Course: Behavioral Finance

Unit No.: 01
Lecture No.: 01
Topic: Introduction to Behavioral finance
– Nature, Scope, Objectives and
Application
By
Mr. Srinu Madem
MBA, M.Phil., (Ph.D)
Assistant Professor
Department of Management Studies
Vignan’s Institute of Information Technology
 Introduction
Behavioral finance is a subfield of behavioral
economics, which argues that when making
financial decisions like investing people are not
nearly as rational as traditional finance theory
predicts.

For investors who are curious about how

emotions and biases drive share prices,
behavioral finance offers some interesting
descriptions and explanations.
Nature
 Scope
Behavioral finance has scope in the following domains:

Financial Planning
Budget Analysis
Investor Relations
Banking
Financial Actuary
Accounts
Credit Analysis
Objectives
 Application
Capital Asset Pricing Model (CAPM) and the Efficient
Market Hypothesis (EMH) are based on rational and logical
theories. These theories assume that people, for the most
part, behave rationally and predictably.

However, as time went on, academics in both finance and

economics started to find anomalies and behaviors that
could not be explained by the theories available at the time.
While these theories could explain certain ‘idealized’ events,
the real world proved to be a messy place in which market
participants often behaved very unpredictably.
 Application
People are not always rational and markets are not always
efficient. Behavioral finance explains why individuals do not
always make the decisions they are expected to make and why
markets do not reliably behave as they are expected to behave.

Recent research shows that the average investors make

decisions based on emotion, not logic; most investors buy
high on speculation and sell low in panic mode. Behavioral
finance is a new academic discipline which seeks to apply the
insights of the psychologists to understand the behavior of
both investors and financial markets. It helps us to avoid
emotion-driven speculation leading to losses, and thus devises
an appropriate wealth management strategy.
 Investment cycle
The four phases of the investment cycle are:
1. Plan Strategically
Assess, set and communicate sector priorities, and identify projects for
implementation.
2. Design Investment
Analyze context and alternatives and carry out detailed project design.
3. Implement and Monitor
Get the job done, monitor and communicate progress towards objectives,
make necessary adjustments.
4. Evaluate and Capitalize
Review and evaluate implementation experience to inform scaling up and
future plans and projects.
 Judgment under Uncertainty
“A decision is the is a conclusion of a process by which one choices between two or
more available courses of action for the purpose of attaining a goal”

A decision an act of choice where in a manager forms a conclusion about what

must be done under a given situation. And decision making is a process to arrive at
a decision.

Three aspects of human behavior are involved in decision making:

Cognition-Activities of mind associated with knowledge

Conation- The action of mind implied by such word as willing , desire and aversion.
Affection- The aspect of mind associated with emotion , feeling , mood and
temperament.
Decision making under Uncertainty- When a decision involves condition
about which the manager has no information , either about the outcome
or the relative chances or any single outcome, he is said to be operating
under conditions of uncertainty. Because the manager does not have any
information on which he can develop any analysis, the best he can do is to
be aware that he has no opportunity of predicting the events. Under these
condition, a number of different criteria have been proposed as possible
bases for decision-making.
These are as follows.
Maximizing the maximum possible payoff- the maximum
criterion(optimistic).
Maximizing the minimum possible payoff- the maximum
criterion(pessimistic).
Minimizing the maximum possible regret to the decision maker- The mini-
max criterion(regret).
Assuming equally likely probabilities for the occurrence of each possible state
of nature- The insufficient Criterion(insufficient reasoning).
https://blog.oureducation.in/decision-making-decision-making-under-u
ncertainty/
Thank You