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Black Book (Draft) Sahil
Black Book (Draft) Sahil
Introduction
Psychologists and sociologists have pushed back traditional finance and economics ideas for decades,
claiming that humans are not rational utility-maximizing actors and that markets are inefficient in the
actual world. The subject of behavioural economics evolved in the late 1970s to address these challenges,
amassing a large body of evidence of people acting "irrationally" on a regular basis. Behavioural Finance
is the application of behavioural economics to the field of finance.
Behavioural finance can be simply classified as the influence of psychology on the behaviour of investors
or financial analysts. It also considers the market's reaction. It emphasises how investors are not always
rational, have self-control limitations, and are impacted by their own biases. Behavioural Finance has
come into existence because of the regular Stock Market complexities and Market anomalies. Financial
market inconsistencies are cross-sectional and time-series patterns in securities returns that can't be
predicted by a single paradigm or theory. Fear, hope, optimism, and pessimism are some of the
psychological factors that have given rise to this new mode of Finance. The importance of these aspects
in investment and trading has shifted the focus of behavioural finance. Researchers’ such as Buchan,
(2001) stated that "Money is desire embodied", Kahneman and Tversky, (1979) and Statman, (1999)
stated that people feelings of pain when they find out that the other choice have good results. As a result,
behavioural finance is a field of research that explains how individual emotions and behaviour affect
stock values.
The aspect of behavioural finance was borrowed from the study of advanced psychology in order to learn
more about how people behave when it comes to investing and how it affects the economy. The concept
is to comprehend the rationality of a market investor, or people making financial judgments, in order to
avoid emotion-driven speculating losses, which benefits many people involved in the country's financial
system. This method was created to better understand an investor's behaviour in the stock market by
examining how they sell and acquire stocks in response to market fluctuations. The goal of behavioural
finance is to figure out why financial markets react inefficiently to public data. One branch of behavioural
finance research looks at how psychological factors lead traders and managers to make poor decisions,
and how those mistakes affect market behaviour. Another stream looks at how economic constraints may
prevent sensible traders from profiting from apparent opportunities. Behavioral finance is still divisive,
but if it can forecast departures from traditional financial models without relying on too many "ad hoc"
assumptions, it will gain traction. Behavioral finance has gained importance over the last two decades as
new area of Research due to the thought that investors rarely behave as per the assumptions made in
traditional theory of finance. Behavioral researchers have taken the view that finance theory should take
consideration the observation of human behaviour. They use research from psychological point of view
to develop an understanding of investment decision making and create the discipline of behavioral
finance. This research paper focuses mainly on understanding the importance of behvaioural finance on
the day to day financial and investment decisions and to analyse various behavioural finance theories
objectively and to define property issues for behavioural analysis.
Heuristics:
Heuristics are mental shortcuts that can help you solve problems and make better decisions. These
generalisations, or rules-of-thumb, lessen cognitive load and can be useful for making quick decisions,
but they frequently lead to unreasonable or erroneous conclusions. Heuristics are used in a variety of
contexts. When attempting to make judgements regarding the frequency with which a specific occurrence
occurs, one form of heuristic, the availability heuristic, frequently occurs. Let's say someone asked you if
Kansas or Nebraska has more tornadoes. The tornado that took Dorothy Gale away to Oz in Frank L.
Baum's The Wizard of Oz comes to mind for most of us as an example of a tornado in Kansas. Despite
the fact that it is fictitious, we can easily relate to this case. On the other hand, most individuals have a
hard time recalling a tornado in Nebraska as an example. As a result, we believe tornadoes are more
common in Kansas than they are in Nebraska. The states, on the other hand, report similar numbers of
tornadoes.
Heuristics, on the other hand, aren't necessarily incorrect. As generalisations, they can be useful in a
variety of contexts, resulting in accurate predictions or sound decision-making. Even though the result is
positive, it was not obtained using rational procedures. We risk neglecting vital information and
overvaluing less relevant information when we apply heuristics. There's no assurance that utilising a
heuristic will work out, and even if it does, we'll be making the wrong option; rather than being based on
logic, our actions are the consequence of a mental shortcut with no true justification.
Heuristics become even more concerning when applied to politics, academia, and economics. We may all
resort to heuristics from time to time, something that is true even of members of these institutions who are
tasked with making important, influential decisions. It is necessary for these figures to have a
comprehensive understanding of the biases and heuristics that can affect our behavior, so as to promote
accuracy on their part.
Why does it happen ?
Daniel Kahneman and Amos Tversky established three types of heuristics in their study "Judgment Under
Uncertainty: Heuristics and Biases" (1974)2: availability, representativeness, and anchoring and
adjustment. Each heuristic is used to reduce the mental effort required to make a decision, although they
are employed in various situations.
Types of Heuristics:
Availability Heuristic: The availability heuristic, which was discussed in the context of
estimating the frequency with which tornadoes occur in Kansas versus Nebraska, is the first form
of heuristic. This heuristic is defined by Kahneman and Tversky as a mental shortcut for
generating frequency or probability assessments based on "how easily instances or occurrences
may be recalled to mind."
Because we can recall certain memories to mind more easily than others, we apply the availability
heuristic. When Kahneman and Tversky asked participants if there are more terms in the English
language that start with the letter K or have the third letter K, the majority of them said the former.
In reality, the latter is correct, however coming up with terms with K as the third letter is far more
difficult than coming up with words that begin with K. In this scenario, recollections of words
beginning with K are more readily recalled than memories of terms beginning with the third letter
K.
Representatives Heuristic: The representativeness heuristic is a second form of heuristic. When
making probability judgements, we frequently use this heuristic. We have a tendency to categorise
occurrences, which, as Kahneman and Tversky show, might lead to our employing this heuristic.
We form probability judgements about the likelihood that an object or event derives from a
category when we utilise the representativeness heuristic, depending on how similar the object or
event in issue is to the archetypal example of that category. For example, if someone we encounter
in one of our university courses appears and acts like a stereotypical medical student, we may
conclude that they are studying medicine despite the lack of hard data to support that assumption.
The prototype hypothesis is linked to the representativeness heuristic. This well-known hypothesis
in cognitive science explains how we recognise objects and people. It implies that in our
memories, we categorise various objects and identities. For example, we may have a chair
category, a fish category, a book category, and so on. According to prototypical theory, we
generate prototypical instances for these categories by averaging all of the examples of a certain
category we come across. As a result, depending on our familiarity with the object, our chair
prototype should be the most typical example of a chair feasible. This helps with object
recognition because we compare every thing we see to the prototypes we have stored in our
memory. We are more convinced that the object fits in that category if it resembles the prototype.
The representativeness heuristic may be a result of prototype theory, since it happens when a
given thing or event is seen to be similar to a prototype stored in our memory, prompting us to
categorise the object or event into the category represented by that prototype. To return to the
previous example, based on the prototype theory of object and identity recognition, if your peer
strongly fits your archetypal example of a med student, you may assign them to that group.
However, you will fall victim to the representativeness heuristic as a result of this.
Anchoring and adjustment heuristic: The anchoring and adjustment heuristic is the third type of
heuristic proposed by Kahneman and Tversky in their first publication on the subject. When
estimating a value, we often offer an initial number and then alter it by raising or reducing our
guess. However, we frequently become fixated on that initial value - a phenomenon known as
anchoring – resulting in inadequate modifications. As a result, our adjusted value is skewed
toward the initial value, which we've chosen to anchor on.
Participants were given a question, such as "guess the number of African nations in the United
Nations (UN)," in the example given by Kahneman and Tversky. Participants were asked to say
whether the number the wheel landed on was higher or lower than their answer to the question. A
wheel labelled with numbers from 0-100 was spun, and participants were asked to say whether the
number the wheel landed on was higher or lower than their answer to the question. The
participants were then asked to estimate the number of African countries in the United Nations.
Participants tended to anchor on the random number produced by spinning the wheel, according to
Kahneman and Tversky. When the number gained by spinning the wheel was 10, the median
estimate given by participants was 25, whereas when the number obtained by spinning the wheel
was 65, the median estimate supplied by participants was 65 median estimate was 45.
Quick and Easy: All of these heuristics have one thing in common: they allow us to respond
instinctively and without much effort. They give a quick reaction and do not consume a lot of our
mental energy, allowing us to devote our mental energies to more essential problems. Heuristics
are efficient in this sense, which is one of the reasons we continue to employ them. However, we
should be cautious about how much we rely on them because their correctness cannot be
guaranteed.
The scarcity heuristic, which relates to how humans value products more when they are rare, may be
exploited to a company's benefit to boost sales. According to studies, promoting items as "limited supply"
boosts customer competition and enhances their desire to purchase the item. While heuristics can be
helpful, they should be used with caution since they are generalisations that can lead to the propagation of
stereotypes that can be erroneous or harmful. All of this new technology generates data, which is being
more widely shared across companies and sectors. To address an issue, an expert in any business may be
confronted with mountains of complicated data. Given limited time and resources, heuristic approaches
can be used to aid with data complexity.
2. Endowment Effect/Bias: The endowment effect is an emotional bias that encourages people to
appreciate an owned thing more than its market value, frequently erroneously.
The endowment effect shows how individuals appreciate things they possess more than things
they don't own. As a result, dealers frequently try to charge a higher price for an item than it
would cost elsewhere. Let's suppose you paid $100 for a concert ticket a few months ago. You've
recently learned that you won't be able to attend the event, so you decide to resell your ticket. You
decide to sell the ticket for $150 since selling it for market value would seem like a loss.
We can be affected by the endowment effect as both buyers and sellers. On the one hand,
marketers and salespeople may readily take advantage of this bias: any technique that helps us feel
a feeling of psychological ownership over a thing will urge us to spend more money on it. On the
other side, the endowment effect might encourage us to overprice something based on the
erroneous belief that if we don't, we'll lose out. When we buy anything, the endowment effect may
lead us to overpay, resulting in extra costs that accumulate over time. Meanwhile, if we overprice
our old items to the point of not selling them, this bias may result in opportunity costs—that is,
gains that we do not receive.
Why It Happens?
The endowment effect is sometimes explained as a result of loss aversion, or the fact that humans
loathe losing things more than obtaining them. When presented with a decision, we tend to focus
more on what we lose than on what we gain due to loss aversion. As a result, we are prejudiced in
favour of maintaining the status quo rather than shaking things up and risking losses.
The endowment effect may be explained in a variety of ways, each of which may play a role in
different contexts to varying degrees. Buyers frequently have various reference prices in mind for
an object, which leads to gaps in their readiness to pay or accept a price; and finally, it is quite
simple for us to establish a sense of psychological ownership over something, which helps us feel
more favourably about it.
Prevent sales approaches that create psychological ownership and consider market pricing when
determining how much to sell for to avoid the endowment effect.
3. Affinity Bias: Affinity Bias refers to an Individual’s tendency to make unreasonably unprofitable
buying or investment decisions based on how they feel a certain product or service will represent
their values Patriotism is a good example of affinity bias in the financial world. Investors who
concentrate their possessions in their native nation or state profit from the expressive advantage of
patriotism, but they risk losing the utilitarian benefits of high returns and low risk that come with
investing overseas. One of the consequences of affinity bias is that in a misguided attempt to attain
investing success, investors choose to invest in weak or otherwise unsound enterprises that
represent expressive rather than utilitarian traits. Affinity bias causes investors to invest in firms
that create or supply items or services that they enjoy, but they do not thoroughly study the
investing qualities of those companies.
Purchasing an Apple iPhone, for example, gives the impression of being technologically cutting-
edge and a little more upmarket. This is despite the fact that some iPhones are rated lower than
others and, as a result, cost more to compensate for their lower performance. The strength of
"brand" lies in instilling this sense of technical opulence in consumers, leading to a genuine effect,
such as a buyer making an illogical decision to buy an iPhone over an alternative. That's not to
suggest an iPhone isn't a nice phone, or that the benefit of "feeling" good about your purchase and
conforming to a societal standard isn't valuable. This similar perception-as-reality affinity bias in
the financial sector might lead to the purchase of "brand name" investment alternatives that may
incur more fees for no better performance than a cheaper alternative without the brand name.
Affinity investing bias may also occur when a person feels that their investment decision
represents a personal value. Patriotism is a classic example of investing affinity bias. Many people
will make uneconomical purchase decisions in order to gain the "benefit" of patriotism by
acquiring domestic property. At the same time, they may forgo the benefit of a more diversified
and global portfolio's higher returns and reduced risk.
Why it happens?
Affinity bias stems from more than simply a person's impression of a brand or how they think
their decision reflects their ideals. It can also stem from positive peer pressure—for example, if all
of my friends are investing in stock X, I should, too, for fear of losing out and being left out. I
desire to be liked by others and/or "fit in" by following a "herd mentality." However, I may have
taken this decision despite a lack of logical diligence, which, if completed, would have shown
some "damage" to my investment option in relation to my objectives.
4. Anchoring Bias: Anchoring bias is a cognitive bias in which we place too much weight on the
first piece of information we are given on a topic. We interpret newer information from the
reference point of our anchor when making plans or generating estimations about something,
rather than perceiving it objectively. This can skew our perceptions and prevent us from updating
our plans or forecasts as frequently as we should.
Assume you're on your way to buy a gift for a buddy. You locate a set of earrings that you know
they'll like, but they're $100, which is a lot more than you planned on spending. After returning
the pricey earrings, you discover a $75 necklace—still more than your budget, but at least it's less
than the earrings!
When we become fixated on a certain person or course of action, we begin to filter any incoming
information through the framework we created in our heads, distorting our view. This makes us
hesitant to make major modifications to our plans, even when the circumstance requires it. Many
additional cognitive biases, such as the planning fallacy and the spotlight effect, are assumed to be
driven by anchoring bias. Anchoring has also been shown to impact judicial decisions, with
research indicating that giving an anchor can influence the punishments handed down by juries
and judges.
Why it happens?
Anchoring bias is explained by two main ideas. The anchor-and-adjust theory states that when
humans make judgments under uncertainty, we begin by computing an initial value and then
adjusting it, but that our modifications are frequently insufficient. The selective accessibility
argument claims that anchoring bias occurs because humans are wired to remember and recognise
anchor-consistent data.
Although it is difficult (if not impossible) to totally prevent the anchoring effect, research has
shown that it may be mitigated by evaluating why the anchor does not match the context
effectively.
5. Outcome Bias: When a choice is made based on the outcome of earlier events, regardless of how
those events unfolded, outcome bias occurs. Outcome bias avoids examining the causes that led to
a prior occurrence, instead emphasizing the outcome and downplaying the events that preceded it.
Outcome bias, unlike hindsight bias, does not require the distorting of previous events.
Because it solely considers actual results, outcome bias is potentially more hazardous than
hindsight prejudice. For example, an investor may decide to invest in real estate after discovering
that a colleague made a large profit on a real estate investment when interest rates were lower.
Rather than considering other elements that may have contributed to the colleague's success, such
as the situation of the broader economy or real estate performance, the investor is solely
concerned with the money produced by the colleague. Gamblers are also susceptible to result bias.
While casinos consistently outperform gamblers statistically, many gamblers rely on anecdotal
"proof" from friends and acquaintances to justify their ongoing participation. This outcome bias
inhibits the gambler from quitting the casino since continuing to play might result in a huge sum
of money being won.
In business, an overemphasis on "performance" is rapidly developing an outcome-centric culture,
which frequently exacerbates people's worries by establishing a zero-sum game in which
individuals are either successful or failing, and "winners" and "losers" are swiftly separated. Few
would dispute the phenomenal expansion of social media firms, for example. Only a few people
raised concerns about the tactics used to achieve growth during this period. The result bias of
social media is on full show after realising that personal and private user data was a big driver of
development. In practise, ethical shortcomings are frequently disregarded when effective
outcomes are achieved. Bad consequences, on the other hand, are significantly more likely to
result in aggressive denunciation.
Why it happens?
When assessing a previous decision, an individual makes this error because he or she will include
currently accessible knowledge. To minimise outcome bias, analyse a choice by disregarding
information gathered after the fact and focusing on what the correct answer is, or was, at the time
the decision was made.
6. Mental Accounting Bias: Mental accounting shows how we attach subjective worth to our
money in ways that often go against basic economic concepts. Despite the fact that money has a
stable, objective worth, how we spend it is often governed by multiple laws, depending on how
we acquired it, how we intend to use it, and how it makes us feel.
Let's say you're strolling down the street and come across a $100 cash on the pavement. Normally,
you're a rather thrifty individual who has been striving to accumulate money for the purpose of
purchasing a car in the future. Today, on the other hand, you're going to spend your newfound
$100 on a nice meal. You convince yourself that this isn't "car money" — it's a once-in-a-lifetime
opportunity, so why not treat yourself to a lovely evening out?
When it comes to money, we often act irrationally as a result of mental accounting. We don't think
about buying something as carefully if we've already set aside money for it; we don't evaluate the
"big picture" of our financial condition; and we react differently to making or losing money
depending on how the issue is presented to us. These kind of errors drive us to overspend and
destroy our attempts to conserve money. Our tendency of mental accounting may be readily
exploited by marketing businesses, in addition to leading to bad budgeting. Because of the
cognitive biases involved in mental accounting, tricks like delivering "bonus" presents or pushing
"extras" on top of large purchases are successful. The sunk cost fallacy, which causes us to stick
with a behaviour or activity for longer than we should, is likewise fueled by mental accounting.
Why it happens?
There are a number of reasons why our mental accounting processes lead us to make poor
financial judgments. All of these causes stem from the fact that individuals do not consider value
in absolute terms. Instead, an object's worth is determined by a variety of different variables.
Money's fungibility is one of its most important characteristics, implying that it is made up of
interchangeable and identical units. Money is fungible because it has the same value regardless of
where it comes from or how it is spent. Furthermore, money has no labels; the same dollar you
spend on your morning coffee may be used to buy a bus ticket or a new clothing.
The easiest method to minimise mental accounting errors is to have a budget and keep a closer eye
on your expenditures. Having a plan in place for dealing with unexpected cash might also assist
you avoid squandering it on frivolous purchases.
7. Snake Bite Effect: The snake bite effect occurs when people experience significant losses in their
stock or other asset investments and subsequently attempt to minimise risk as a result of their
losses. This bias frequently results in a portfolio that is overly weighted in conservative assets,
failing to match an investor's need to keep up with inflation or gain capital gains.
9. Availability Bias: The availability heuristic describes our inclination to make future judgments
based on information that comes to mind fast and easily. Assume you're considering either John or
Jane, two of your company's employees, for a promotion. Both have a long track record of
employment, yet Jane has always been the top performer in her field. When Jane's PC failed
during her first year, she unintentionally erased a corporate project. The painful memories of
losing that project probably weighs in on the choice to push Jane more heavily than it should. This
is related to the availability heuristic, which states that single memorable occurrences have a
disproportionately large impact on decisions. Because experiences that are easily recalled are
typically insufficient for determining how probable things are to happen again in the future, the
availability heuristic can lead to poor decision-making. As a result, the decision-maker is left with
low-quality data on which to base their judgement. Investigating the availability heuristic yields
unsettling results in a variety of academic and professional fields. If each of us emphasises
memorability and proximity above accuracy when analysing information, the paradigm of a
rational, logical chooser, which is prevalent in economics and many other professions, can be
inaccurate at times. Many academics, policymakers, business leaders, and media personalities may
need to reassess their basic assumptions about how people think and act as a result of the
availability heuristic's implications in order to enhance the quality and accuracy of their work.
Why it happens?
A heuristic is a mental shortcut or "rule of thumb" that helps us make decisions. The availability
heuristic simplifies our decision-making process. However, because our memories may not be
realistic models for anticipating future outcomes, the availability heuristic puts a strain on our
capacity to properly evaluate the probability of specific events. On a local scale, the best strategy
to avoid the availability heuristic is to combine behavioural science expertise with committed
attention and resources to identify the moments when it takes hold of individual choices. The
solution is comparable on a greater scale. Wherever human behaviour is concerned, dedicating a
professional team to focus on the function of heuristics in public policy, institutional conduct, or
media output can yeild more rational conclusions.
10. Self Attribution Bias: Also called as the self serving bias When we ascribe favourable
occurrences and triumphs to our own character or activities, yet external forces unrelated to our
character are blamed for poor outcomes. The self-serving bias is a well-known cognitive bias that
has piqued the interest of scholars throughout the world for decades. Many people recall their
school days, particularly their various experiences and responses to obtaining a high or bad grade.
When obtaining a good mark on an assignment, many people may recall attributing success to
their own abilities, especially as younger pupils. In turn, when someone would receive a poor
grade, they would perhaps initially attribute the poor result due to external factors. External
reasons might have included things like a professor's failure to teach the subject, the complexity of
the subject matter, or the shortcomings of the group members.
This is a frequent attitude among many of us, since our first instinct is to congratulate ourselves on
our accomplishments and ascribe them to our skills, while blaming external sources for failures.
This seemingly innocuous habit can have far-reaching consequences as we become older,
emphasising the necessity of recognising and avoiding it. It's critical to be conscious of the self-
serving bias and its possible influence on our life since it may alter how we learn from our failures
and how we make decisions. The self-serving bias can be troublesome because we are less likely
to learn from our mistakes and avoid them in the future if we do not credit our failures on our own
mistakes. Failing, learning from our shortcomings, and then improving on them is an important
part of becoming successful and reaching our life goals and desires. If an individual is unable to
attribute their own failures to mistakes they themselves made, then improvement is a difficult and
unlikely process.
When looking at civilizations and nations as a whole, self-serving biases might have a bigger
influence. When considering nations and climate change, one may observe an example. A study
undertaken by academics at Carnegie Mellon University looked at climate change policies and
citizens’ perspectives on which countries should cut its emissions. The researchers found that each
set of students had patriotic self-serving biases in relation to the economic constraints that would
emerge from mitigating climate change and lowering greenhouse gas emissions after conducting
surveys among both Chinese and American college students. improbable procedure.
Why it happens?
The Self-Serving bias is extremely common and is described as a human perceptual process that is
distorted.3 Researchers have identified several different reasons for why the self-serving bias
occurs so frequently among individuals.
Self Esteem: Self-serving bias is widespread when it comes to our desire to preserve or improve
our own self-esteem. 3 We avoid any real possibility for criticism by attributing our triumphs to
our own attributes and our failures to external events. The self-serving bias distorts our
perceptions of ourselves and reality in order to boost and maintain our own self-esteem.
Self Presentation: The way a person presents oneself to others is referred to as self-presentation.
Self-presentation is used to offer information that either matches an individual's self-image to
others or matches audience expectations and preferences. Individuals' self-esteem is aided by self-
presentation since they are influenced by others' impressions of them. An individual intentionally
projects positive perceptions of oneself to others in order to maintain their self-esteem.
Natural Optimism: Another explanation for this cognitive bias's prevalence is that humans are
essentially optimistic creatures. People are more prone to ascribe poor results or outcomes to
situational and external variables rather than personal reasons when they are unexpected. In
addition to our proclivity for optimism, our self-serving bias causes us to commit what
psychologists refer to as a basic attribution mistake. A basic attribution error, also known as
correspondence bias or the attribution effect, shows how we blame others when they make errors,
but we blame circumstances when we make mistakes.
Age & Culture: Self-serving bias is a prejudice that many people will face at some point in their
life. However, when looking at different age groups and civilizations, self-serving bias varies.
Self-serving bias is more common in young children and older individuals, according to research.
From a cultural standpoint, there is no formal consensus about self-serving biases and cross-
culture impacts. However, scholars throughout the world are increasingly looking at the cultural
implications of self-serving bias, especially the disparities between Western and non-Western
societies' self-serving bias. Our failures are due to a variety of factors.
The best method to prevent self-attribution bias is to first understand what it is and how you could
be employing it in your own life. Mindfulness gives us the chance to identify ways to overcome
this prejudice. Additionally, being open to criticism and empathetic toward oneself might help one
avoid self-serving prejudice. You will be more able to accept your own faults if you are self-
compassionate and work on viewing criticism as a chance for progress rather than an attack. When
people become aware of typical cognitive biases, they may begin to observe their presence, when
they occur in everyday life, and how they might be improved.
11. Recency Bias: Investors overemphasise current occurrences over those in the near or distant past,
due to a cognitive bias and information processing bias.
Examples:
Due to recency bias, investors only look at the most recent 1-, 2-, and 3-year track records
when evaluating investment managers.
Due to recency bias, investors will focus on the asset class that is currently in favour, such
as investors pursuing growth companies or technology stocks while they are performing
well.
Investors who focus on pricing rather than valuation are more likely to estimate future
returns incorrectly.
12. Cognitive Dissonace Bias: When we avoid having contradicting thoughts and attitudes because it
makes us feel uncomfortable, this is referred to as cognitive dissonance. The confrontation is
normally dealt with by rejecting, refuting, or ignoring new information. We can make poor
judgments if we reject, rationalise, or avoid evidence that contradicts our views. This is because
the information is not rejected because it is untrue but because it makes us uncomfortable. This is
typically the case when information is both factual and valuable. Decisions taken in the absence of
accurate and helpful knowledge might backfire. For example, smoking has been found to cause
cancer and contribute to a variety of other chronic health problems. Smokers frequently justify
their harmful decision to continue smoking by either rejecting or thinking themselves to be the
lucky exception to the health concerns.
Further research into the impact of cognitive dissonance yields alarming findings in academics
and politics. Cognitive dissonance may jeopardise the objective approach that underpins much of
today's academia if researchers prefer to examine data in a way that supports findings that are
compatible with their own ideas. Cognitive dissonance also threatens the efficiency of social
initiatives. Many people must adjust their present ideas and behaviours in order to achieve the
change they seek. This will be impossible if a major percentage of the population refuses to
examine data that contradicts the beliefs or habits that these causes are attempting to change. A
notable example is environmentalism and its linked climate change action initiatives. Most of us
care for nature and want to preserve it. But the research championed by these groups frequently
reveals that we aren’t doing enough as individuals. Many of us are contributing to the issue. Such
evidence shows us that our behaviors are often at odds with our beliefs.
Cognitive dissonance may also aid in the formation of political divisions. We are more prone to
disregard evidence that contradicts a political leader's or ideology's message when we have a
strong belief in them. To put it another way, we frequently disregard or misrepresent facts that
contradicts our political convictions. This is one of the reasons why changing someone's thinking
on political matters is so tough. Voters are prone to remain loyal to their chosen politicians and
party even when data that might question their loyalty is given
Why it happens?
When there is an uncomfortable conflict between two or more beliefs that are believed at the same
time, it is called cognitive dissonance. 2 This most typically arises when our behaviours do not
correspond with our attitudes — we think one thing, but act against those views. The severity of
cognitive dissonance, or the discomfort it generates, is determined by the quantity and relative
weight of the opposing ideas. This internal struggle, as well as the pain it causes, drives us to
choose between beliefs, justifying and rationalising one while rejecting or downplaying the value
of the others. We are more likely to choose the notion or thought that is the most known and
imprinted in our minds. Changing our ideas, as well as the attitudes and behaviours that go along
with them, isn't simple. As a result, we tend to adhere to our existing ideas rather than embracing
new ones that are offered to us. Many of us go even further to avoid circumstances or knowledge
that could conflict with our pre-existing views in order to prevent cognitive dissonance.
It is impossible to eliminate cognitive dissonance entirely. Our natural reaction to it, though, may
be reduced. When our views are challenged by new knowledge, it is typically preferable to ignore
the facts or rationalise our old ideas, which may be incorrect. While we think about change
negatively, we may avoid using it when we're in a state of dissonance. As a result, we should try
to equate change with pleasure and benefit. A conditioned or "learned reflexive reaction" is what
this is known as. By conditioning ourselves to favour change as a response to mental conflict, we
might be able to avoid rejecting, rationalizing, or avoiding conflicting information. And, as usual,
being aware of a cognitive bias that happens subconsciously might assist us in recognising when
our decisions are influenced by it.
13. Self Control Bias: Hyperbolic discounting is a behavioural fault that causes self-control bias.
According to hyperbolic discounting, the way investors perceive gains has an inherent defect.
They have a voracious thirst for quick profits. When offered to pick between short-term profits
and long-term gains that will be significantly larger, most people will select the short-term gains.
As a result, investors' time preferences are skewed, which has a detrimental influence on their
decision-making. To put it another way, investors with this inclination are more likely to spend
now while saving less for the future. The financial realm isn't the only place where self-control
bias may be found. It may also be found in various aspects of our everyday lives. People may, for
example, be unable to reduce weight while knowing that doing so is in their best long-term
interests. They may continue to eat harmful foods while knowing that they would injure
themselves.
Why it happens?
The first thing to notice about self-control bias is that it causes people to have a smaller portfolio.
This is because they may place a higher priority on monthly luxuries than long-term retirement
funds. As a result, they either invest late or invest a lesser percentage of their income. They may
have a modest portfolio and save at a low rate, but they have big dreams. This is why those with
self-control bias are more likely to make riskier bets. This is done so that they can achieve their
objectives with less money. However, their self-control bias plays a role here as well. They tend to
overvalue the short-term rewards from hazardous investments while undervaluing the long-term
impact of the increased risk on their portfolio. People who suffer from self-control bias prefer
investments with shorter lock-in periods. This frequently leads to them overlooking superior
investment opportunities just because it means their money will be tied in for a longer length of
time. People who have a self-control bias believe they should be able to spend the money soon.
They don't see things in the long run. Another feature of persons with self-control bias is that they
choose investments that pay out a monthly income. The difficulty with this strategy is that they are
likely to spend their whole monthly payout as soon as it is received. Any investment's actual
worth may only be appreciated if it is allowed to compound over a long length of time. If the
investor with the self-control bias continues to get dividends, they are more inclined to spend
them. As a result, they may never be able to benefit from their assets' compounding potential.
People who suffer from self-control bias should try to eliminate it at the source. This implies that
people should prioritise their savings objectives. This frequently necessitates a rethinking of their
spending habits.
Self-control biases prevent investors from having a well-thought-out investing strategy. Instead,
their investing selections are a series of haphazard choices made on the spur of the moment. In the
financial realm, failing to plan is the same as intending to fail.
Investors with self-control bias should be made aware of the need of making realistic assumptions.
Their portfolio should not be allocated based on their hazardous choices. Instead, they should use
a scientific technique to determine their debt-equity mix based on their stage of life.
In the end, self-control bias is neither minor nor insignificant. This prejudice, like other
behavioural biases, has a significant influence on the investor's portfolio as well as the return they
receive.
14. Confirmation Bias: Our fundamental inclination to notice, focus on, and give higher credibility
to data that supports our previous ideas is known as confirmation bias. Confirmation bias is the
propensity to process information by seeking out or interpreting data that supports one's pre-
existing ideas. This skewed approach to decision-making is often accidental, and it frequently
leads to the omission of contradictory data. Expectations in a certain scenario and forecasts
regarding a specific event are examples of existing beliefs. When the problem is very significant
or self-relevant, people are more inclined to analyse facts to support their own ideas.
Because it alters the reality from which we take evidence, this bias might lead us to make
incorrect conclusions. Under experimental conditions, decision-makers are more likely to actively
seek information and place a higher weight on data that confirms their current ideas than on
evidence that contradicts them. This can be considered a sort of evidence-gathering bias.
Conclusions based on biassed evidence are more likely to be incorrect than conclusions based on
objective evidence. This is due to the fact that they are more removed from reality. Individual
confirmation bias can have severe consequences in the aggregate. If we're so set in our ways that
we only accept facts that confirms them, larger socio-political collaboration (which sometimes
necessitates examining different points of view) might be hampered. Our predisposition to
prioritise information that confirms our current opinions and dismiss facts that contradicts them
may be the source of major societal conflicts and stagnant policymaking.
Why it happens?
When obtaining and evaluating data, we employ confirmation bias as a cognitive shortcut.
Because evaluating information takes time and effort, our brain seeks for ways to speed up the
process.
Our brains use shortcuts, these shortcuts are caalled heuristics. Confirmation bias is debatable as
to whether it can be classified as a heuristic. But one thing is certain: we utilise it as a cognitive
tool to find data that best supports our assumptions. The hypotheses we currently have are the
most easily available. It's only natural that we do so. We frequently need to make sense of
information rapidly, yet it takes time to establish new explanations or beliefs. We've evolved to
choose the road of least resistance, which is typically the most practical option. When we are
accumulating information to make judgments, confirmation bias is most likely to occur. It's also
likely to happen subconsciously, with us being completely oblivious of its impact on our
decisions. As a result, recognising confirmation bias is the first step in avoiding it. We should
focus on starting with a neutral fact foundation since confirmation bias is more likely to emerge
early in the decision-making process. This can be accomplished by having one (or, preferably,
numerous) third parties collect facts in order to create a more objective body of data.
15. Hindsight Bias: Our inclination to look back on an unusual occurrence and believe it was readily
anticipated is known as hindsight bias. The 'knew-it-all-along' effect is another term for this
phenomenon. It's a psychological phenomena that permits people to persuade themselves that
they correctly foresaw an event before it occurred. People may think as a result of this that they
can properly foresee future occurrences. In behavioural economics, hindsight bias is examined
since it is a widespread flaw among individual investors. When a person looks back on an event,
they feel they could have foreseen the outcome. This is known as hindsight bias. This suggests
that the majority of individuals feel their judgement is superior to what it actually is. The
argument is that knowing the outcome makes it much easier to come up with a believable
explanation. As a result, we become less critical of our decisions, which leads to future bad
decision-making. Investors are frequently under pressure to timing their stock purchases and sales
properly in order to maximise their profits. When they experience a setback, they lament the fact
that they did not act sooner. With regret comes the realisation that they should have seen it coming
from the start. It was, in reality, one of the numerous scenarios they may have foreseen.
Regardless of which one succeeds, the investor is persuaded that they saw it coming. This permits
investors to make terrible selections in the future without even realising it. To avoid hindsight
bias, the investor must be able to make forecasts ahead of time, such as by keeping a decision-
making record that can be compared afterwards.
When new information about a former experience becomes available, it causes hindsight bias,
which alters how we remember that experience. Only the information that verifies what we
already know or believe is true is remembered. Then, if we believe we have always known what
will happen, we neglect to thoroughly examine the outcome (or the reason for the outcome). After
the event, hindsight bias entails adjusting the likelihood of a result. A person will overestimate the
extent to which they predicted the outcome after they know it. These biases may be observed in
almost any circumstance, including weather forecasting and election predictions. Our decision-
making can be influenced negatively by hindsight bias. Making excellent judgments necessitates a
realistic assessment of the implications. It can lead to an overestimation of our capacity to foresee
these outcomes. If we look back on previous actions and decide that their effects were known to
us at the time (when they weren't), it's natural to overestimate our capacity to predict the outcomes
of future decisions. This can be risky, as our arrogance may cause us to take unwarranted risks.
Consider a gambler who sees prior losses as predictable, enhancing his confidence that his next
trip to the casino would be profitable. This prejudice can have negative consequences in a variety
of academic and professional settings. Researchers' ability to put themselves in the shoes of
decision-makers at the time — whose actions were not guided by the foresight we have studying
them in retrospect — may contaminate the correct analysis of previous historical and political
events or trends. Details that appear evident after the event may be neglected as a result of this.
Realistic risk evaluations based on similar prior events are used in law, insurance, and finance.
These forecasts may be skewed due to prejudice.
Why it happens?
Hindsight bias occurs when fresh knowledge about a former experience alters our remembrance of
that experience, turning it from an original notion into something else. 2 According to
psychologists Neal Roese and Kathleen Vohs, this can happen at three different stacking levels.
"Memory distortion" is the first stage. This entails misremembering a previous decision or
opinion. When we say we stated something when we didn't, we frequently do this. The second
level is based on our conviction that a previous incident was unavoidable. This level of hindsight
bias is referred to as "inevitability" by Roese and Vohs. The last degree, "foreseeability," implies
that we believe we might have predicted the incident. 3 As a result, the bias arises when we
misremember our previous views, assume a prior occurrence was unavoidable, and hence believe
the event was predictable.
Roese and Vohs conclude from their analysis of current literature on hindsight bias that there are
three types of factors that influence the three degrees of hindsight bias to cause our tendency to
overestimate our forecasting abilities:
Cognitive: We frequently distort our memories of prior experiences by recalling only
information that matches what we already believe to be true. In what is known as
"sensemaking," we do this to create a storey that makes sense with the information we
already have. This has something to do with confirmation bias.
Metacognitive: When we think about our own thoughts, we are said to be metacognitive.
People might confuse ease with certainty when they find it simple to think about and grasp
a previous judgement or experience (an earlier idea). Due, at least in part, to the
availability heuristic, it is typically straightforward to comprehend how or why an event
occurred in retrospect. This reassures us that we were on the same page earlier.
Motivational: It is reassuring to believe that the world is well-ordered and predictable. This
might lead us to believe that unpredictably occurring occurrences are predictable. It's also
comforting to believe that your forecasts were correct or that you "knew it all along," even
if you didn't. Our activities are frequently unconsciously driven to create a favourable
opinion of oneself, according to research.
It is critical that we are aware of the potential consequences in our life. As previously stated,
the overconfidence it frequently inspires might have negative consequences. Having
reasonable predictions about the future is an important aspect of making excellent decisions in
our personal and professional life. Hindsight bias obstructs our ability to forecast the future by
distorting our internal track record of prior predictions. This can lead to overconfidence in
future forecasts, which can be used to justify dangerous decisions with negative consequences.
In a broader sense, prejudice keeps us from learning from our mistakes. If we already believe
we understood something all along, we are unlikely to ponder closely on its conclusion, and
we will surely be unable to comprehend why our forecasts at the time were incorrect. Finally,
this may impede us from grasping the full nature of an event or discovering flaws in our
prediction methods.
One method is to analyse and describe how different outcomes may have occurred. An event
will appear less inevitability and predictable if you mentally analyse all of the possible
possibilities. Keeping track of your prior judgments and their related forecasts is another
strategy to combat the harmful overconfidence that hindsight bias may cause. Having an
explicit and irreversible record of the forecasts linked with your judgments (which will almost
certainly reveal some wrong predictions) may help you avoid making the error of believing
you'knew it all along.'
17. Overconfidence Bias: The propensity to have a mistaken and inaccurate evaluation of our
abilities, intellect, or ability is known as overconfidence bias. In a nutshell, it's an arrogant
conviction that we're better than we are. It's a harmful bias that's common in behavioural finance
and the stock market. The overconfidence bias will be explored in further depth in this tutorial.
Learn more about behavioural finance in CFI's Behavioral Finance Course. One of the most
crucial talents in finance and investing is knowing where the markets are heading. Most market
analysts feel their analytical abilities to be above average in their field. However, it is statistically
impossible for most analysts to do better than the average analyst.
While confidence is generally viewed as a positive in many situations, it is more commonly
viewed as a weakness in investing. Successful investment necessitates careful risk management.
However, being overconfident in our investing selections detracts from our capacity to manage
risk effectively. Overconfidence bias causes us to see our financial selections as being less
dangerous than they are.
Types of Overconfidence Bias:
Over Ranking: When someone overrates their own personal performance, they are
implying that it is better than it is. The truth is that most people consider themselves to be
above average. This may be problematic in business and investment since it usually leads
to taking on too much risk.
Illusion of Control: When people believe they have control over a situation when they
actually don't, this is known as the illusion of control bias. People, on average, feel they
have more control than they do. This may be extremely harmful in business or investment
since it causes us to believe things are less risky than they are. Failure to appropriately
identify risk results in ineffective risk management.
Timing Optimism: Another facet of overconfidence psychology is optimism timing.
People often overestimate their ability to work swiftly while underestimating how long it
takes them to complete tasks. Businesspeople frequently underestimate how long a project
will take to complete, especially for complex activities. Similarly, investors usually
misjudge how long an investment will take to pay off.
Desirability Effect: When individuals overestimate the chances of something happening
solely because the outcome is desired, this is known as the desirability effect. This is a sort
of overconfidence bias that is frequently referred to as "wishful thinking." We make the
error of assuming that a particular conclusion is more likely just because it is the one we
want.
18. Paradox of Choice: Let's say you're out of milk and need to go to the supermarket to get some.
When you arrive to the dairy section, you'll find a plethora of choices. These days, you must
choose not only the fat percentage (1 percent, 2 percent, skim, etc.) but also the source of your
milk: cows, almonds, soybeans, oats, and so on. You stand in the middle of the aisle, almost
speechless, unsure of which milk to choose. You're completely overwhelmed by the number of
options available.
This phenomenon is known as the paradox of choice and it is becoming a concern in the modern
world, where more and more options are becoming easily available to us. While we may assume
that being given with several alternatives makes it simpler to pick one that we like, and so
promotes consumer happiness, having an excess of options really involves more work to make a
decision, and might leave us disappointed with our choice. If we simply had to pick between 1%
and 2% milk, it would be easy to decide which choice we prefer since we could clearly assess the
benefits and drawbacks. As the number of options grows, it becomes more difficult to decide what
is ideal. The paradox of choice indicates that, rather than enhancing our freedom to get what we
desire, having too many options actually limits our freedom.
As we make social, scientific, and technical advancements, we realise that we have more
alternatives than prior generations. The ability to choose which milk to buy is only one example of
how we have come to have a plethora of options. There are hundreds of possibilities for what sort
of clothes we should buy, what food we should buy, what automobile we should drive, what
beauty products we should use, what restaurant we should dine at, and so on. While the abundance
of alternatives may appear to boost customer happiness on the surface, because consumers are
more likely to discover one option that meets their specific wants and requirements, we may also
get highly overwhelmed. While it is simple to pick option A when just option B is available,
determining the worth and usefulness of option A when alternatives A-Z are available becomes
considerably more difficult. As a result, we experience option overload and grow more unsatisfied
with the decision we ultimately select.
The paradox of choice is not simply a worry for economics and consumer happiness, but it's also
an issue that's surfacing in other parts of our life as our options become increasingly limitless.
Furthermore, the internet and social media have made it simpler for us to view all of the numerous
alternatives accessible to us, eliminating the need to physically stand in a store to see what we
have.
According to psychology studies, decision makers are more prone to the paradox of choice
phenomena, in which individuals are less likely to make a decision when given with a large
number of options than when faced with a small number of options, the studies in psychology
have typically examined the decisions of individuals who have no particular experience in the
decision task.
The paradox of choice phenomena is visible for people with little or no experience with investing,
but not for those with greater expertise. In fact, contrary to the paradox of choice phenomena,
those with greater investing expertise were less inclined to invest when presented with a limited
option set. These data show that when people with investing expertise make judgments, the
paradox of choice may not exist.
These were some of the key behavioural biases that we Investors face in a day to day basis. Not important
that we fall into all of these biases and not importantly all of these biases are wrong some of them also
helps us to be cautious and invest safely where others bind us a bit too much and can turn out to be not
profitable if not paid attention to.
4. Under-diversifying
Lack of variety in a portfolio, which is often connected with familiarity bias, can have major
effects, exposing you to increased risk and possibly dramatic market movements. While there is
no set rule for how much diversification you should have, your portfolio mix should be based on
your objectives and risk tolerance. Typically, advisors recommend diversification by asset class as
well as individual assets. Mutual funds and exchange-traded funds, for example, are pooled assets
that can help with the latter. Keep in mind, however, that diversification does not guarantee a
return or protect you from losing money.
6. Going It Alone
We can make critical investing decisions in a vacuum due to overconfidence and familiarity bias.
Getting a second opinion, whether from a trusted friend or a professional counsel, is usually
always a good idea. Also, don't be hesitant to enlist the help of people who are more competent to
make investment decisions on your behalf. They might be able to help you overcome some
behavioural biases and stay on track with your objectives.
3. Investors are Often Overconfident When They Have Small Amounts of Information You'd think
that when there's less information accessible, investors would be less confident. Regrettably,
they've always been readily reassured by good news. They felt that if the stock market performed
well, they might make a lot of money with little effort.
5. Detailed Descriptions Influence Investors More Than Boring (But More Relevant) Facts
A five-page report with flashy visuals has a greater impact on people than a bundle of real
statistics. Although a few bits of data may be more relevant and helpful in making a choice, many
individuals appear to respond better to long and entertaining reports. Even if they aren't seeking
for anything specific or have no preconceived notions about what they're looking for, this is true.
8. Mental Accounting
When people divide their money into several accounts for personal reasons, this is known as
mental accounting. They could have a savings account for their next summer trip, a Christmas
present account, and a college savings account for their children. This may make individuals feel
more organised, but it can also lead to rigid financial planning and a reluctance to move money
from a low-yielding account to a higher-yielding account.
9. Gambler’s Fallacy
When it comes to anticipating unpredictable future occurrences, humans have a tendency to be
overconfident and unreasonable. They make the error of believing that previous events have any
bearing on future happenings. If someone flips a coin twice and both times it comes up tails,
they're more inclined to wager the coin will come up heads next time. They think the rule of
averages applies, ignoring the fact that the coin is just as likely to land on its side the following
time. Many individuals think about trading methods based on random price swings in this way. It
also explains why consumers have a hard time benefitting from technical analysis trading
techniques and why many financial professionals have questions about technical analysis. They
argue that the market has no memory and that attempting to forecast it based on previous price
movements is futile. It's possible that they're correct.
10. Placing More Emphasis on Recent Events Rather Than Considering All Events Together
People believe that current and important events are inextricably linked. To some extent, this is
correct, but in many circumstances, this logic is flawed. Investors frequently think the most recent
report from a group of analysts who all had access to the same data is accurate. They overlook the
fact that previous experts examined the same data over the same time period and came up with
different conclusions. It's almost as if the previous occurrences or studies were statistically
inconsequential and didn't deserve to be included in the sample.
Research Methodology
The current research is based on understanding mainly how behavioural finance impacts various
investment decisions made by investors. The data has been procured through primary and secondary
sources. The primary data is obtained from the designed Questionnaire and Interview method. The target
was to collect a maximum of 40 responses. On the other hand, the secondary data used is a review of a
bunch of published articles,research papers, blogs, and sites from the Internet.
Data Collection
The primary data for this study was collected with the help of a well-structured questionnaire. The
questionnaire was designed on Google Forms and was circulated through the medium of social media
apps.
For certain audience the questionnaire was also verbally collected and the resullts were entered into the
questionnaire by me as the target audience also considered of middle aged, youth and older individuals.
For the study a minimum of 40 respondents were required. The google form was kept opwn for a period
of 1 month after which a total of 40 respondents were received
On the other hand secondary data was received with the help of Internet where numerous studies on
behavioural finance nd how it affects the investor were collected through academic research papers,
journals and various internet sites.
Sampling Design
For the purpose of this study, two types of sampling design were utilised. They were convenience
sampling and snowball sampling.
Since the study was aimed at mostly the working class population and the age group of 20 and above
these age groups were easily accessible and easy to reach out to, convenience sampling was used.
On the other hand, respondents were also encouraged to forward the questionnaire to the age group
mentioned above, and hence with the help of snowball sampling, sufficient responses were also collected.
Statistical Tool
For the purpose of this study, pie charts and tables were used as ameans of staistical tool to represent data
that has been obtained through the questionnaire which was automatically analysed by Google Forms.
Review of Literature
Dehnad 2011: For more than 30 years, the Efficient Market Hypothesis has dominated finance (EMH).
EMH is founded on three key theoretical arguments: first, investors are rational, and so value stocks
rationally; second, people analyse all available information before making investment decisions; and
third, decision makers always act in their own best interests. Investors, on the other hand, have been
found to be subjected to a variety of decision-making biases that have a detrimental impact on their
investing success. Stock market investors are prone to behavioural biases, which cause them to make
cognitive mistakes. When trading liquid assets, one must be aware of concepts such as market attitudes,
resistance, and support, among others.
Markowitz, 1952 & Sharpe, 1964: mentioned in the financial theory based on Modern Portfolio theory
related to capital asset pricing model has a significant contribution to the field of behaviour and
investment performance of a different set of investment avenues in the stock market. The theory explains
the notion that investors act rationally and consider all available information for taking the investment
decision-making the process
Thaler and Barberis (2002): Behavioural finance has two major significant scenarios, one is limits to
arbitrage, and the second one is psychology. Limits to arbitrage means, seek to explain the existence of
arbitrage investment opportunities which do not change quickly in the stock market. Every investment
and trading position takes specific time for getting a result in the stock market, so until risk and return
will be correlated. It is mainly related to arbitrageurs coexisting with not entirely wise investments of the
investors in the stock market, and most of the time not able to get profits from the stock market
dislocations. Understanding the past and existent of arbitrage investment opportunities, although
theoretically counter-intuitive, is not enough to make share estimations and predictions in the stock
market. This will relate to how they misunderstood the Bayless law or deviated from the subjective
expected utility theory. To mention on the type of irrationality, investigators have turned to experimental
evidential proof compiled by a cognitive psychologist on the biases that arise when people form beliefs,
and on the people preference towards stock market investments and trading decisions.
Fama 1998: Classical finance theory, often known as the efficient-market hypothesis, posits that investors
make rational decisions when selecting financial items to invest in. Eugene Fama (1998), a Nobel winner,
supports this theory, stating his dissatisfaction with the new behavioural financing hypothesis, which is
founded on two ideas:
Market anomalies are random results.
Anomalies tend to disappear when changes occur in the methodology used to measure them.
However, according to the "theory of behavioural finance," the typical investor's choice of financial items
is dependent on their psychological, social, and emotional preparedness. Furthermore, owing to the
acceptance of published facts and the maintenance of reputation, household bias connected with
information and culture influences its behaviour (Aren et al., 2016). As a result, this theory views
irrational behaviour as central to financial decision-making. Shiller (2003) defines behavioural finance in
this sense as "finance from a larger social science perspective, encompassing psychology and sociology."
Kahneman & Tversky 1979: Both ideas have advocates today, including numerous Nobel Laureates in
economics, such as Kahneman, who, together with Tversky, was one of the architects of the so-called
"prospect theory or theory of perspectives." This theory allows us to understand how individuals make
judgments in circumstances when they must choose between prospective losses and rewards, both of
which include risk in the selection process.
Thaler 1980: He developed the mental accounting theory. Money has the same worth no matter where it
originates from or what it is used for. However, it takes less effort to spend money obtained without effort
than it does to spend money earned via hard labour. This occurs because our minds deceive us into
thinking the first money is worth less than the second. The mental accounting trap is what it's called.
Hammond (2015) regards Kahneman and Tversky (1979), as well as Thaler (1980), as the progenitors of
behavioural finance, claiming that investment decisions are guided by feelings rather than rational
grounds.
Godoi et al., 2005: The hypothesis of anticipated utility is established by the theory of perspectives, in
which the most helpful choice is chosen. That is, when the predicted results are unknown, there is a
preference for secure rewards over less likely ones, even if the former is less valuable. It is important to
remember that loss is a subjective experience that cannot be defined, despite the fact that the following
factors contribute to it: family influence, investment objectives, risk dimension, guilt, rationalisation, fear,
and sorrow (Godoi et al., 2005). As a result, human emotions and wants are involved in loss aversion.
Baker and Wurgler 2006: They came to the conclusion that if confidence indicators are low at the start of
the period, future yields will be comparatively high, or, conversely, relatively low yields will be attained
when the anticipation is greater. They discovered the capability of assessing investor sentiment and that
spikes in sentiments had explanatory repercussions for individual firms and the stock market as a whole
in future studies.
Qiu & Welch, 2004: There are measures based on surveys such as the Michigan Consumer Sentiment
Index (MCSI) or Investor Intelligence, and measures based on market variables such as the closed-end
fund discount. Sentiment plays a role in financial markets, although CEFD may be an incorrect method
for measuring it. Also, Qiu & Welch believe that “consumer confidence can robustly explain the
profitability differential of small business and the profitability differential between the shares held
disproportionately by retail investors and those of institutional investors”.
Bandopadhyaya & Jones 2006: Investor sentiment can also be gauged using indexes built from various
market indicators, such as the Equity Market Sentiment Index (EMSI) or the Baker and Wurgler
sentiment index. The feeling has the most impact on activities that are hardest to arbitrate or value,
according to these writers. The topic at hand is whether it is possible to determine the price of an
economy's assets using existing pricing methods.
Shefrin & Statman, 1985: They have studie the dispostion effect that occurs in investors who hold
financial assets that have lost value for too long and sell assets that have gained value without waiting for
those assets to continue the increase in the value trend. People despite losing far more than they love
winning, thus most investors rely on the usage of stop-loss orders, which reduce the investor's disposition
impact (Richards et al., 2011). Another important addition comes from the study of "overconfidence," or
the propensity to overestimate our abilities and expertise (Fischhoff et al., 1977; Michailova et al., 2017),
which is reflected in overconfident investors' financial judgments (Odean, 1998). Suresh (2013), on the
other hand, believes that all of these biases aid in making effective investing decisions.
Lans Bovenberg, R.S.J. Koijen, Theo Nijman, and C.N. Teulings highlighted how the age of an investor
has a significant impact on saving and investing in their study paper "Saving and investing across the life
cycle and the influence of collective pension funds."
By performing a sampling survey, Kiran and Rao (2005) investigated whether demographic and
psychographic factors were effective on risk-bearing ability of Indian investors in her study work
Identifying Investor Group Segments Based on Demographic and Psychographic Characteristics. They
confirmed a high link between risk taking attitude and demographic and psychographic characteristics by
evaluating the obtained data using multinomial logistic regression and factor analysis (FA) in SPSS.
Waweru et al. 2008: identified major market determinants and their inverse proportion on investors'
decision-making based on price movements, market knowledge, previous trends of different stock scripts,
consumer regarded preferences, and market over-reaction.
The herding effect on investment decisions made based on other market actions, moreover, investment
decisions are dependent on the different investment decisions made by investors, and investors tend to
invest money from market experts or other investors to gain a return in a given period of time, the risk
and return models have different impacts on the various asset pricing theories, and the risk and return
models have different impacts on the various asset pricing theories.
Ritter 2003: discussed psychological elements of behavioural finance and indicated that personal
purchasing and selling behaviours are the subject of many cognitive illusions. The majority of illusions
are divided into two categories: those created by heuristic investment choice processes, and those induced
by the adoption of psychological frames gathered in the prospect theory.
60%
50%
40%
30%
20%
10%
0%
yes no
1. From the above graph we come to know that around 53% people are comfortable doing stock
market investments whereas the rest 47% are not, from this we understand that people still are
concerned about doing stock market investments and are well comfortable considering other
modes such as bank deposits, and out of the total respondents only 38% people are aware of what
behavioural finance is which explains us that how new of a concept behavioural finance is to the
eyes of an investor
Indians have a love-hate relationship with the stock markets. According to research, barely 2% of
Indian investors invest in the stock market. Stocks are avoided by the typical individual because
the equity markets have not been able to give the same degree of confidence that other kinds of
investing have. Furthermore, financial illiteracy causes investors to favour traditional investing
strategies that guarantee a profit.
Some other reasons why people don’t invest on the equity markets are:
Financial Illitaracy
Lack of Money
Lack of patience
Traditional mode of investments give a guaranteed returns
Lack of Courage
“Play Safe” Attitude
Word of Advice
2. The above graph represents the primary goal of why people invest and what do they expect in
return, as we can see majority of the respondents consider assured return as their prime reason and
the second most rated reason was tax benefit. These two goals can simultaneously be attained
through financial products such as Mutual Fund Investments.
3. The above graph portrays how respondents behave to an investment situation given where the
three options given can be seen in the x-axis. Almost 48% of the respondents have chosen option
three which is “I would rely totally on advice given by financial advisors” rather than listening to
friends or peer or information from the Internet. This explains us that people only invest in such
assets where they trust that they have good information about the asset, in this case a financial
advisor who knows much about the sector will give them good advice and so people are
comfortable relying on such advises.
4. "Will you hold your investment if it shows a loss in order to recover the loss?" This was the
question posed to determine how respondents would react to another investment
circumstance, 70% replied yes, while the remaining 30% said no. This might be an instance of
Loss Aversion, which is a bias toward avoiding losses over obtaining gains, or it could be a case
of Anchoring bias, which is when a person holds on to an asset for too long regardless of whether
it is profitable or not. Sticking with an asset that is losing money can be a smart idea in some
situations only if we know the asset will grow in the future, but if it is showing loses continuously,
it can be a negative decision.
5. The graph above shows whether investment decisions are impacted by outside media or expert
forecasts, with 70% of respondents saying yes and 30% saying no. This indicates how much
influence external factors have on our investment decisions. Various studies have shown that own
research is the most effective way to earn profits, and that we should just analyse outside sources
of information, not rely on them. However, if a person is unsure about the facts he has obtained, it
is always a good idea to seek advice from financial advisors or experts.
6. One of the major objectives of the study was to understand the preferred investment options
selected by the consumer. According to the above graph we can clearly see that the most favoured
investment option is Growth Investments which are long terms, and the second most selected
investment options are shares. Based on the above graph we study that people are moving from
the traditional cash and bank investments onto more modern shares and long-term growth
investments. Such investments anchor us to study more about the usefulness of behavioural
finance in the major field of economic finance.
30%
70%
yes no
7. The above graph depicts us the consideration of behavioural biases into investing decision. As we
can see that majority of the respondents have said that behavioural finance biases should be
considered while making investment decisions and the rest 40% have said no to that matter. Now
this question was a manoeuvre because we never ‘consider’ behavioral biases its usually an
involuntary behaviour that happens within us. Behavioural biases as mentioned before can be
good in some situations and the opposite sometimes. So to clearly neglect it or not depends on
individual investor decision.
Suggestion by Family 40
Friends/Peer 27.5
News Channels 20
0 10 20 30 40 50 60 70
8. Before we invest in a stock or an asset, there are certain factors that push us to do so. These
factors may differ for each individual, and they may also differ for each specific asset. The graph
above depicts the major factors that influence various individuals to invest in a specific stock or
asset. As can be shown, personal research has had the greatest influence on investors. Personal
research, according to researchers and top investors, is one of the finest strategies to gain
maximum earnings since it allows the investor to change the investing criterion to suit his/her
needs. The help of an investing expert is the second most popular alternative. What we can deduce
from the graph above is that investors will only invest in a particular asset if they are confident in
the information they have about it.
50
Yes No
9. Can maximum profits be attained if only used financial calculations and ruled out all the biases while investing?
This was the question asked to the respondents to which the results were equally yes and no. Behavioral biases are
a common stumbling block to successful investing. Even the most reasonable people can make terrible investing
decisions based on a faulty conclusion or an emotional reaction to new facts. Behavioral biases contribute to
investors' well-documented tendency to underperform market benchmarks in terms of returns. Investors who have a
plan in place to prevent behavioural biases are more likely to succeed in their investments.
Anchoring Bias
Herd Mentality
Representative Bias
Hindsight Bias
Overconfidence/illusion of control
0 10 20 30 40 50 60 70
10. The graph above depicts the most prevalent biases that investors experience in their daily lives. As
can be seen, the respondents' most preferred bias is overconfidence/illusion of control. The
explanation for this might be because investors believe they know enough about investing until
they lose money, at which point they believe that more study should have been done on the
investment to fully understand it. As said in the bias, control is an illusion that investors have. The
only thing we can do is thoroughly research the investment. The second most common bias is
anchoring bias, which refers to depending too much on prior data nevertheless, history does not
always repeat itself, and the trend might change.
70
60
50
40
30
20
10
0
Yes No
11. As we can see above majority of the respondents said yes the rely on their gut feeling and the rest
of them said no. We hear expressions like "gut feeling" and "hunch" all too often. It's also rather
frightening to observe individuals being directed by an unknown power, possibly a sixth sense. In
the decision-making process, trusting your gut only makes sense if you have a lot of expertise to
back up your instincts. Simply "feeling" that something is correct or should be done is very
subjective and may swamp you.
37.5
62.5
Yes No
12. The above graph shows wether people prefer traditional finance theories over bheavioural finance,
as we can see 65.5% of the respondents have said that they prefer traditional finance theories.
Investors must recognise that reasonable financial judgments are frequently made, but they must
avoid falling into the trap of forming an investment based on emotions or inclinations. For
example, a student volunteers to help and does so flawlessly. If the same kid decides to run for
student president tomorrow. It will be a biassed judgement to support him. This means that an
investor may get gifts or favours from a company, which may inadvertently affect his choice to
purchase or sell the company's shares. A lifestyle includes cash, assets, properties, liabilities,
budgeting, and other financial components. Any entrepreneur needs financial documents since
they provide a clear plan and method for requiring or beginning their business.
Suggestions & Conclusions
Behavioural finance is a well-known topic these days, and it is an essential tool for measuring investment
performance all around the world. This term is usually employed in advanced economies since it is a
significant approach in these economies. Furthermore, there is a growing body of evidence that
behavioural finance outperforms standard investing strategies. The goal of this research study is to
evaluate the relevant literature. It's great to see that the number of studies on the subject has increased
dramatically in recent years, notably between 1975 and 2020. By examining the literature, it is possible to
infer that further study in the topic of behavioural finance is required in order to address its
implementation challenges. It is important to remember that while testing the viability of an idea, data
from long periods of time should be evaluated rather than data from short periods of time, which often
yields incorrect findings.
As a result, efforts should be made to demonstrate the usefulness of this notion in today's investing
pattern. A vast range of micro and macro variables, such as inflation, demand and supply, money supply,
regulatory bodies, and so on, now impact the investment climate. Aside from the aforementioned
elements, investor psychologies have a significant effect on investing decisions. There are several
psychological elements stated, some of which are comprehensive, such as herding behaviour,
overconfidence, disposition effect, mental accounting, anchoring, and so on. All of these reasons have
sparked investor irrationality, causing them to be biassed when making investment decisions and causing
a stock market bubble. Before constrained rationality theory, or irrational thinking, theory prevailed in the
market termed efficient market hypothesis (rational theory) of decision making, however rational theory
has lost its polish in contemporary market circumstances due to psychological biases. It was also
discovered that all of these psychological biases are impacted equally by demographic characteristics
such as age, education, and experience, all of which are mutually dependant. When these characteristics
are combined, they work differently in different scenarios, such as when an investor is overconfident and
their age is taken into account. The combined influence of these variables created an environment for
securities investing.
In the future years, numerous distinct aspects of behavioural finance are expected to shine. The first is the
management of money and investments. Behavioral finance must be tackled on two fronts by investment
advisors. Advisors must be able to comprehend both the behavioural phenomena contained in pricing as
well as their clients' behavioural biases and heuristics. As a result, I expect there will be more study on
individual investor biases until a standard test for investor biases is developed.
While financial advisers will gain greatly from behavioural finance, corporate finance will as well. This is
because, despite the fact that CFOs and managers in charge of capital budgeting are experts, organisations
nevertheless suffer from overconfidence.
Finally, behavioural finance should focus on two more topics in the future. To begin, scholars must
commit to and support an alternative to the Efficient Markets Hypothesis. This might be the AMH or a
similar hypothesis, as detailed in this study. If this is accomplished, behavioural finance will have a robust
foundation and a clear understanding of how markets actually function. Secondly, it will be interesting to
see if researchers can devise a structure for market life. This means that research should be conducted to
determine whether there is a consistent pattern of behavioural biases or mistakes that investors in
emerging markets exhibit that gradually become less and less BEHAVIORAL FINANCE prevalent as the
market becomes more developed, or whether each economy develops independently based on the
population and its unique elements.
Because the survey's main purpose was to determine the impact of behavioural finance on investment
decisions, we know that most people invest in the stock market but are unaware of the term behavioural
finance, even though they are exposed to it daily. This area of finance should be given more attention
because it has a significant impact on our investment behaviour. With the market's increasing hurdles,
investors can gain and even outperform the market if they carefully assess the various investment
possibilities and assets. Established finance theory has assumed that investors have no trouble making
investing decisions for the previous five decades. Investors are well-informed, cautious, and dependable.
The traditional theory states that investors are not persuaded by their emotions and are not misled by how
information is presented to them. However, reality plainly does not fit these assumptions, causing a shift
in finance theory. Although the behaviour pattern of investing in the capital market differs from that of
general human behaviour, there are some common points such as goal clarity, product understanding, risk
analysis, investment comparison, linkage with individual goals and requirements, and investment time
that are generally acceptable key factors to judge an individual's behaviour and link it with capital market
investment. From this research paper it is concluded that behaviour matters a lot when it comes to making
a wise investment decision and therefore in selecting a particular investment option it requires an
investors complete behavioural pattern which includes various psychological factors. Every Investor
might have a different point of view on a same financial asset this is because the reason for investment for
each Investor is different and the risk bearing capacity is also different for every investor, what is a good
investment for one individual may not be so attractive to other investor. To be a good investor, one must
follow one's own research when examining the various investment routes available in the Indian capital
market and making a final decision on which investment avenue to pursue
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