Behavioral Finance

TITLE: BEHAVIORAL FINANCE

AUTHOR: SHREYA KOTIAN

 

1. Albert (2023) – He states that behavioral finance is a new field of study that examines the impact of psychological elements on financial behavior. It focuses on the deviation from rational choices and the need to find solutions to them. Behavioral finance accepts and uses elements from psychology to explain investors’ behavior, as individuals tend to make systematic errors in decision-making. Traditional finance assumes investors are fully rational and can process information unlimitedly. Behavioral finance does not abandon traditional approaches, but instead allows them to survive. This paper examines behavioral patterns such as herding behavior, overconfidence, introspection bias, anchoring, mental accounting, and loss aversion. Behavioral finance studies examine real behavior of individuals and corporations without assuming specific outcomes. Despite numerous studies and solutions proposed, behavioral finance should not be separated from traditional finance. It was developed to complete and upgrade traditional approaches, not to disagree or run against them.

2. Athota, et al. (2023) – This paper proposes the use of artificial intelligence (AI) to manage behavioral biases in financial decision-making. Cognitive and emotional biases pose a significant challenge for financial planners in making optimal decisions for clients. The study focuses on two common biases: confirmation and hindsight bias. The authors propose an AI method to mitigate these biases using backpropagation and deep reinforcement learning techniques. The backpropagation model within the deep neural network and deep reinforcement learning can manage confirmation and hindsight biases through layers that do not overlap, preventing previous information from influencing the outcome. The authors argue that there is a greater need for financial planners to employ AI technology to overcome cognitive biases in the financial decision-making process, enabling them to make optimal investment decisions.

3. DeBondt, et al. (2010)- The financial crisis is not entirely behavioural, as its origins make us despair about human judgement. These crises are rooted in the unquenchable capability of humans to presume prosperity will continue. The presence of prominent contributors to the behavioural finance tradition, such as Larry Summers and Cass Sunstein, within President Obama’s administration, suggests that the trend of behavioural finance will grow in policy circles. Practitioners spend significant time responding to state intervention in financial markets, making understanding of the behavioural tradition more relevant to professional lives. By recognizing behavioural issues from the crisis, we can reform regulation and partially anticipate problems ahead of time.

4. Khajiev, & Turgunov. (2022) – This paper aims to identify the relationship between financial literacy, a combination of financial experience and learning, and four behavioral biases (overconfidence, representativeness, attachment, and herd city) and investment performance. It also investigates the relationship between these biases and investment performance. The study finds that financial literacy is positively related to self-confidence, negatively related to representativeness, negatively related to herd bias, positively related to retention, and positively related to investment performance. However, overconfidence, representativeness, skepticism, and anchorage are negatively related to investment efficiency, while overconfidence is positively related to representativeness. The findings suggest that understanding behavioral biases in emerging markets is crucial for improving financial performance and efficiency.

5. Parveen, et al. (2023)- The COVID-19 pandemic has significantly impacted global economies, particularly stock markets, leading to increased volatility and market crashes. Behavioral finance concepts, such as representative heuristic, anchoring heuristic, and risk perception, have been used to explain this instability. Representative heuristic involves overreliance on recent information, while anchoring heuristic focuses on the first information and gives it too much weight in decision-making. These psychological biases and heuristics are used to reduce the risk of loss in uncertain markets. However, these biases can lead to wrong decisions, market inefficiency, and irrational investment decisions. Behavioral finance suggests that investment decisions can be irrational due to asymmetric information, highlighting the significant impact of behavioral heuristics on investors during the pandemic.

6. Peyravi, et al. (2018)- The financial activity model proposed by Markuitz is based on the logical actions of investors. But, a new branch of study called behavioral finance has emerged, which is based on the works of Kahneman and Tversky. Behavioral finance suggests that the psychology of investors and their social behavior can affect their financial decisions. The financial behavior of investors in different market periods is not always rational and can have abnormalities, like herding behavior. This research aims to study herding behavior in the Tehran stock market from 2009 to 2014 from two perspectives: standard finance and behavioral finance. The results show that investors in the Tehran stock market tend to follow general decisions rather than making independent financial decisions, which confirms the presence of herding behavior in the market.

7. Pujara, & Joshi. (2020)- This research explores the behavior of individual investors in India, focusing on portfolios, investment preferences, risk perception, investment patterns, awareness levels, and problems affecting investment behavior. The study highlights the importance of returns expectation, demographic profile, and investor personality in financial markets. Understanding investor behavior can help identify market anomalies, help policymakers, investment agencies, and researchers respond to varying moods, and predict decision-making. The research suggests that authorities and governments should devise policies and procedures to create a healthy investment environment and encourage investment decisions. It is also crucial to harness the untapped potential of rural investors to corporate securities. However, traditional and cultural limitations in rural India make it difficult to study investment decision-making. The study recommends policymakers and investment institutions to develop creative ways to harness the potential of future Indian investors. Further research is needed to understand psychological concepts, personality parameters, and available investment avenues. The potential for growth in Indian behavioral finance as a discipline is significant, and further research in this area is recommended.

8. (2023)- Saxena suggests that people often make investment decisions based on emotions and cognitive biases, rather than rational calculations. This research analyzes the relevance of behavioral finance in individual investment decisions. Results show that psychological components such as overconfidence, representativeness, self-attribution bias, familiarity, and representativeness significantly influence investment behavior. These psychological determinants vary depending on an individual’s demographic profile. These psychological components can lead to irrational investment decisions, as people may not remain balanced when selecting investment avenues. This study aims to help financial planners and investment advisors suggest rational and customized portfolios for clients, helping them avoid mistakes that could decrease their personal wealth. The relevance of behavioral finance in investment planning can help financial planners and advisors make informed decisions.

9. Sharma, & Kumar. (2020)- They suggest that psychology literature highlights the numerous biases inherent in human behavior, but the focus is on systematic ones that affect investors’ decision-making and choice clustering ability. Choice clustering is a narrow framing of problems, limiting choices and affecting investors’ choices and preferences based on context and reference points. Investors tend to focus on local choices that may seem profitable, rather than a larger collective outcome, which could be mediocre. This narrow framing can be associated with the issue of narrow framing. Additionally, traditional theorists’ preferences are well-defined, but biases in behavioral finance literature suggest that investors’ preferences are dependent on the context of the problem and reference points.

10. Srinivasan, & Karthikeyan. (2023) – Srinivasan & Karthikeyan collectively say that behavioural finance, a recent field in finance, posits that investors’ decisions are influenced by psychological factors rather than rationality. This approach has gained significant impact in India over the past two decades. It suggests that extraneous factors and emotions do not significantly impact investment decisions. Herding, where investors discard beliefs and information to make other decisions, is another aspect of this approach. Self-efficacy, which regulates motivation, idea processes, and sentimental states, is closely linked to regulating these factors. The study aims to examine the association between self-efficacy and behavioural bias in stock market investment decisions using structural equation modelling. This approach suggests that investors’ intentions are reflected in their estimation of gains, which can be influenced by various factors.

CONCLUSION:

Behavioral finance is a new way of looking at financial decision-making, especially in situations like COVID-19, where biases like overconfidence and herd behavior can affect choices. Financial literacy can help counter these biases, but it may not be enough. Artificial intelligence (AI) has the potential to reduce biases in decision-making. This can be achieved through a process called backpropagation and deep reinforcement learning. Essentially, AI can learn from its mistakes and adjust its decision-making approach to make fairer and more accurate decisions. In Pakistan, the impact of COVID-19 on emerging markets highlights the need for adaptive strategies in the face of uncertainty. Behavioral finance challenges the Efficient Market Hypothesis by offering a more realistic explanation for stock returns and asset pricing movements. The literature shows that emotions, psychology, and market efficiency all play a role in shaping investment decisions. Herd behavior, in particular, can have a significant impact on stock returns and prompt a reevaluation of traditional portfolio selection methods. Overall, these studies show that biases can affect financial decision-making in many different situations. Combining behavioral finance with AI and financial education can help enhance decision-making in complex financial markets. By understanding the dynamics of collective decision-making and adapting to uncertainty, we can make more informed and resilient financial decisions.

REFERENCES:

1. Albert, R. (2023). INVESTIGATING STUDENTS’ BEHAVIORAL BIASES IN REGARD TO FINANCIAL DECISION-MAKING. Studia Universitatis Babes-Bolyai, 68(2), 34-54. doi:https://doi.org/10.2478/subboec-2023-0008

2. Athota, V., Hasan, Z., Vaz, D., Sop Désiré, & Pereira, V. (2023). Can artificial intelligence (AI) manage behavioural biases among financial planners? Journal of Global Information Management, 31(2), 1-18. doi:https://doi.org/10.4018/JGIM.321728

3. DeBondt, W., Forbes, W., Hamalainen, P., & Yaz, G. M. (2010). What can behavioural finance teach us about finance? Qualitative Research in Financial Markets, 2(1), 29-36. doi:https://doi.org/10.1108/17554171011042371

4. Khajiev, B., & Turgunov, D. (2022). The effect of behavioral prejudices on the effectiveness of investments. International Economic Policy, (36), 61-73. doi:https://doi.org/10.33111/iep.eng.2022.36.03

5. Parveen, S., Satti, Z. W., Qazi, A. S., Riaz, N., Samreen, F. B., & Bashir, T. (2023). Examining investors’ sentiments, behavioral biases and investment decisions during COVID-19 in the emerging stock market: A case of pakistan stock market. Journal of Economic and Administrative Sciences, 39(3), 549-570. doi:https://doi.org/10.1108/JEAS-08-2020-0153

6. Peyravi, S., Dehghan, A., & Zadeh, A. A. (2018). The comparative study of behavioral finance approach and standard finance in choosing the optimized portfolio: Evidence from iran. Journal of Economic & Management Perspectives, 12(2), 142-150. Retrieved from https://www.proquest.com/scholarly-journals/comparative-study-behavioral-finance-approach/docview/2266934931/se-2

7. Pujara, V., & Joshi, B. (2020). Indian behavioral finance: Review of empirical evidence. International Journal of Applied Behavioral Economics, 9(3), 54-67. doi:https://doi.org/10.4018/IJABE.2020070104

8. Saxena, P. (2023). Relevance of behavioral finance in investment decision of individuals. Global Journal of Research in Management, 13(1), 1-14. Retrieved from https://www.proquest.com/scholarly-journals/relevance-behavioral-finance-investment-decision/docview/2860831491/se-2

9. Sharma, A., & Kumar, A. (2020). A review paper on behavioral finance: Study of emerging trends. Qualitative Research in Financial Markets, 12(2), 137-157. doi:https://doi.org/10.1108/QRFM-06-2017-0050

10. Srinivasan, K., & Karthikeyan, P. (2023). Investigating self-efficacy and behavioural bias on investment decisions. E+M Ekonomie a Management, 26(4), 119-133. doi:https://doi.org/10.15240/tul/001/2023-4-008