...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...
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...Chapter 18 A SURVEY OF BEHAVIORAL FINANCE ° NICHOLAS BARBERIS University of Chicago RICHARD THALER University of Chicago Contents Abstract Keywords 1. Introduction 2. Limits to arbitrage 2.1. Market efficiency 2.2. Theory 2.3. Evidence 2.3.1. Twin shares 2.3.2. Index inclusions 2.3.3. Internet carve-outs 3. Psychology 3.1. Beliefs 3.2. Preferences 3.2.1. Prospect theory 3.2.2. Ambiguity aversion 4. Application: The aggregate stock market 4.1. The equity premium puzzle 4.1.1. Prospect theory 4.1.2. Ambiguity aversion 4.2. The volatility puzzle 4.2.1. Beliefs 4.2.2. Preferences 5. Application: The cross-section of average returns 5.1. Belief-based models 1054 1054 1055 1056 1056 1058 1061 1061 1063 1064 1065 1065 1069 1069 1074 1075 1078 1079 1082 1083 1084 1086 1087 1092 ° We are very grateful to Markus Brunnermeier, George Constantinides, Kent Daniel, Milt Harris, Ming Huang, Owen Lamont, Jay Ritter, Andrei Shleifer, Jeremy Stein and Tuomo Vuolteenaho for extensive comments. Handbook of the Economics of Finance, Edited by G.M. Constantinides, M. Harris and R. Stulz © 2003 Elsevier Science B.V All rights reserved . 1054 5.2. Belief-based models with institutional frictions 5.3. Preferences N. Barberis and R. Thaler 6. Application: Closed-end funds and comovement 6.1. Closed-end funds 6.2. Comovement 7. Application: Investor behavior 7.1. 7.2. 7.3. 7.4. 7.5. Insufficient diversification Naive diversification Excessive trading The selling decision...
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...Libre des Sciences Commerciales Appliquées Review of Literature Behavioral Finance Presented to Dr. Mohamed EL-Hennawy Group Assignment Prepared By Albert Naguib Noha Samir Wael Shams EL-Din Moshira Gamil Marie Zarif January 2012 | TABLE OF CONTENTS | | | |List of Table………………………………………………………………………….. | |List of Figure ………………………………………………………………………… | |List of Abbreviations/Acronyms ……………………………………………………. | |Introduction……………………………………………………………………….. | |2. Appearance of Behavioral Finance…………………………………………………… | |2.1. Important Contributors…………………………………………………. ………. | |3. Behavioral Biases…………………………………………………………………… ...
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...A Critical Analysis of: Investor Irrationality and Self-Defeating Behavior FIN645 Introduction For many years, finance traditionalists have held on to the theory that markets are efficient and that prices correctly reflect the information available to the market as a whole. This has come to be known as the efficient market hypothesis which was originally postulated by Eugene Fama in 1965. After a thorough statistical study of the movements of investment prices Fama concluded that “such movements were essentially random and unpredictable” (Shefrin p.75). Fama pointed out that “in an efficient market, prices correspond to intrinsic (or fundamental) value” (Shefrin p.75). In short, what the theory concludes is that it is impossible to beat the market; that no investor can ever purchase undervalued stocks or sell stocks at inflated prices. The market will always correct itself by incorporating all relevant information into the price of a security thus eliminating an individual investor’s ability to outperform. EMH has grown to become a cornerstone of financial theory and is still applied by many traditionalists when attempting to explain the behavior of financial markets. While there is much evidence in support of this theory there is an equal amount dissention. There are many who argue that there is ample evidence available that counters the central ideas of EMH and demonstrate its shortcomings such as: individuals who have shown that they can consistently...
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...Without Mr. Sandberg’s and Mr. Östebo’s contribution, this thesis would not have been possible to complete. To all the respondents: thank you for your participation! _____________ Hannes Bernéus ____________ Carl Sandberg Jönköping International Business School Date: 2008-12-11 i _____________ David Wahlbeck Bachelor Thesis within Business Administration Title: Authors: Tutor: Date: Subject terms: Behavioral Finance – Investors’ Rationality. Hannes Bernéus, Carl Sandberg, David Wahlbeck Urban Österlund 2008-12-02 Behavioral Finance, Behavioral Economics, Finance, Economic Psychology. Abstract Purpose: The purpose of this thesis is to examine if professional investors are indicating tendencies of irrational behavior when exposed to certain psychological dilemmas related to the financial world. Background: A new field within financial theory emerged in the 1980s; one which did not build on fundamental cornerstones but from the world of psychology, called Behavioral Finance. The theories within Behavioral Finance also offered a new perspective when explaining market movements. The market is determined by people who can not always be considered rational in their investment decisions, especially not during times of financial distress...
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...Title Page Introduction a. Global Health Issues b. Economic Impact Behavioral Finance a. Emotional Biases i. Risk Aversion ii. Regret Aversion Market Implications a. Every market in today’s economy was impacted either directly or indirectly by the SARS epidemic. i. Most saw measurable decreases in GDP b. Global cost of lost economic activity due to SARS was approximately $54 billion Conclusion a. Economic damage caused by SARS can be attributed to the behavioral finance emotional biases of loss aversion and regret aversion affecting investors globally. Global Health Issues, Behavioral Finance and the Markets: The Role of Behavioral Finance in how Global Health Issues Impact the Economy Jonathan Davis David A Kennedy Lee V Smith Tayler T Young Syed Zain T Zaidi November 10, 2015 University of Houston- Downtown Global Health Issues, Behavioral Finance and the Markets: The Role of Behavioral Finance in how Global Health Issues Impact the Economy With globalization on the rise, infectious diseases that appear in one country have the opportunity to spread rapidly to others. Recent examples include the 2003 outbreak of Severe Acute Respiratory Syndrome (SARS) and the 2014 outbreak of the Ebola virus. According to the World Health Organization (WHO), 8,098 individuals became infected worldwide with SARS and 774 of those individuals ultimately died from the illness (CDC, 2005). While Ebola killed 5,160 out of the 14,098 people...
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...Behavioural Finance Martin Sewell University of Cambridge February 2007 (revised April 2010) Abstract An introduction to behavioural finance, including a review of the major works and a summary of important heuristics. 1 Introduction 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. For more information on behavioural finance, see Sewell (2001). 2 History Back in 1896, Gustave le Bon wrote The Crowd: A Study of the Popular Mind, one of the greatest and most influential books of social psychology ever written (le Bon 1896). Selden (1912) wrote Psychology of the Stock Market. He based the book ‘upon the belief that the movements of prices on the exchanges are dependent to a very considerable degree on the mental attitude of the investing and trading public’. In 1956 the US psychologist Leon Festinger introduced a new concept in social psychology: the theory of cognitive dissonance (Festinger, Riecken and Schachter 1956). When two simultaneously held cognitions are inconsistent, this will produce a state of cognitive dissonance. Because the experience of dissonance is unpleasant, the person will strive to reduce it by changing their beliefs. Pratt (1964) considers utility functions, risk aversion and also risks considered as a proportion of total assets. Tversky and Kahneman...
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...Behavioural Finance Martin Sewell University of Cambridge February 2007 (revised April 2010) Abstract An introduction to behavioural finance, including a review of the major works and a summary of important heuristics. 1 Introduction 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. For more information on behavioural finance, see Sewell (2001). 2 History Back in 1896, Gustave le Bon wrote The Crowd: A Study of the Popular Mind, one of the greatest and most influential books of social psychology ever written (le Bon 1896). Selden (1912) wrote Psychology of the Stock Market. He based the book ‘upon the belief that the movements of prices on the exchanges are dependent to a very considerable degree on the mental attitude of the investing and trading public’. In 1956 the US psychologist Leon Festinger introduced a new concept in social psychology: the theory of cognitive dissonance (Festinger, Riecken and Schachter 1956). When two simultaneously held cognitions are inconsistent, this will produce a state of cognitive dissonance. Because the experience of dissonance is unpleasant, the person will strive to reduce it by changing their beliefs. Pratt (1964) considers utility functions, risk aversion and also risks considered as a proportion of total assets...
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...Technical analysis involves identifying crowd behavior in order to join the crowd and take advantage of its momentum and direction. This is called the bandwagon effect. Here’s how a bandwagon works: A fresh piece of news comes out, a majority of traders interpret it as favorable to a security, and buying overwhelms selling so that the price rises. You profit by going with the flow. Then when everyone is jumping off the bandwagon, you jump, too. As market participants get excited about a security, they become increasingly bullish and either buy for the first time or add to positions, a phase namedenamed accumulation. When traders become disillusioned about the prospect of their security price rising, they sell, in a phase named distribution. To buy 100 shares of a stock is to enter a position. To buy another 100 shares for a total of 200 is toadd to your position. If you have 500 shares and sell half, you would be reducing your position. To sell all the shares you own is to square your position. When you’re square (also called flat), you have no position in the security. All your money is in cash. You’re neutral. After traders have been accumulating the security on rising prices, eventually the price goes too far.Too far is a relative term and can be defined in any number of equally valid ways, but basically it means any price extreme that’s wildly abnormal, statistically speaking. When a price has reached or surpassed a normal limit, it’s at an extreme....
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...THE JOURNAL OF FINANCE • VOL. LVI, NO. 4 • AUGUST 2001 Investor Psychology and Asset Pricing DAVID HIRSHLEIFER* ABSTRACT The basic paradigm of asset pricing is in vibrant f lux. The purely rational approach is being subsumed by a broader approach based upon the psychology of investors. In this approach, security expected returns are determined by both risk and misvaluation. This survey sketches a framework for understanding decision biases, evaluates the a priori arguments and the capital market evidence bearing on the importance of investor psychology for security prices, and reviews recent models. The best plan is . . . to profit by the folly of others. — Pliny the Elder, from John Bartlett, comp. Familiar Quotations, 9th ed. 1901. IN THE MUDDLED DAYS BEFORE THE RISE of modern finance, some otherwisereputable economists, such as Adam Smith, Irving Fisher, John Maynard Keynes, and Harry Markowitz, thought that individual psychology affects prices.1 What if the creators of asset-pricing theory had followed this thread? Picture a school of sociologists at the University of Chicago proposing the Deficient Markets Hypothesis: that prices inaccurately ref lect all available information. A brilliant Stanford psychologist, call him Bill Blunte, invents the Deranged Anticipation and Perception Model ~or DAPM!, in which proxies for market misvaluation are used to predict security returns. Imagine the euphoria when researchers discovered that these mispricing proxies...
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...Simple Stimulus Learning Detra Mathias PSYCH/535 Dr. Ming Zheng February 11, 2013 Simple Stimulus Learning Learning involves obtaining new knowledge. Learning involves exposure to various stimuli within one’s environment. An organism’s behavior is the result of learning to respond to stimuli. Animals and humans acquire knowledge through simple stimulus learning. The purpose of this paper is to explain the concept of habituation, evaluate issues affecting perceptual learning, and examine outcomes of stimulus exposure. In addition, this paper will discuss the application of simple stimulus leaning to two real life situations. Concept of Habilitation Habituation is a decrease in response after constantly introducing an unconditioned stimulus within the environment. It involves the basic changes that occur in an organism as a result of learning. An organism will respond less to a stimulus; the more it is introduced to the organism’s environment, and the organism becomes more familiar with the stimulus (Sullivan, 2009). For example, an individual receives a new cell phone and the ring tone alert for notifications initially startles him or her. However, after becoming familiar with the sound, the individual pays less attention to the sound and his or her response diminishes. Habilitation demonstrates...
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...Research TOC BEHAVIORAL ECOLOGY, “SOCIOBIOLOGY,” AND HUMAN BEHAVIOR Bobbi S. Low W hen Juliet was twelve, her father, without consulting her, betrothed her to a man more than twice her age. She, being in love with Romeo, complained. Her father’s answer was (Act III, Scene V): An you will not wed, I’ll pardon you! Graze where you will, you shall not house with me; … An you be mine, I’ll give you to my friend; An you be not, hang, beg, starve, die in the streets, For, by my soul, I’ll ne’er acknowledge thee, Nor what is mine shall never do thee good. Today, in the United States, Juliet would probably sue her father for child abuse. And she would be likely to win. What is common, approved, and thought ethical varies widely across human cultures in time and space: whether one may marry more than one person at a time; who chooses marriage partners; whether abortion and infanticide are approved or forbidden; whether one may eat all meats, some meats, or none; what kinds of killings are forbidden or encouraged. How are we to make sense of all this variety? Human behavior has traditionally been the province of anthropology, sociology, and psychology. Within each of these fields there exist diverse approaches. Recently, behavioral ecology, an evolutionary approach to why we behave as we do, has joined other fields in trying to explain some of the diversity in human behavior. With its roots in Charles Darwin’s work 1 on natural selection, it examines how environmental conditions...
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...What is Foraging Behavior? According to our textbook, foraging behavior also known as feeding behavior involves locating and selecting food as well as gathering and capturing food. (1136). It also states that ecologist study the cost and benefits of searching for and selecting certain types of food as well as the mechanism used to locate prey. (1136). Foraging behaviors also have other characteristics such as optimal foraging and whether or not the species is considered a generalist or a specialist. Every animal uses its own attack strategy when it comes to foraging behavior and their prey have their own technique on how to Lessing there changes of being eaten. Our textbook defines optimal foraging as the most efficient way for an animal to obtain food. You would think that animals just eat whatever they see and what’s available but this hypothesis is absolutely wrong. According to Darrell Ray, an American Biology teacher human also go through a phase of optimal behavior. Darrell did an experiment with his general ecology class involving a plate of cookies and broccoli. In his experiment he polled how many students would choose a cookie over broccoli. At the end of his experiment he asked his students why did the majority pick cookies over broccoli. There response was because of the taste. Optimal foraging theory suggests a different answer, and it lies in the economic principle of profitability.” Fats and sugars do taste good, as the students noted, but...
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...Markets and Information Market Efficiency Overview So far we have considered a number of asset pricing models These have all required that price is a good reflection of value Is this likely to be the case? How? Why? Week 5 FINS5513 2 Today Trend and predictability Efficient market hypothesis Implications Supporting evidence Behavioural biases Barriers to the EMH Anomalies Can we build a fully efficient market? Week 5 FINS5513 3 Market Efficiency Efficiency in engineering: the best possible use of the inputs. An efficient market: investors make the best possible use of information. A useful initial perspective: As speculators we are trying to predict where a stock price will be in the future. Do we know anything today that will help us make this prediction? Week 5 FINS5513 4 Price of GE 104 102 100 98 96 94 92 90 88 0 Week 5 20 40 FINS5513 60 80 100 5 Are Prices Predictable? There are apparently short-run trends If we know we are at the start of a downward trend, sell short If we know we are at the start of an upward trend, buy How do you know when a trend is starting? ending? Can we devise rules (statistical or “technical”)? Week 5 FINS5513 6 Trend and Predictability The price path is simulated: Price(Today) = Price(Yesterday) + x, where x is a standard normal random variable This process...
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... animal behavior and recording single neuron activity. The key insight for economics is that the brain is composed of multiple systems which interact. Controlled systems (‘‘executive function’’) interrupt automatic ones. Brain evidence complicates standard assumptions about basic preference, to include homeostasis and other kinds of state-dependence, and shows emotional activation in ambiguous choice and strategic interaction. Keywords: Behavioral economics; neuroscience; neuroeconomics; brain imaging JEL classification: C91; D81 I. Introduction In a strict sense, all economic activity must involve the human brain. Yet, economics has achieved much success with a program that sidestepped the * We thank participants at the Russell Sage Foundation-sponsored conference on Neurobehavioral Economics (May 1997) at Carnegie-Mellon, the Princeton workshop on Neural Economics (December 2000) and the Arizona conference (March 2001). This research was supported by NSF grant SBR-9601236 and by the Center for Advanced Study in Behavioral Sciences, where the authors visited during 1997–1998. David Laibson’s presentation at the Princeton conference was particularly helpful, as were comments and suggestions from referees, John Dickhaut, Paul Zak, a paper by Jen Shang, and...
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