Behavioral Finance
Behavioral finance is a field that combines psychology and finance to understand how individuals make financial decisions. It recognizes that people's behavior and emotions can influence their financial choices, often deviating from traditional economic theories that assume rational decision-making. Behavioral finance seeks to explain and predict these deviations, shedding light on the impact of cognitive biases and emotions on financial markets.
8 Key excerpts on "Behavioral Finance"
eBook - ePub- John R. Nofsinger, Corey A. Shank(Authors)
- 2020(Publication Date)
- Routledge(Publisher)
...Behavioral Finance tries to explain actual behavior through psychological, cognitive, and emotional factors that often lead a person to biased, non-rational, financial decisions. As such, Behavioral Finance and behavioral economics have become mainstream financial paradigms. Some of the early pioneers in Behavioral Finance have received the Nobel Memorial Prize in Economic Sciences. They include Daniel Kahneman and Vernon L. Smith in 2002, Robert J. Shiller in 2013, and Richard Thaler in 2017. When people make consistent errors, psychologists call them cognitive biases. One common cognitive bias is the bandwagon effect (also known as groupthink or herd behavior), whereby people tend to believe in things or ideas simply because the vast majority of others do. Similarly, consider the endowment effect, which is the tendency for people to put a higher value on objects that they own compared to a similar object that someone else owns. One aspect of the endowment effect is the IKEA effect, whereby people place a higher value on items, such as furniture, that they assembled themselves. Behavioral Finance calls these cognitive biases investment biases when describing investors’ decisions about their investments. For example, the literature consistently shows that investors who commit these investment biases earn lower returns compared to those who do not. However, if investors were rational, they would not make these financial decisions. As such, Behavioral Finance describes investors’ decision making much better than the standard finance ideal over recent decades. Furthermore, there is a good deal of variation in the decisions which people make that has not been explained...
eBook - ePubFinancial Intelligence in Human Resources Management
New Directions and Applications for Industry 4.0
- Gurinder Singh, Hardeep Singh Dhanny, Vikas Garg, Silky Sharma, Gurinder Singh, Hardeep Singh Dhanny, Vikas Garg, Silky Sharma(Authors)
- 2021(Publication Date)
- Apple Academic Press(Publisher)
...Behavioral economics is essentially experimental and uses research methods rarely used in traditional financial literature. Tversky and Kalineman (1973) argue that Behavioral Finance is a behavioral economy, Behavioral economics is a combination of two disciplines, namely psychology and economics. This combination should explain why and how people make irrational or illogical financial decisions when they save, invest, spend and borrow money. Fama (1998) "Behavioral Finance is a study of the influence of psychology on the behavior of a finance specialist and its subsequent impact on the market." He studied the theory of Behavioral Finance and the market's efficiency with a different view. He focused on how and why the market can be ineffective due to irrational behavior of people. Thaler (1999) stated that Behavioral Finance is no longer as controversial as it was before. While financial economists are used to thinking about the role of human behavior in raising stock prices, readers will look at articles published in the past 15 years and wonder why such a fuss. He predicts that in the near future, the term "Behavioral Finance" will be correctly perceived as a useless sentence. What other type of financing is there? In their enlightenment, economists generally include in their models as much "behavior" as they observe in the real world. In the end, doing die opposite would not be wise. These definitions provide clear information about Behavioral Finance and its importance for financial decision-making. The Nobel Prize in Economics was awarded to Kahneman (2003), himself a professor of psychology, which shows that the contribution of Behavioral Finance to the financial economy is accepted worldwide. Professor Daniel Kahneman has studied and simplified the heuristics and prejudices resulting from financial decisions in the face of uncertainty...
eBook - ePubBehavioral Finance and Wealth Management
How to Build Investment Strategies That Account for Investor Biases
- Michael M. Pompian(Author)
- 2011(Publication Date)
- Wiley(Publisher)
...We will delve into the topic of the irrational behaviors of markets at times; however, the focus of the book is on individual investor behavior. Fundamentally, Behavioral Finance is about understanding how people make financial decisions, both individually and collectively. By understanding how investors and markets behave, it may be possible to modify or adapt to these behaviors in order to improve financial outcomes. In many instances, knowledge of and integration of Behavioral Finance may lead to better than expected results for both advisors and their clients. But advisors cannot view Behavioral Finance as a panacea or “the answer” to problems with clients. Working with clients is as much an art as it is a science. Behavioral Finance can add many arrows to the art quiver. We will begin this chapter with a review of the prominent researchers in the field of Behavioral Finance, all of whom promote a deeper understanding of the benefits of the Behavioral Finance discipline. We will then review the key differences debate between standard finance and Behavioral Finance. By doing so, we can establish a common understanding of what we mean when we say Behavioral Finance, which will in turn permit us to understand the use of this term as it applies directly to the practice of wealth management. This chapter will finish with a summary of the role of Behavioral Finance in dealing with private clients and how the practical application of Behavioral Finance can enhance an advisory relationship. Behavioral Finance: THE BIG PICTURE Behavioral Finance, commonly defined as the application of psychology to finance, has become a very hot topic, generating credence with the rupture of the tech-stock bubble in March of 2000, and has been pushed to the forefront of both investors’ and advisors’ minds with the financial market meltdown of 2008–2009...
eBook - ePubBehavioral Finance and Wealth Management
How to Build Optimal Portfolios That Account for Investor Biases
- Michael M. Pompian(Author)
- 2011(Publication Date)
- Wiley(Publisher)
...PART One Introduction to the Practical Application of Behavioral Finance CHAPTER 1 What Is Behavioral Finance? People in standard finance are rational. People in Behavioral Finance are normal. —Meir Statman, Ph.D., Santa Clara University T o those for whom the role of psychology in finance is self-evident, both as an influence on securities markets fluctuations and as a force guiding individual investors, it is hard to believe that there is actually a debate about the relevance of Behavioral Finance. Yet many academics and practitioners, residing in the “standard finance” camp, are not convinced that the effects of human emotions and cognitive errors on financial decisions merit a unique category of study. Behavioral Finance adherents, however, are 100 percent convinced that an awareness of pertinent psychological biases is crucial to finding success in the investment arena and that such biases warrant rigorous study. This chapter begins with a review of the prominent researchers in the field of Behavioral Finance, all of whom support the notion of a distinct Behavioral Finance discipline, and then reviews the key drivers of the debate between standard finance and Behavioral Finance. By doing so, a common understanding can be established regarding what is meant by Behavioral Finance, which leads to an understanding of the use of this term as it applies directly to the practice of wealth management. This chapter finishes with a summary of the role of Behavioral Finance in dealing with private clients and how the practical application of Behavioral Finance can enhance an advisory relationship. Behavioral Finance: THE BIG PICTURE Behavioral Finance, commonly defined as the application of psychology to finance, has become a very hot topic, generating new credence with the rupture of the tech-stock bubble in March of 2000...
eBook - ePubValuations of Early-Stage Companies and Disruptive Technologies
How to Value Life Science, Cybersecurity and ICT Start-ups, and their Technologies
- Tiran Rothman(Author)
- 2020(Publication Date)
- Palgrave Macmillan(Publisher)
...A non-professional investor may see an opportunity where a sophisticated one may see a no-go investment. Also, there might be some diversity within the new investors’ group regarding an investment. The primary ground for all human beings is excessive optimism, high expectations, and limited attention to the many decisions we make during our everyday lives. In this part, we will focus on the question of how psychological elements affect bias in valuations. And more specifically, we will examine how Behavioral Finance aspects can affect venture capital investment drivers and uncertainties. Traditional finance theory relies on the utility theory, which projects the combination of commodities that a person or a society would receive to maintain a given level of satisfaction (Von Neumann and Morgenstern 1944). In investing, utility expects investors to be rational in their decision making. Contrary to this view, Behavioral Finance criticizes the logical viewpoint, arguing that whenever investors make investment decisions, they tend to deviate from rationality. Over the years, several behavioral biases that may occur in investment decision making have been studied and tested empirically. Behavioral Finance became a new concept in the 1990s, integrating psychological and behavioral aspects in financial and economic decision making. The efficient market perspective is challenged by Behavioral Finance. In addition, Behavioral Finance helps to explain why investors behave in a particular way when they invest in financial assets. Many studies have been conducted on such behavioral biases, attributing them to investors’ optimism and overconfidence, disposition effect, herd behavior, and home bias (Kumar and Goyal 2015). When investing at an early stage, usually done by venture capital (or VC) investors, the “fear of missing out” and information overload escalate the burden on VC investors...
eBook - ePubBehavioral Finance and Your Portfolio
A Navigation Guide for Building Wealth
- Michael M. Pompian(Author)
- 2021(Publication Date)
- Wiley(Publisher)
...With regard to BFMA, the debate asks: Are markets “efficient,” or are they subject to behavioral effects? With regard to BFMI, the debate asks: Are individual investors perfectly rational, or can cognitive and emotional errors impact their financial decisions? These questions are examined in the next section of this chapter; but to set the stage for the discussion, it is critical to understand that much of economic and financial theory is based on the notion that individuals act rationally and consider all available information in the decision-making process. In academic studies, researchers have documented abundant evidence of irrational behavior and repeated errors in judgment by adult human subjects. Finally, one last thought before moving on. It should be noted that there is an entire body of information available on what the popular press has termed the psychology of money. This subject involves individuals' relationship with money—how they spend it, how they feel about it, and how they use it. There are many useful books in this area; however, this book will not focus on these topics, it will focus on building better portfolios. Standard Finance versus Behavioral Finance This section reviews two basic concepts in standard finance that Behavioral Finance disputes: rational markets and the rational economic man. It also covers the basis on which Behavioral Finance proponents challenge each tenet and discusses some evidence that has emerged in favor of the behavioral approach. Overview On Monday, October 18, 2004, a significant but mostly unnoticed article appeared in the Wall Street Journal...
eBook - ePub- Ensar Yılmaz(Author)
- 2020(Publication Date)
- Routledge(Publisher)
...However, it is widely recognized that these are not realistic. Behavioral economics constrains this unboundedness and ties it to reasonable boundaries of realism. This makes the behavioral perspective crucial to understanding the mechanisms behind financial crises, in addition to the functioning of economies in normal times. In this sense, a psychological perspective can be used to complement the perspectives provided by economics. For this, three subjects may be listed. First, cognitive biases are pervasive and important in human behavior in a general sense, and in economics in particular. Second, cognitive biases can be mitigated by various cognitive or structural tools. Third, economic behavior is not only concerned with individual behavior but it occurs in a collective environment, such as herd behavior. Policy implications of behavioral economies are valuable, especially in order to guide decentralized interactions among actors in any economy, which has the potential to lead to financial disruptions. Hence we have to mention that there should be an external constraint that will limit markets whose main concern is not to optimize social welfare. Markets can contain imperfections, inefficiencies, and psychological biases of their agents, such as greed, herd behavior, fear, ignorance, competition among people (jealousy), and many other biases mentioned above. Understanding them can help us to construct more resilient economic structures. However, if we reduce the reasons for crises to just behavioral biases, we cannot understand the other structural mechanisms playing critical roles in the development of crises that are discussed in the different chapters of this book...
eBook - ePubA simple approach to behavioural finance
The introductory guide to the theoretical and operational principles of behavioural finance to improve investment results
- Stefano Calicchio(Author)
- 2022(Publication Date)
- Stefano Calicchio(Publisher)
...Why it is important to know about behavioural finance "If I had only one hour to solve a problem and my life depended on it, I would use the first 55 minutes to formulate the right question because once I found it, I could solve the problem in less than 5 minutes." Albert Einstein We have analysed what behavioural finance is. The next step is to understand why it is so important in order to achieve positive results in the financial markets. The behaviour and results that every human produces are strongly influenced by psychology. Behavioural finance combines psychology, finance and social sciences to address the shortcomings of an approach based solely on economics. It is about understanding why people make certain financial choices and not others. Emotional and psychological factors have a tendency to distort investment decisions. Knowing how to recognise and distinguish these elements is therefore essential to avoid the negative impact of the behavioural bìas to which people are normally subjected. Ultimately, this is important knowledge to understand the mistakes made and avoid repeating them. Bringing the principles of behavioural finance into one's knowledge base allows one to be more aware of one's own biases and to recognise them in time so that they do not produce negative results. Thousands of academic studies have now shown that people are not always able to produce rational decisions. In addition to this, knowing behavioural finance also allows us to understand and explain abnormal events that occur in the markets. And it allows a deeper understanding of the dynamics linked to price volatility, because the market is nothing more than the sum total of human behaviour. Obviously, the impact of a single person is negligible. But the individual actions of each person have collective consequences that can produce speculative bubbles and financial collapses...
