behavioral finance intro

Introduction to behavioral finance

1. Nature , Scope, Objectives and Significance of Behavioural Finance

2. Behavioral Finance: Introduction Behavioral Finance: It is a concept developed with the inputs taken from the field of psychology and finance. It tries to understand various puzzling observations in stock markets with better explanations. The behaviour of individuals, practitioners, markets and managers is sometimes characterized as irrational.

3. Behavioural Finance: Introduction Behavioural Finance: Behavioural Finance denotes the study of finance based on credible assumptions about how people behave, often confirmed by psychological experiments. Shefrin (2005) in his book on behavioural asset pricing states ‘Behavioural finance is the study of how psychology phenomena impact financial behaviour’.

4. Behavioral Finance People in standard finance are rational. People in behavioral finance are normal . Meir Statman

5. Behavioral Finance: Introduction Behavioral Finance: Some decisions are simple choices like, which brand of toothpaste we will use, how hard we will study in behavioural finance. Other decisions such as whether we should buy a particular stock, how should we invest in tax saving instruments, etc impact our financial well being.

6. Why Behavioral Finance?????? Conventional" or "modern" finance is based on rational and logical theories, such as the capital asset pricing model (CAPM) and the efficient market hypothesis (EMH). These theories assume that people, for the most part, behave rationally and predictably. One of the most rudimentary assumptions that conventional economics and finance makes is that people are rational "wealth maximizers" who seek to increase their own well-being. Behavioral finance seeks to explain our actions, whereas modern finance seeks to explain the actions of the "economic man"

7. Behavioural Finance: Introduction Nature Behavioral Finance is just not a part of finance. It is something which is much broader and wider and includes the insights from behavioral economics, psychology and microeconomic theory. The main theme of the traditional finance is to avoid all the possible effects of individual’s personality and mindset

8. Behavioural Finance: Introduction Behavioural finance is divide it into two branches . Micro Behavioral Finance: This deals with the behaviour of individual investors. In this the irrational investors are compared to rational investors (also known as homo economicus or rational economic man) Macro Behavioral Finance: This deals with the drawbacks of efficient market hypothesis. EMH is one of the models in conventional finance that helps us understand the trend of financial markets.

9. Behavioral Finance: Introduction Behavioral Finance as a Science : Science is a systematic and scientific way of observing, recording, analyzing and interpreting any event. Behavioural Finance has got its inputs from traditional finance which is a systematic and well designed subject based on various theories. On this basis behavioural finance can be said to be a science .

10. Behavioral Finance: Introduction Behavioral Finance as an Art In art we create our own rules and not work on rules of thumb as in science. Art helps us to use theoretical concepts in the practical world. Behavioural finance focuses on the reasons that limit the theories of standard finance and also the reasons for market anomalies created. It provides various tailor made solutions to the investors to be applied in their financial planning. Based on above behavioural finance can be said to be an art of finance in a more practical manner.

11. Behavior Trend is holding – Lets Buy Good thing I didn’t wait I will use this correction to increase my position Greed Don’t want to sell at a loss, lets wait for it to recover Enough, I am selling it Good thing I sold everything I should not have sold Fe a r

12. Behavioral Finance: Objectives Correct Decision making Provide knowledge to unaware investor Examining the investors behaviour Identifies Emotions and Mental Errors Maintaining consistent approach Delivering what the Client Expects. Ensuring Mutual Benefits.

13. Behavioral Finance: Introduction Objectives To discuss the development of new financial instruments to hedge the conventional instruments against various market anomalies To get the feel of trend of changed events over years, across various economies. To examine the contagion effect of various events. An effort towards more elaborated identification of investor’s personalities. More elaborated discussion on optimum Asset Allocation according to behavioral aspects as well as aspects like age, gender, income etc of the investor.

14. Comparison Behavioural Finance Recognises how investors make decision. Based on Micro & Macro behavioural Finance It recognise that People employ imperfect rules of thumb Assumes that perception of risk and return are significantly influenced by how decision problem framed. Traditional Finance How investors should behave Based on neoclassical Economics Assumes that people process data appropriately and correctly It presupposes that people view all decision through the transparent and objective lens of risk and return

15. Comparison Behavioural Finance Prices are pushes by investor to unsustainable levels in both directions Observes that individual sometimes can have both risk averse and risk seeking behaviour. Traditional Finance EMH views that price follow random walk. Utility theory of diminishing marginal returns

16. Behavioral Finance: Scope To understand the Reasons of Market Anomalies: (Like creation of bubbles, the effect of any event, calendar effect etc) To Identify Investor’s Personalities: Various new financial instruments can be developed to hedge unwanted biases created in financial markets. Helps to identify the risks and their hedging strategies Provides an explanation to various corporate activities: Effect of good or bad news, stock split, dividend decision etc. To enhance the skill set of investment advisors: Done by better understanding of investor’s goal, maintaining a systematic approach to advise.

17. Inflation and Stock Market Understanding of Initial Public Offerings (IPO) Investors Corporations Markets Regulations Education Behavioral Finance: Scope

18. Features of Behavioral Finance Heuristic Framing Emotions Market Impact

19. Significance of Behavioral Finance Determining Goals of Investor Signifies that Investor are Emotional Defines Investor’s Biases Helpful for Financial Advisor and Fund Manager Helps in Investment Decision.

20. Limitations of Behavioral Finance Lacking in discipline Analogy Beyond the narrow micro level study Not pervasive in nature