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Indian Investors Dilemma A study of financial market paradigm conflict through behavioral finance approach. - Dr.Mahabaleswara hatta !

The decade (1998-2008) saw a great momentum in the investment scenario of Indian financial market. There was an un recedented s urt in the stock trading volume !oth in the regular stock e"changes and over the counter e"change of India. #eo le from various walks of life $through information technolog% advancement em owered themselves to !e well informed $ stormed in to the investment market. &hat was hither to the domain of u er middle and a!ove $!ecame a common la%ground for even the middle and lower middle grou s. The% 'um ed into the market with little savings that the% have$ in the ho e of making !ig !ucks without recogni(ing the underl%ing and hidden risk element in such investments. )verlooking the need to understand the fundamentals of the market themselves$ the% 'ust relied on others* o inions and suggestions. This led to a remarka!le shift from rationalit% to irrationalit% in the investment !ehavior. The current stud% em hasi(es the aradigm in the financial market scenario and investigates through !ehavioral finance a roach whether $ in the milieu$ the Indian investors are reall% tra ed and then $attem ts to throw some ti s to get out of the tra . Key words+ ,inancial -arket$ -ilieu$ Investment tra $ #aradigm$ .ationalit% $ Irrationalit% $ /ehavioral finance. #a er to !e #resented at )smania 0niversit% 1onference $ 2$3$4$ -arch 2010.


Title: Indian Investors Dilemma A study of financial market paradigm conflict through behavioral finance approach. - Dr.Mahabaleswara Bhatta HS Author : Dr.Mahabaleswara hatta.!." #lobal Institute of Management "ciences$ %&$'rd (ross$D )oad$Ideal !omes *ownship$ )a+ara+eswari ,agar $ engaluru -.&//01. 2mail :
Intro u!tion:- *here is a 5henomenal growth in the investment sector both in terms of volume and number of investors. *here is a spurt of various investment products with numerous options to lure the investors to invest. *he number of stock e6changes has increased to 77. 28uity shares as an investment option has come a long way from the mere higher dividend e6pectations to the greater capital appreciation. 5rice discovery through ook uilding process has given tremendous boost to the Initial public offers 9I5:; and further public offers 9<5:;. *he 8uadruple structure of the investment market -Investor$ Issuer$ intermediaries and )egulator$ has strengthened. *he pattern and dimension of investment has changed over time. *he investment "cenario of Indian <inancial market wears a new look$ with a overwhelming response not only from the Indian investors but also from foreign institutional investors. *he 8uality of ever changing regulations$ the payment guarantee by the depositories$ 5roductive involvement of the #overnment$ vibrant intermediaries and up to date and technologically advanced e6changes$ all have instilled a sense of confidence among the investors. *he powerful and cost effective communication net work has made the investors$ even from a small village to take part in the investment process. *his has broad based the investors and hence created a healthy environment for a stable investment market. Theoreti!al "ra#ewor$: *he 2fficient market hypothesis implies that the market establishes the right price for the e8uities. It assumes that investors are rational $orderly and tidy. ased on this assumption$ Investors make <undamental analysis and *echnical analysis before finally taking investment decision to buy or sell the securities. *hese statistical tools help to make logical conclusions. !owever$ behavioral paradigm argues that there is often a divergence between the fundamental value and market price. Markets are not orderly or simple. 5rices vary over a very wide range $dependent on bullish enthusiasm$ concentrated speculative interest and other influences. According to (.)angara+an$ former #overnor of ) I$ = "hare price in India tends to be considerably influenced by short term technical consideration and speculation. *he

fundamentals affect the share price after a considerable time lag. *his disparity of perception leads to volatility and over heating of the stock market>. ?here as Dr.Manmohan "ingh$ !onble 5rime Minister of India$ says$ ="tock markets behavior in India has often had no relation with the fundamental strength of the economy. It is often in response to the sentiments that are shared in the market>. Irwin <riend e6presses that =*here have been numerous occasions when bodies of investors have been emotionally affected by fads and fashions in ?all "treet> According to )obert "hiller$ the e6cess volatility in stock prices is not due to changing e6pectations about future dividends$ but due to the propensity of investors to trade on fads and fashions$ thus inducing speculative bubbles. *hus$ it is evident that market at times display high irrationality causing significant discrepancy between intrinsic values and market prices. *here are sufficient evidences to this type of unwieldy behavior of the market. In India$ the sense6 rose over 7/$/// points and fell back to below 1$/// points in a short span of about '-@ months in 7//1. Resear!h %uestions:- *he premise of this study has been structured around the following research 8uestions: A. !as the paradigm of investment base really brought in the re8uired stability of prices in investment marketB 7. ?hether the investors really base their decision on the assumption of efficient market hypothesis B '. ?hether the investors have got effective orientation about investment tradingB @. ?hether the behavioral finance tenets can throw light on rationality in the investment decision making processB State#ent o" the &roble#:- In the backdrop of the above research 8uestions the problem of the study in stated as below:,ot all investors in India are well educated about the investment intricacies. ,ot all investors are knowledgeable about the happenings in the investment scenario. *he up spring of various investment products C schemes have lured the investors to +ump in to trading. Investment has become a habit without the support of essential information and knowledge. In spite of the best scientific approaches$ the price movement has become a chimera. *he non-predictability of the price fluctuation and the desire to make huge bucks have paved the way for irrational +udgments. :ver the study period 9A001-7//1;$ the market has seen violent fluctuations. *he prices increased dramatically tempting the investors to buy the shares in the e6pectation of further hike. !owever$ they are now struck. Due to long recession$ shares bought at higher prices have remained stagnant at low price level for a lengthier time than e6pected. *hey are in a precarious position$ whether to stay put or come out of the situation. *his study Investigates from behavioral finance angle$ as to whether the investors were biased while taking decision and as a conse8uence are they trapped in the investment cobweb.

Metho olo'(:- "econdary data is collected in respect of the following :A. Data regarding the investment on e8uity shares over A/ year period A001-7//1. 7. Data regarding their price movements over the study period. '. *he intrinsic values of the designated shares and their (omparison with market values S!o&e o" the stu (: *he study period is A001-7//1. *he study pertains to A/ Indian (ompanies listed in ,ational "tock 26change9,"2;. Sa#&le:- A/ companies belonging to different sectors are selected on a selective random basis. Data relating to theseA/ companies are collected and analyDed. *he percentages are calculated in order to establish the relationship between the variables. Anal(sis:ased on the research design $ the data are presented in the form of tables and analyDed by calculating the percentages of increase or decrease. Table ) )esource mobiliDation from public e8uity shares Issues 7//&-/E ,umber 7//E-/1 ,umber

I5:s EE 1. Issues by listed @E '0 (os: a.5ublic issues 1 A7$0'/ E A$A0$A&/ b.)ight issues '0 'E$AA/ '7 '$7.$A1/ *otal A7@ '$'.$/1/ A7' 1$E/$70/ "ource:- "2 I <rom *able A$ it can be observed that $*he issue of I5:s has increased by )sA$@/$0A/ Mn i.e @0.@@F from 7$1.$/@/ Mn in 7//&-/Eto )s@$7.$0./Mn in7//E-/1.?here as the 5ublic issues from listed companies saw a significant rise of 177F from A7$0'/ Mn in /&-/E to A$A0$A&/ Mn in 7//E-/1. *he overall *otal resource mobiliDation from public issues increased by A.0.E'F to )s.1$E/$70/ Mn in /E./1 from )s.'$'.$/1/ Mn in 7//&/E. *he above figures show that there is enormous participation of the public in the e8uity investment market. Table * 5erformance of I5:s issued on ,"2 during /E-/1 "l.,o (omp ,ame "ector Issue price 5rice at the end 5rice appreciation of Mar 9depreciation; F A :rbit (orpn Gtd Infra AA/ .7E.A/ 'E0.A1

Amount )s. mn 7$1.$/@/ ./$/@/

Amount )s. Mn @$7.$0./ @$@@$'@/

7 ' @ . & E 1 0 A/

I()A Gtd Advanta India Gtd !ilton Metal <orging MI( 2lectronics Gtd (elestial Gabs Gtd 2veronn "ystem Gtd (entral ank of India 5uravankara 5ro+ects )eliance 5ower Gtd

<inance <M(# Mfg *elcom 5harma *elcom ank Infra Infra

''/ &@/ E/ A./ &/ A@/ A/7 @// E./

&&@./. A/&'.&. 7E.E/ EA..'/ 'E'/ .1@.'. 1&.0/ 7@A./. 'A1.//

A/A.7. &&.7/ 9&/.@.; 'E&.1E 9'E1'; 'AE.'0 9A@.1/; 9'0.E@; 970.'';

"ource:,"2 <rom *able 7 $ it can be observed that $there is a significant difference between the issue prices and the prices at the end of March 7//1 of the selected shares. ?hile ./F of the selected shares have shown the appreciation$ the remaining ./F have shown the decline. <inance$ <M(# and *elcom shares have shown a significant increase $where as Mfg$ 5harma$ ank and infra 9e6cept :rbit (orporation; have shown a significant decrease in the share prices. *his data indicates the volatility in the share prices in different sectors. Table + Resour!es raise b( ,or&orate Se!tor Hear 0E-01 01-00 00-// //-/A /A-/7 /7-/' /'-/@ /@-/. /.-/& /&-/E /E-/1 5ublic 28uity Issues Debt Issues 9)s Mn; AA$'7/ '$70$A7/ .$/@/ @$&A$../ 70$E./ .$0'$00/ 7@$E0/ .$&.$E7. A/$17/ .$A.$&A/ A/$'0/ .$'A$&&& A$E1$7A/ .$7E$.A0 7$A@$'7/ .$@7$E11 7$'&$E&/ 1$A1$@&& 7$@0$0'/ 0$7.$..7 .$77$A0/ AA$&7$&&A *otal '$@/$@./ @$&&$.1/ &$7'$E@/ .$0/$.7/ .$7&$@'/ .$@A$..& E$/.$E70 1$/E$A/1 A/$..$77& AA$E'.@17 A&$1@$1.A

"ource: 5rime data base During /E-/1$ total resource raised by corporate sector Increased by @'..'F to A&$1@$1.A Mn as compared to AA$E'$E17 Mn and in that e8uity route was '/.00F where as debt &0./F. *he significant factor is that the 28uity issue has increased from )sAA$7'/ Mn in A00E01 to )s .$77$A0/ Mn in 7//E-/1. *hat is a hopping increase by @../F.

"ince April 7//E "2 2 has made it mandatory for all I5:s to be graded by "2 I registered rating agencies. I5: rating in designed to provide Investors an independent$ reliable C consistent assessment of the fundamentals of new I5: offering. !owever$ rating agencies neither comment on the pricing nor do forensic audit. It is not more than what knowledgeable investor can himself gather from the offer document. *hus$ investor not so knowledgeable$ is sub+ect to bias while taking a decision on investment. Table ,a&ital #ar$et turn on sto!$ e/!han'e in In ia "tock e6changes ,"2 "2 :thers *otal 7//&-/E )s Mn A0$@.7$1&. 0$.&A$1./ A.1&7 70$/'/$.EE 7//E-/1 )s Mn '.$.A/$'1/ A.$E11$.E/ @1./ .A$'/'$E// F Increase 17...F &..A7F

"ource:-,"2 *able @ shows the capital market turn over in A0 stock e6changes in India over a period of 7 years from 7//&-/E to 7//E-/1. It can be observed that in ,"2 the increase is by 17...F and in "2 it is &..A7F. *he figures relating to other AE stock e6changes put together is insignificant. *he decline in other stock e6changes is due to technological advancement and hence the two ma+or stock e6changes are catering to the tune of over 00 F. *his significant increase in capital turn over indicates the increased participation of the investors over a year.

TABLE 0 Pri!e Mo.e#ents o" IP1s issue on 2SE "l.,o A (omp ,ame "ector 5rice on Mar ,ov A.$/0 F Increase 'A$/1 9or decrease; .7E.A/ 710./. 9@..A&;

:rbit (orpn Gtd Infra

7 ' @ . & E 1 0 A/

I()A Gtd <inance Advanta India <M(# !ilton Metal Mfg MI( electronic *elcom (elestial Gabs 5harma 2veron "ystem *elcom (entral ank of ank India 5uravankara Infra 5ro+ect )eliance Infra 5ower

&&@./. A/&'.&. 7E.E/ EA..'/ 'E.'/ .1@.'. 1&.0/ 7@A./. 'A1.//

EE/.0. &AE.// AE.0. @A.'/ 7..0/ @7&.7. A.7.'/ A/A... A@'.&.

A.A& 9@A.00; 9'..7/; 90@.7'; 9'/..&; 97E./&; AE..7. 9.E.1E; 9.@.1';

"ource:- ,"2$ "harekhan.(om$ 9A..AA./0; *able . shows the price change of I5:s issued in ,"2 from March 'A$7//1 to ,ovember A.$7//0. *he change $increase or decrease $ is e6pressed in percentages. It can be observed that e6cept I()A and (entral ank $ all the other companies have shown a significant decrease in the prices. *he prices are 8uoted very low in the stock e6changes. *his indicates that $ those investors who purchased the shares of these companies on March 'A$7//1 and wishing to sell the shares on ,ov A.$ 7//0 will be incurring huge losses. *hose who purchased the shares hoping an increase in shares based on the issue price of these shares are at positional loss. *hey are neither in a position to dispose nor in a position to retain. A situation of being trapped.

TABLE 3 ,o#&arison o" intrinsi! .alue an Mar$et .alue )eference )eturn I A/F 5A "l.,o A 7 (omp ,ame :rbit (orpn Gtd I()A Gtd 25" Intrinsic Jalue Market Jalue 1.@' 1@.'/ 710./. '&.// '&/.// EE/.0. F !ype '@7.11 7A@.A&

' @ . & E

Advanta India ../0 !ilton Metal 7.// MI( electronic .../ (elestial Gabs &..A 2veronn A1.71 "ystem 1 (entral ank of A@.A' India 0 5uravankara @.1A 5ro+ect A/ )eliance A./@ 5ower Intrinsic value I 25"K)eference )eturn 26: :rbit (orporation GtdL 1.@'K/.A I 1@.'/

./.0/ 7/.// ...// &..A/ A17.1/ A@A.'/ @1.A/ A/.@/

&AE AE.0. @A../ 7..0/ @7&.7. A.7.'/ A/A../ A@'.&.

A7A7.A1 91.0&; 9E..A; 9'.01; 7''.A1 A/E.E0 7AA.A7 A'1A.7.

*able & shows the comparison of Intrinsic value of the selected shares with that of their market values on a particular date. *he intrinsic value is calculated on the basis of a reference return of A/F 5er Hear. It can be observed from the table F !ype column that$ e6cept !ilton$ MI( and (elestial$ all other shares are sowing a significant difference between the intrinsic value and market value$ i.e intrinsic value being far less than the market value. *hese figures indicate that the reference shares are over valued to a great e6tent. It means that the investors are paying much more than its real worth. "uch a situation tends to create ubble in the market. A bubble is only an illusion$ not real and hence likely to be burst at any time.

Beha.ioral Finan!e A&&roa!h: )etail investors are an important segment in the

stock market and their prudent presence is very essential for a healthy growth of stock market . *he long belief of the 2fficient Market !ypothesis is gradually being eroded. 2mpirical studies have time and again proved that the irrational behaviors have caused stock market bubbles and crashes. *he knowledge so developed through the studies would provide a framework of behavioral principles within which the investors can critically inspect their investing decisions and if need be $take corrective actions to hopefully make their future financial decisions a bit more rational and a lot more lucrative as well. *heoretical and empirical evidence suggested that (apital Asset 5ricing Model $ 2fficient Market !ypothesis and other rational financial theories did a respectable +ob of predicting and e6plaining certain events 9)obert M."hiller $7//';. !owever$ the real world
is altogether different and in which$ market participants often behave very unpredictably. *he fact is$ investors fre8uently behave irrationally. *he Manuary 2ffect 9Michael and ?illiam$A0E&;$*he ?inners (urse 9)obert *haler$A011; and *he 28uity 5remium 5uDDle are the stock market anomalies that remained une6plained by the traditional theories. *hese anomalies prompted academics to look to cognitive psychology to account for the irrational and illogical behaviors9Albert 5hung$7//7;. Investors trade for both cognitive and emotional reasons. *hey trade because they think they have information when they have nothing but

noise$ and they trade because trading can bring the +oy of pride. *rading brings pride when decisions turn out well$ but it brings regret when decisions do not turn out well. ,ow$ let us look in to some of the most prominent behavioral biases that cause irrational decisions: Pros&e!t theor( e6plains the occurrence of the disposition effect$ which is the tendency for investors to hold on to losing stocks for too long and sell winning stocks too soon. *he most logical course of action would be to hold on to winning stocks in order to further gains and to sell losing stocks in order to prevent escalating losses. An!horin' Bias: Nahneman and *versky9A0E@; have provided an academic evidence of the presence of strong anchoring effect even in random cases. According to them$ investors have the tendency to attach or OanchorO their thoughts around a reference point despite the fact that it may not have any logical relevance to the decision at hand. Mental A!!ountin' :"ome Investors have the tendency of separating the found money

and the earned money from the standpoint of the purpose for which it is utiliDed. <ound money is recklessly spent where as e6tra caution is used to spend earned money $ though there is no logical reason to distinguish. ,on"ir#ation Bias :*he investors would be more likely to look for information that supports his or her original idea about an investment rather than seek out information that contradicts it.
As a result$ this bias can often result in faulty decision making. Hin si'ht Bias:*he belief that they can easily predict the future based on the past events may result in incorrect oversimplifications and disastrous investment decision. 4a#bler5s Falla!( ::ften$ Investors erroneously believe that the onset of a certain

random event is less likely to happen following an event or a series of events. Investors can easily fall prey to this gamblerPs fallacy.
Her beha.ior:Investors have the tendency to mimic the actions 9rational or irrational; of a larger group. )esearchers have theoriDed that investors follow the crowd and conventional wisdom to avoid the possibility of feeling regret in the event that their decisions prove to be incorrect. *he =(rowd effects> have resulted in nasty turbulences in the stock market9"howryC*abassum$7//E; ,on"i en!e :Investors are consistently overconfident in their ability to outperform the market$ however$ most fail to do so 9Mames Montier$7//&;. At the height of optimism $greed moves the stocks beyond their intrinsic value $creating an overpriced market. At other times $fear moves prices below intrinsic value$ creating an under valued market. In recent years it has been e6perienced that the market fre8uently mispriced the stocks. *his is most often caused by human emotions of fear and greed 9Meir "tatman$A011;. <ollowing are some of the tips to avoid being trapped by the investors biases: 9A;It is possible to minimiDe the disposition effect by using a concept called =!edonic <raming> to change investors mental approach. If investors try these methods of framing$ their thoughts should make their e6perience more positive.

97; Anchoring can be avoided by a rigorous critical thinking about the figures that are used for the evaluation of a stocks potential. 9'; Mental accounting bias can be avoided if the investors think that the money is fungible.
9@; A solution to overcoming confirmation bias would be finding someone to act as a Odissenting voice of reasonO. *hat way investors will be confronted with a contrary viewpoint to e6amine.

9.; Must because everyone is +umping on a certain investment ObandwagonO doesnPt necessarily mean the strategy is correct. *herefore$ it is necessary for an investor to always do proper homework before following any trend.
9&;Availability bias can be avoided if the investors retain a sense of perspective. ,on!lusion *here is a paradigm shift of attention from the 2fficient Market !ypothesis to ehavioral <inance. *hough there is no concrete solution to the unpredictable human behavior $ several studies by the behaviorists have time and again thrown light on the conse8uences of wrong +udgments. *hese studies have helped to provide a broader framework within which the investors can critically inspect their investing decisions. A set of behavioral principles would certainly guide the investors to be in the race continually and yet make reasonable gains in trading.

In India$ "ecurities 26change oard9"2 I; has realiDed the importance of the presence of individual investors for a healthy growth of stock market. *o this end $there is a need to educate and counsel the investors from time to time about the wisdom re8uired in the stock trading and also about the unethical and tactical practices of brokers $shady dealings of the companies and the insider trading. *he ,"2 conducts Awareness C 2ducation seminars on a regular basis across various centers. Informative brochures C booklets are distributed. @A. investor awareness programs were held during 7//1.It has also created Investor 5rotection funds.
!owever$ ehavioral finance offers no investment miracles$ but it can help investors train themselves how to be watchful of their out behavior and$ in turn$ avoid mistakes that will be disastrous.

Albert 5hung$ 7//7$ =*aking a chance on ehavioral <inance>$ Daniel Nahneman and Amos *versky$ A0E0$ =5rospect *heory:An analysis of decision making under risk>$2conometrica. Meir "tatman$ A011$ =Investor psychology and market inefficiencies> 28uity Markets and valuation methods$ *he institute of (hartered financial Analysts. 5rasanna (handra$ 7//1$>Investment Analysis and 5ortfolio Management>$'rd 2d$*ata Mc#raw!ill. )obert M."hiller $7//'$ =<rom efficient market theory to ehavioral <inance>$Hale Qniversity-(owles$Discussion 5aper A'1.. http:KKdigitalcommons.pace.eduKhonorscollege thesesK@@