Republic of the Philippines

UNIVERSITY OF NORTHERN PHILIPPINES

COLLEGE OF BUSINESS ADMINISTRATION & ACCOUNTANCY
Vigan City

LEARNING MATERIAL

in

FIN 111 – BEHAVIORAL FINANCE

by:

JONAH VIA C. PECHO

ARLETTE DIAN N. REAL
JOANA E. RIVAD

Series 2022
 Introduction

Elective 4- Behavioral Finance is an elective subject

of the course Bachelor of Science in Business
Administration Major in Financial Management. This
subject focuses on the relationship between finance and
the behavior of humans in dealing with financial matters.
It also focuses on psychological influences in the field of
finance.

It is essential for the students to take the course and

be provided with accurate knowledge, clear discussions
and presentations for them to understand the concepts
and theories of Behavioral Finance.

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 ABOUT THE MODULE

This module covers the Basic Concepts, Theories and Themes of Behavioral Finance. In like manner,
activities must be accomplished to assess one’s knowledge and understanding about the lesson.

Below are the icons to remember:

PRE-TEST. This means that a student needs to undergo pre-assessment to measure his existing
knowledge about the lesson.

LESSON. This means that a new lesson is to be tackled and discussed.

OBJECTIVES. This icon presents the objectives to be met during a discussion.

Self-Test. The student needs to undergo a post-assessment by answering the post-activity.

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 ABOUT THE AUTHORS

JONAH VIA C. PECHO, MBA

Faculty, CBAA-Financial Management Program

Ms. Jonah Via C. Pecho is a graduate of Bachelor of Science in Business and Administration Major in
Financial Management. She obtained her Master’s Degree in Business Administration in July 2021.

Ms. Pecho obtained her Civil Service Professional Eligibility in the year 2015, which motivated her to work
in government offices. She was a former office assistant of University of Northern Philippines from June
2015 to January 2017. She also rendered her service as an Administrative Assistant in the finance
department of Philippine Science High School-Ilocos Region Campus from January 2017 to September
2020.

Currently, Ms. Pecho is a faculty member of the Financial Management Program at College of Business
Administration and Accountancy. She is also an active member of the UNP-Faculty Union.

JOANA ENCARNACION RIVAD

Faculty, CBAA-Financial Management Program

Mrs. Joana Rivad is a graduate of Bachelor of Science in Business Administration Major in Banking and
Finance. In September 2020, Ms. Rivad obtained her Master’s degree in Public Administration.

In the year 2000, Mrs. Rivad gained Sub-Professional and Professional Civil Service Eligibility, which
encouraged her to work in the government field. In 2007, she rendered her service as an office
enumerator in the Philippine Statistics Office (formerly known as National Statistics Office). She even
served as an office assistant at the College of Public Administration from March 2016 to September 2020.
She also rendered her service as a part-time instructor in the same college in August 2019.

Presently, Mrs. Rivad is a faculty member of the Financial Management Program at College of Business
Administration and Accountancy. She is currently a member of the UNP-Faculty Union.

ARLETTE DIAN N. REAL

Faculty, CBAA-Financial Management Program

Mrs. Arlette Dian N. Real is a graduate of Bachelor of Science in Business Administration, Major in Financial
Management. She recently finished her academic requirements in Master in Business Administration and
enrolled for her Thesis Writing.

Mrs. Real rendered her service as an administrative staff at Galleria Entertainments in Dubai, United Arab
Emirates from September 2014 to August 2016. In addition, she also worked as a relationship executive
at WWICS Immigration Services-WWICS Group in the same country.

At present, Mrs. Real is a faculty member of the Financial Management Program at College of Business
Administration and Accountancy.

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 PRE-TEST.

TRUE OR FALSE

Direction: Write True if the statement is correct. If the statement is wrong, write False.

_______________1. Behavioral Finance and Standard Finance are similar.

_______________ 2. Heuristic is a method of finding solutions of problems in a rapid way.
_______________3. Emotional Gap occurs when people with anger or anxiety immediately make
decisions.
_______________ 4. Behavioral Finance describes how their behavior can affect the outcome of their
choices.
_______________5. Risk Perception refers to how a person understands or thinks about possible risks.

Essay:

1. What is Behavioral Finance? (5 pts.)

2. How important is human behavior in financial decision making? (5 pts.)

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 LESSON 1: BEHAVIORAL FINANCE: BASIC CONCEPTS, THEORIES AND THEMES

INTRODUCTION

This chapter covers the Basic Concepts of Behavioral Finance. It also deals with the Theories and
Themes of this course.

Learning Objectives:
 To understand the basic concepts of Behavioral Finance.
 To analyze the difference between Standard Finance and Behavioral Finance.
 To apply in their daily lives the theories and themes of Behavioral Finance.

1. Standard Finance vs. Behavioral Finance.

 Standard/Traditional Finance – This refers to the rationality of individuals especially in

investments. In standard finance, individuals are not swayed by emotions and
expectations. That is why they can rationally make decisions in managing or investing
their money.

 Behavioral Finance - It pertains to the behavior of investors and financial managers in

making decisions in their investments. This also describes how their behavior can affect
the outcome of their choices.

- This usually includes several practices, evidences, theories and experiences of

investors, financial managers and individuals.

2. Heuristics - This is also called the Heuristic Technique. In behavioral finance, this is a method
of finding solutions of problems in a rapid way. Using this approach, investors and financial
managers quickly decide without hesitation to immediately come up with a solution.

Heuristics and Psychology

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 Herbert Simon, who was an American political scientist in the 20 th Century, asked why people,
companies and/or business firms do not act in a rational way. He had observed that these investors would
use shortcuts to immediately get their jobs done.

In fact, Amos Tversky and Daniel Kahneman, who worked at the Hebrew University in Jerusalem,
developed the Prospect Theory, which will help an investor to make decisions by observing their potential
gains or losses.

Recently, several behavioral economists tried to correct people’s irrational way of achieving
outcomes by developing effective measures.

Advantages:

 Delivers an immediate result.

 Speeds up investment decisions.

Disadvantages:
 Can lead to miscalculation of investments.
 Can lead to poor choices.

Types of Heuristic Thinking

a. Availability Heuristic –This is also known as availability bias. Individuals, with this thinking
or approach immediately tend to utilize the information they gather without hesitation
to come up with a decision quickly. This approach can lead to bad choices because it can
give the decision-maker an incomplete set of information. This is sometimes considered
as a mental shortcut.

For instance, an illustration of an investor below, who possesses Availability Heuristic.

He is making a judgement on the level of quality of a certain investment based on what he
gathered from the latest news without verifying the truthfulness of the information gathered.

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Image: https://thedecisionlab.com/biases/availability-heuristic/

b. Representativeness Heuristic - This occurs when individuals make a comparison

between a past event and a current event about a financial situation. In most cases, they
perceive that the two events are similar.

c. Anchoring and Adjustment - This approach occurs when an individual based their
decision on the first information they gathered and will make some changes in their
decisions later once they gather another information.

For instance, if you encounter a pair of shoes that costs P700.00, and suddenly you see
another pair which costs P500.00. You would probably think that the first pair is more
expensive than the second one.

3. Psychological Biases

a. Mental Accounting – It is also called Psychological Accounting. This deals with the
ordinary way of categorizing and/or separating money into different accounts. Individuals
tend to immediately invest and/spend money for a particular thing, without identifying
other expenses that are more important.

b. Herd Behavior - This is simply the behavior of a whole group. This occurs when people act
uniquely from one another and make different decisions. In stock market, investors tend
to rally or argue because of their different decisions and choices.

c. Emotional Gap – This occurs when people with anger or anxiety immediately make
decisions. People with this gap do not make choices logically or rationally.

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 d. Loss aversion – This refers to an investor’s possibility to avoid financial losses. Individuals
have fear to invest because they focus on financial risks, not on financial gains.

e. Hindsight Bias - This occurs when an individual always claims that he is right. With this
claim, some may mistakenly believe that he can predict an outcome.

4. Prospect Theory

Prospect Theory - This pertains to how people come up with their decisions when a certain
theory is presented with uncertainty. According to this theory, investors choose to keep their
capital to avoid loss rather than to invest.

- This theory was formulated by Daniel Kahneman and Amos Tveersky. It was first published in

There are two (2) phases of Prospect Theory

a. Editing Phase – In this phase, choices are presented. An individual is given the chance to
decide what activity to pursue. Individuals in this phase are usually influenced by methods
and orders.

Example: A company is about to go bankrupt. Employees have to contemplate if they will close
the company or not. If not, they have to think of processes how they will overcome the problem.

b. Evaluation Phase – In this phase, once they have the option, they will evaluate using the
statistical analysis in order to assess the performance of a business firm.

The Evaluation Phase has two kinds:

 Qualitative Analysis – This is the process of gathering and collecting important data
such as revenue and wages to assess the status of a certain business firm

Example: Balance sheet of a firm

 Quantitative Analysis - This refers to the perception of a company that are based on
business cycle and other relations. This is used in evaluating business opportunities.
This is also intended to people who are very understanding in terms of business
cultures.

5. Risk Perception

Risk Perception - This refers to how a person understands or thinks about possible risks.

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 - This also pertains to the judgement that individuals when identifying financial
risks.

Weinstein 1989 – Risk Perception goes beyond the individual, and it is a social and cultural construct
reflecting values, symbols, history and ideology.

BEHAVIOR AND PERCEPTION OF RISK

Risk perception is influenced by the following factors:

1. Trial and Error - This is done by executing multiple attempts. This is usually done by organizations,
investors and business firms. In this approach, they try to execute simple steps until they reach
larger opportunities.

Things to consider to adopt the Trial and Error Approach:

 Learn to accept failure.
 Taking risks is sometimes an advantage.
 Must be willing to adapt changes.

2. Mental Models or Strategic Frame

- This is a model which can be utilized on how one is going to interpret something in this world
especially in business.
- A mental model serves as a guide in making decisions and in solving major problems we
encounter in life. Sometimes, some businessmen try to expand their mental models to increase their
efficiency as business operators and to make their businesses more profitable.

An example of a Mental Model is the Eisenhower Matrix

 The Eisenhower Matrix – This is a framework that helps someone identify his
priorities.
- This helps an individual manage his task by identifying the urgent priorities and
important priorities. In

Below is an example of an Eisenhower Decision Matrix. This helps someone organize his task by identifying
the urgent and important. Using the Eisenhower Decision Matrix, one can list down what to do first.

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Image: https://expertprogrammanagement.com/2017/07/the-eisenhower-matrix/

Quadrant 1: Do – This is where one can place any kind of tasks may it be urgent or important.
Quadrant 2: Schedule- This is where you can write down your important but not urgent tasks .
Quadrant 3: Delegate – This is where you can write down your urgent but not important tasks.
Quadrant 4: Eliminate/Delete – This is where you can write down the things that are not so important nor
urgent.

6. Different Thinking Approaches

There are different thinking approaches used by investors and financial managers when making financial
decisions.

a. Convergent Analytical Thinking – With this thinking approach, imagination and creativity is
not necessary for an investor. Instead, a simple and direct will do. A convergent analytical
thinker just needs to recall and apply the formulated procedures in order to solve a problem.

Example: An investor must recall the facts and procedures on how to invest in order to get a high
return.

b. Divergent Thinking - This thinking approach requires an individual’s mind to explore and think
of solutions to come up with correct and rational answers. This is simply the opposite of
Convergent Analytical Thinking.

Example: An individual cannot decide where to invest his money. In this case, he has to
profoundly think twice and decide.

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c. Critical Thinking Skills – This thinking approach requires observation and analysis to form a
rational statement. Critical thinkers utilize three processes: deduction, induction and
abduction. These processes lead them to rational

d. Creative Thinking - This thinking approach requires an individual to think about substitute or
alternative ways to come up with new ideas. A creative thinker always tries to be imaginative
and think of new sets of unique ideas.

Here are some factors to consider to become a creative thinker in finance:

a. Willingness to fail. One must consider taking risks by trying to new business ventures or
by investing their money in business. One may utilize his ideas to succeed.

b. Willingness to work with teammates. Listening to the opinions of teammates in an

organization will help you decide for the better. Investors always need pieces of financial
advice from those who have enough experience in business and investments.

c. Willingness to learn new things. Opening your minds to new knowledge and technologies
may help you succeed as an investor. In this modern era, investing in cryptocurrency or
stock is becoming popular. One may try to learn how to invest in these things.

7. Cognitive vs. Emotional Issues/Bias

 Cognitive Issue/Bias – This occurs when investors/financial managers immediately

make assumptions based on the established concepts. This issue is considered as a
“Rule of Thumb” for the reason that investors make decisions without verifying the
accuracy of the set of the information they gathered.

Examples of Cognitive Bias / Issues:

a. Confirmation Bias – This lets investors stick to their own perceptions. Although they are
open to other sets of information, they only agree to sets of information that match their
perceptions.

b. The False Consensus Effect - This occurs when an individual believes that he has the same
opinion with other people especially in making financial decisions. This may lead to
disappointment, because we may be thinking that people who are similar to us share our
preferences.

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  Emotional Bias – This occurs when investors make decisions based on their personal
feelings. This is not always considered as an error of investors because it helps them
to be careful in making decisions. Sometimes, when this occurs, investors base their
decisions on their personal experiences in investing which enables them to be careful
when making decisions before investing.

Examples of Emotional Bias/Issue

a. Loss-Aversion - This occurs when an investor has no courage to invest because of a certain
past experience about losing money.

b. Overconfidence Bias – This occurs when an investor has this belief that he is better than
any other investors. This can lead to poor decision-making or poor choices because it is
based only on personal judgements.

8. Self-Perception Theory

 Self-Perception Theory - In this theory, individuals observe their own behavior to develop
an attitude and beliefs. For instance, if an investor observes that he continuously likes
investing money, he may conclude that he has a huge interest in investing. To conclude,
when people are uncertain of their attitude, they have to look into their own behavior.

- Self-Perception Theory was developed by Daryl Bem in 1967. Daryl Bem is a Psychologist
in Cornell University. To support his developed theory, Bem cited several studies related
to beliefs and attitudes.

9. Individual vs. Group Behavior

 Individual Behavior – This refers to how an individual reacts to any situation in an

organization or in a workplace.

There are two (2) categories of an individual behavior:

a. Inherited Characteristics – This pertains to the features that an individual inherited by birth
such as Eye Color, Shape of the nose, Religion, etc.

b. Learned Characteristics
- These characteristics can be acquired by observing, discovering, applying or practicing.

Note: No one in this world knows everything at birth. No one was born intelligent. Before
we acquire knowledge from society and school, we learn the basic things at home first.

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There are features of Learned Characteristics:
1. Perception - It is the ability to interpret, observe and identify something through your senses.
2. Values
3. Personality - This is the quality of a person.
4. Attitude

Organizational Behavior - This is simply the study of human interaction and behavior in an organization.

There are 4 types of Organization Behavior:

 Autocratic Model - In this type of model, individuals in an organization are very dependent. They
rely too much on their boss especially in making financial decisions.

 Custodial Model - This refers to the provision of financial security for the employees in an
organization. This will also help the employees in an organization establish motivation to work
hard.

 Supportive Model - In this model, employees in an organization are supported with proper
orientation and guidance by the boss. This will also lead them to establish their own motivation
and loyalty in a firm or in an organization.

Example: New employees in the bank are properly oriented about their tasks before they start
working.

 Collegial Model - Each person in an organization has his/her task. They work together as a team.

Example: In a bank, the labor is divided and distributed to each employee to be able to work
together as a team.

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 Post-test.

Identification.
Direction: Write the correct answer beside each number.

____________ 1. These characteristics can be acquired by observing, discovering, applying or practicing.

____________ 2. This pertains to the features that an individual inherited by birth such as Eye Color,
Shape of the nose, Religion, etc.
_____________ 3. This lets investors stick to their own perceptions. Although they are open to other sets
of information, they only agree to sets of information that match their perceptions.
_____________ 4. This occurs when investors/financial managers immediately make assumptions based
on the established concepts.
_____________ 5. With this thinking approach, imagination and creativity is not necessary for an
investor.
____________6. It pertains to the behavior of investors and financial managers in making decisions in
their investments.
_______________ 7. This occurs when individuals make a comparison between a past event and a
current event about a financial situation.
___________________ 8. This is done by executing multiple attempts. This is usually done by
organizations, investors and business firms.
___________________ 9. This occurs when investors make decisions based on their personal feelings.
____________________ 10. This thinking approach requires observation and analysis to form a rational
statement.

Essay:

1. Differentiate between Behavioral Finance and Standard Finance. (5 pts.)

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-----------------------------------------------END OF MODULE 1-----------------------------------------------

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References

Meir Statman.Behavioral Finance: Finance with normal People.

https://www.sciencedirect.com/science/article/pii/S2214845014000143 . 12 March 2014

https://www.investopedia.com/terms/b/behavioralfinance.asp
https://en.wikipedia.org/wiki/Mental_accounting

https://en.wikipedia.org/wiki/Herd_behavior

https://www.investopedia.com/terms/h/heuristics.asp

https://thedecisionlab.com/biases/heuristics/

https://en.wikipedia.org/wiki/Availability_heuristic

https://www.verywellmind.com/what-is-a-heuristic-
2795235#:~:text=Anchoring,and%20lead%20to%20poor%20choices.

https://www.behavioraleconomics.com/

https://www.businessinsider.com/behavioral-
biases#:~:text=Behavioral%20finance%20biases%20can%20influence,and%20make%20better%20financi
al%20decisions.

https://thedecisionlab.com/

https://www.investopedia.com/articles/investing/051613/behavioral-bias-cognitive-vs-emotional-bias-
investing.asp

https://www.encyclopedia.com/social-sciences/applied-and-social-sciences-magazines/self-perception-
theory

https://thedecisionlab.com/reference-guide/psychology/self-perception-theory

https://helpfulprofessor.com/thinking-skills/

https://www.afponline.org/ideas-inspiration/topics/articles/Details/finance-leaders-need-to-embrace-
creativity.-and-fast!

https://www.slideshare.net/cityuelearning/pm508-week-1-organization-risk-tolerance-behavior-and-
perception

https://www.indiehackers.com/post/5-mental-models-for-running-your-business-78ba35e6bd

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