individuals who hasn’t traded in stock market towards investment. * The respondents involved almost an equal share among people who have invested and who haven’t.

FINDINGS

* The study showed that majority feel stock market as a gambling process. Only a small portion of the respondents felt that stock market is an avenue for long term gains. * It was found out that the stock market can be profitable for an investor only if he/she has significant knowledge towards stock market and good analytical skills. * The study revealed that people would go for an option where there is even the slightest chance for making profit. * It was found out that none of the investors would like to lose money, no matter how small the amount is. * It was found out that women depend solely on themselves when it comes to decision-making on stock and trading. On the other hand men preferred depending on experts opinion than their own analysis. * There is an equal share among people who prefer long term stability and those who prefer short term gains. * The ‘herd follow’ symptom can be witnessed suggesting that people mainly invest depending on the mass behavior and not on rational basis. * The study reveals that on an overall basis women are self-dependent on the matter of financial management than men. * It is also evident from the study that factors such as over confidence can be seen across both the genders, and on an average women tend to be more over confident than compared to men. * It can also be seen that when it comes to other investors’ financial well-being, men are more worried than compared to men. * The study reveals that there is a sense of pride in owning shares of reputed firms. Individuals are ready to sacrifice the returns for brand name so that it adds respect and prestige to them. * People tend to sell their winners quickly and hold to their weak performers for a long time. This basically happens because of the expectations of investors and also their confidence level. * People tend to behave according to the changes in the market. * Majority of the respondents are not much bothered about the fluctuations of other stock prices.

CONCLUSION

Behavioral finance provides explanations for why investors make irrational financial decisions. It demonstrates how emotions and cognitive errors influence investors in the decision making process. The various causes that led to behavioral finance are anchoring, overconfidence, herd behavior, over and under reaction and loss aversions. In essence, behavioral finance approach investigates the behavioral patterns of investors and tries to understand how these patterns guide investment decision. Behavioral finance offers many useful insights for investment professionals and thus, provides a framework for evaluating active investment strategies for the investors.

ANNEXURE

BEHAVIOURAL FINANCE QUESTIONNAIRE
Kindly respond to the below questions which are prepared to assist my term paper on behavioural finance. Mail your responses by 4 pm 27/10/2013.
Please be fair while responding and provide the actual facts.
1. Name:
2. Age:
3. Gender:
4. Have u traded on stock market: A. yes in live market B. yes in simulation C. no Your option:
5. What is your general perception towards stock market? Your opinion:
6. Which one do you choose? A) Accepting a sure loss of $5,000, or B) taking a chance where there is a 50% chance you will lose $10,000 and a 50% chance that you will lose nothing. A) or B)? Your opinion:
7. On what basis would you judge a share performance? A. Experts opinion B. Your own analysis of the market C. Based on mass behavior
Your opinion:
8. If there is a sudden hike in the price of your share, what would you do? A. Sell to maximize profits B. Retain for long term gains C. Wait for the price to increase more
Your opinion:

9. Do you depend on other’s opinion for your investment? A. yes B. no C. sometimes
10. On a scale of 10 what would you rate yourself when it comes to trusting your own decisions?
Your opinion:
11. In your class where would you rank yourself?
Your opinion:
12. I am concerned about others’ financial well-being. A. Strongly Disagree B. Moderately Disagree C. Neither Agree Or Disagree D. Moderately Agree E. Strongly Agree
Your opinion:
13. I enjoy owning big-name stocks. A. Strongly Disagree B. Moderately Disagree C. Neither Agree Or Disagree D. Moderately Agree E. Strongly Agree
THANK YOU FOR YOUR PATIENCE
Please your responses to prithvi0406@gmail.com

REFERENCE * www.behaviouralfinance.net * www.investopedia.com * www.behaviouralfinance.net