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Personality Traits and Risk Attitude

Systematic Approach of using Behavioural Factors in Corporate Decision-Making

An eight step process to make decision making better

• Identify the decision problem: Be careful in stating the problems and avoid
unwarranted assumptions and option-limiting prejudices.

• Specify your objectives: Determine what you want our to accomplish and which of
your interests, values ,concerns ,fears and aspiration are the most relevant.

• Create imaginative alternatives : your decision can be no better than your best
alternatives

• Understand the consequences: determine how well different alternatives satisfy all
of your objectives

• Grapple with your tradeoffs : Since objectives frequently conflict with each other, it
becomes necessary to choose among less-than –perfect possibilities

• Clarify your uncertainties: Confront un certainties by judging the likelihood of


different outcomes and assessing their possible impacts

• Think hard about your risk tolerance: In order to choose an alternative with an
acceptable level of risk ,Become conscious of how much risk you can tolerate

• Consider linked decisions : Many imemportant decisions are linked over ti

Systematic Approach of using Behavioural Factors in Corporate Decision-Making

Behavioural finance is based on psychology which suggests that human decision processes
are subject to several cognitive illusions. These illusions are divided into four categories:

Heuristic Approach: Heuristics theory finds an easy-going approach which helps in making
decisions easier especially in complex and uncertain environment. the three factors which
are related to heuristic theory as follows:

• Representativeness

• Availability bias

• Anchoring

Prospect Theory: Prospect theory is based on subjective decision-making which is


influenced by the value system of the investors.
Market Variables: Market factors also have a great impact on the decision-making of the
investors. The behaviour of the investor affects the financial market, which we can now
study through our approach of behavioural finance.

Herding Effect: Herding effect explains that the investors believe on collective information
as compared to private information which can result in the price deviation of the securities
from fundamental value that can impact the investment. Herding impacts on stock price
changes influence the attributes risk which untimely impact on the asset pricing theories

Personality Traits and Risk Attitude: Neurophysiology of Risk-taking

• Neurophysiology is the stream of physiology which deals with the study of functioning
of the nervous system. Neurophysiology seeks inputs from various other fields such
as neurobiology, psychology, cognitive science, biophysics, and mathematical biology.
Neurophysiology in investment environment can be well explained in form of
neuroeconomics.

Emotions

• Usually we find that positive emotional states such as excitement leads the investor
to take risks and to become overconfident in their ability to evaluate investment
options, while negative emotions such as anxiety have the opposite effect.

Beliefs

• Beliefs are mental state which force to maintain a positive emotional state by
ignoring information that contradicts the prior choices of individuals .

• Neuroeconomics

• Neuroeconomics is an emerging field which provide much explanation of the


investor’s behaviour by using the tool of neuroscience. Electrophysiology,
psychology, and psychophysiology have contributed to the field of neuroeconomics
giving better explanation to experimental economics.

Questions such as :

Does emotion play any role in decision-making?

What people think about an uncertain decision?

People ‘s feelings towards risk.


At the time of investment decision –making investors encounter emotion such as
anxiety, fear, happiness, feeling of satisfaction or dissatisfaction with the return
generated by their investment.

Now we will discuss the feelings with reference to neurophysiology and their implication
on investor behaviour .Neurophysiology deals with the structure and secretion of the
brain responsible for investor behaviour.

Brain Secretions Responsible for Investor Behaviour

• Role of Dopamine : Dopamine is a chemical secreted in the brain at the time of


feeling of pleasure and depression.

• Role of Serotonin : Serotonin is a transmitter available in the nervous system and


digestive tract. Serotonin is responsible for the feelings of anxiety and appetite

• Role of Amygdala : Almond –shaped body situated in the brain temporal medial
lobe is responsible for feeling of emotion such as fear,pleasure, developing phobia
stress.

• Role of Prefrontal Cortex : The prefrontal Cortex of brain is responsible of complex


cognitive decision making in social behaviour and expression of personality .The
Preforontal Cortex is responsible for memorizing ,analyzing and drawing
conclusion from different situation.

• Role of Nucleus Accumbens and Anterior Cingulate : nucleus accumbens is a


group of neurons located behind the ears of human beings. It helps people to
identify patterns and evaluate alternatives.

• Personality Traits and Risk Attitudes in Different Domains

• Passive Managers : They believe that markets are efficient and they cannot beat the
market.

• Active Managers: who believe that the right market strategies can lead to
outperformance of portfolio.

Barnewall’s Two-Way Model: This model is coined by Marilyn MacGruder Barnewall in


1987, who noted that there can be two categories of investors.

• Active Investors : are those who have earned money in their lifetimes and then
taken risks on the capital for wealth creation.

• Passive Investors : who earned money by taking lesser risk or take risk on someone
else’s money
Abelard, Biehl, and Kaiser’s Five-Way Model: In their research works, Bailard, Biehl, and
Kaiser in 1986 coined a model on investor’s personality. And in this model the behaviour of
investor is judged on the basis of two parameters, which are as follows:

• Level of confidence

• Method of action

BB&K model classify the personality of investors into five categories

• The Adventurer: Confident about their skills and believe that they don’t require
any advise.

• The Celebrity: Don’t have ideas of their own. Follow herd bias

• The Individualist: Make good money because of their strategies and analytical skills

• The Guardian: Investors usually belong to retired or pension drawing senor citizen
.They are risk-averse.

• The Straight Arrow : This category belongs to most balanced class of investors who
are confident of their strategies and take balanced risk for their portfolio.

Topography by Jonathan Myers

• Jonathan Myers classified the investors as follows:

• Cautious

• Emotional

• Technical

• Busy

• Casual

• Informed

Big Five Model

• Neurotic Personality: Such investors are emotionally unstable characterized by


anxiety,anger,depression and have intense reactions. Such type of investors get
stressed easily ,hence they are unlikely to trade excessively

• Extrovert Personality: The investors are confident, assertive and action


oriented.They are also prone to the heuristic bias .
• Agreeable Personality: They are friendly and considerate and get along with people
very well. Such type of investors show low degree of association with behavioural
finance concept they still prefer to follow the concepts and explanations given by
standard finance.

• Conscientious Personality : They have a strong need for achievement and are
generally impulsive and perfectionist by nature.

• Open To Experience Personality : Such people are creative and imaginative

Tailor-Made Investor Personalities

• Follower is a type of investors who are affected by herd behaviour and self-
attribution bias, causing them to follow investment decisions of their friends,
colleagues, relatives etc. This behaviour places on High risk but low returns

• Guardian : who is under the influence of ambiguity aversion and mental accounting

• Situations : who is under the influence of status quo and endowment bias. Because
of these biases investor access different investment options differently at different
times.

• Balancer : which is affected by regret- aversion bias

• Aversors : Investment style conservative and framed in certain options only

• Adventurer

• Optimists

• Individualist

• Orthodox