INTRODUCTION TO

BEHAVIORAL
FINANCE
D E NI A H . M A R A D D AG
IN ST R UCTOR
BEHAVIORAL FINANCE
• Behavioral finance is an area of study focused on how psychological
influences can affect market outcomes.
• Behavioral finance can be analyzed to understand different outcomes
across a variety of sectors and industries.
• One of the key aspects of behavioral finance studies is the influence
of psychological biases.
BEHAVIORAL FINANCE
• Daniel Kahnneman and Amos Tversky – considered as the Fathers of
Behavioral Finance

“ Behavioral Finance is a field of finance that proposes psychology-

based theories to explain stock market anomalies such as severe rises
or falls in stock price. Within behavioural finance, it is assumed the
information structure and the characteristics of market participants
systematically influence individual’s investment decisions as well as
market outcomes”
WHY IS IT
IMPORTANT?
B E H AV I O R A L F I N A N C E   S E E K S T O A C C O U N T F O R T H I S B E H AV I O U R , A N D C O V E R S
T H E R AT I O N A L I T Y O R O T H E R W I S E O F P E O P L E M A K I N G   F I N A N C I A L   I N V E S T M E N T
D E C I S I O N S . U N D E R S TA N D I N G   B E H AV I O U R A L F I N A N C E   H E L P S U S T O AV O I D
E M O T I O N - D R I V E N S P E C U L AT I O N L E A D I N G T O L O S S E S , A N D T H U S D E V I S E A N
A P P R O P R I AT E W E A LT H M A N A G E M E N T S T R AT E G Y.
ASSUMPTIONS OF BEHAVIOURAL
FINANCE
• LOSS AVERSION : The characteristics of seeking to limit the size of
the potential loss rather than seeking to minimise the variability of
the potential returns.
• BOUNDED RATIONALITY: The manner in which human being
behave, limits their rationality.
• DENIAL OF RISK: They may know statistical odds but refuse to
believe these odds.
NATURE OF BEHAVIORAL FINANCE
• Behavioral Finance is just not a part of finance. It is something which is
much broader and wider and includes the insights from behavioural
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.
• Behavioral Finance studies the psychology of financial decision-making.
• It makes the understanding of investment decision.
• It is the study of investor’s psychology.
• It is analytical in nature.
BRANCHES OF BEHAVIORAL FINANCE
• 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 economics 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.
SCOPE OF BEHAVIORAL FINANCE
• 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 huge 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.
OBJECTIVES OF BEHAVIORAL FINANCE
• To review the debatable issues in Standard Finance.
• To protect the interest of stakeholders in volatile investment scenario.
• To examine the relationship between theories of Standard Finance
and Behavioral Finance.
• To analyse the influence of biases on the investment process because
of different personalities in the financial markets.
• To examine the various social responsibilities of the subject.
• To discuss emerging issues in the financial world.
OBJECTIVES OF BEHAVIORAL FINANCE
• 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
behavioural aspects as well as aspects like age, gender, income,etc.,of
the investors.
APPLICATIONS OF BEHAVIORAL FINANCE
1. Investors
2. Corporations
3. Markets
4. Regulators
5. Educations
BEHAVIORAL BIASES
• Denial
• Information Processing Errors
• Emotions
• Loss Aversion
• Social Influence/Herd Mentality
• Framing
• Anchoring
Approaches to Decision-Making in
Behavioral Finance
• Reflexive
• Reflective
TRADITIONAL FINANCE and BEHAVIORAL
FINANCE
• Traditional Finance assumes that people process data appropriately
and correctly. In contrast, Behavioral Finance recognizes that people
employ imperfect rules of thumb to process data which induces
biases in their belief and predisposes them to commit erroes.
Behavioural Finance is integration of various
fields as explained in this figure:
SOCIOLOGY: is the systematic study of human
social behaviour and groups, and influence of social
relationship on attitude and behaviour.

BAHAVIORAL
FINANCE

FINANCE; is the discipline concerned

PSYCHOLOGY: is the scientific study of
with determining value and making
behaviour and mental processes, which is
decisions. The finance function
affected by human’s physical, mental, and
allocates capital, including the
external
acquisition and allocation.
CHARACTERISTICS OF BEHAVIOURAL
FINANCE
1. Heuristics
2. Framing
3. Emotions
4. Market Impact
KEY CONCEPTS IN BEHAVIORAL FINANCE
1. Mental Accounting
2. Herd Behavior
3. Emotional Gap
4. Anchoring
5. Confirmation and Hindsight Biases
6. Gambler’s Fallacy
7. Self attribution or Overconfidence
8. Overreaction and the availability Bias
9. Prospect Theory
Thank You for Listening!
MA’AM DENIA