BEHAVIORAL FINANCE

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BEHAVIORAL FINANCE
Presenting by: Anjan
kavya
Manoj
Murali
Santosh

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Aspects of Behavioral Finance
Definition
Structure
Traditional vs Behavioral finance
Theories of Behavioral Finance
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Introduction
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Introduction
1. Since 1950s, the field of finance has been dominated by
traditional finance model.
2. Key assumption- people are rational.
3. However, Behaviorists/Psychologists challenged this
assumption.
4. People often suffer from cognitive and emotion biases
and act in a seemingly irrational manner.
5. The finance field was reluctant to accept this view of
psychologist who proposed behavioral finance model.
6. As this evidence of the influence of psychology and
emotions on decisions became more convincing.
Behavioral finance has received greater acceptance.
2002 Nobel prize in Economics to Psychologists Daniel
Kahneman and experimental economists Vernon Smith
– vindication of Behavioral Finance

Definition
Behavioral finance is the study of the influence of psychology on
the behavior of investors or financial analysts. It also includes the
subsequent effects on the markets. It focuses on the fact that
investors are not always rational, have limits to their self-control,
and are influenced by their own biases.
Behavioral finance argues that emotions and sentiment play
a crucial role in determining the behaviour of investors in the
market place and very offen they act irrationally due to
influence of psychological factor
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Economy
Behavioral
Finance
Psychology
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Personal finance:
Asset pricing:
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Behavioral Finance
• Price Anomalies
• IPO underperformance
• Value Anomaly
• Sentiment
• Equity premium
• PEA drift
• Momentum
• Bubbles
• IPO timing
• Winner’s curse
• Cash-flow
sensitivity
• Overconfidence
• Superstar CEO’s
• Procrastination
• Emotional choice
• Loss aversion
• Narrow Framing
• Return chasing
• Passivity
• Financial illiteracy
• Home bias
• Overconfidence
• Wishful thinking
Use psychology and economics to understand finance:
Corporate finance:

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TRADITIONAL FINANCE BEHAVIORAL FINANCE
People process data appropriately and
correctly
People employ imperfect rules of
thumb(heuristics) to process data which
includes biases in their beliefs and
predisposes them to commit errors.
People view all decisions through the
transparent and objective lens of risk and
return( inconsequential frame definition)
Perception of risk and return are significantly
influenced by how decision problems are
framed
People are guided by reason and logic and
independent judgement
Emotions and herd instincts play important
role influencing decisions.
Market are efficient. Market price of each an
unbiased estimate of an intrinsic value.
Heuristic-driven biases and errors, frame
dependence, and effects of emotions and
social influence often lead to discrepancy
between market price and fundamental value.

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Anchoring
Prospect theory
Regret theory
Over and under reactions
Theories of
Behavioral finance
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 Tversky and Kanheman (1979) developed the theory showing how people manage risk.
 Explaining the apparent regularity in human behaviours when assessing risk under uncertainty.
 People respond differently to equivalent situations depending on whether it is presented in the
context of a loss or a gain.
 Investors are risk hesitant when chasing gains but become risk lovers when trying to avoid a loss
Prospect theory
Regret theory
 Emotional reaction to having made an error of judgement.
 Investors avoid selling stocks that have gone down in order to avoid the regret of having made a
bad investment and the embarrassment of reporting the loss.
 They find it easier to follow the crowd and buy a popular stock : if it subsequently goes down, it
can be rationalized as everyone else owned it.
 Investors defer selling stock that have gone down in value and accelerate the selling of stock that
have gone up.

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 Anchoring is a phenomenon in which in the absence of better information, investors assume
current prices are about right.
 Anchoring describes how individuals tend to focus on recent behavior and give less weight to
longer time trends.
 People tend to give too much weight to recent experience, extrapolating recent experience,
extrapolating recent trends that are often at odds with long run average and probabilities.
 In the absence of any better information, past prices are likely to be important determinants
of prices today. Therefore, the anchor is the most recently remembered price.
Anchoring theory
Over and Under reactions
 The most robust finding in the psychology of judgement needed to understand market anomalies
is overconfidence.
 People tend to exaggerate their talents and underestimate the likelihood of bad outcomes over
which they have no control.
 The greater confidence a person has in himself, the more risk there is of overconfidence.
 Manager overestimate the probability of success in particular when they think of themselves as
experts.
 People tend to become more optimistic when the market goes up and more pessimistic when
the market goes down.

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Aspects of Behavioral Finance
Behavior of the Investor
Behavior of the Market
• Behavioral finance is an important subfield of finance
which combines psychology and economics to explain
why and how investors act and to analyze how that
behavior affects the market.
• Indeed, It attempts to explain the decisions of
investors by viewing them as a rational actor looking
out of their self- interest, given the sometimes
inefficient nature of the market.
• Behavioral finance is an important subfield of finance
which combines psychology and economics to
explain why and how investors act and to analyze
how that behavior affects the market.
• Indeed, It attempts to explain the decisions of
investors by viewing them as a rational actor looking
out of their self- interest, given the sometimes
inefficient nature of the market.

THANKYOU

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Questions?