Introduction :
Introduction Investor needs better insight, and understanding of human nature in the existing global perspective, plus development of fine skills and ability to get best out of investments.
In designing the investment portfolio, the investors should consider their financial goals, risk tolerance level, and other constraints.
In the present scenario, behavioural finance is becoming an integral part of the decision-making process, because it heavily influences investors’ performance. They can improve their performance by recognising the biases and errors of judgment to which all of us are prone.
Emergence of Behavioural Finance :
Emergence of Behavioural Finance In the early years, investment was based on performance, forecasting, market timing and so on. This produced very ordinary results.
There was also a huge gap between available returns and actually received returns which forced them to search for the reasons.
In the examining process, they identified that it is caused by fundamental mistakes in the decision-making process. In other words, they make irrational investment decisions.
In recognizing these mistakes and means to avoid them, to transform the quality of investment decisions and results, they realized the impact of psychology in investment decisions.
The researchers began to study the field of Behavioral Finance to understand the psychological processes driving these mistakes.
Definition of Behavioural Finance :
Definition of Behavioural Finance Lintner defines behavioural finance as being ‘the study of how humans interpret and act on information to make informed investment decisions’.
Olsen ‘it seeks to understand and predict systematic financial market implications of psychological decision processes.’
Behavioural Finance Principles :
Behavioural Finance Principles
Heuristic Theory :
Heuristic Theory The decision process by which the investors find things out for themselves, usually by trial and error, lead to the development of rules of thumb.
Representativeness
Overconfidence
Anchoring
Gamblers fallacy
Availability bias
Prospect theory -Kahneman and Tversky :
Prospect theory -Kahneman and Tversky Loss aversion
Regret Aversion
Mental Accounting: Three components of mental accounting receive the most attention.
This first captures how outcomes are perceived and experienced, and how decisions are made and subsequently evaluated.
A second component of mental accounting involves the assignment of activities to specific accounts.
The third component of mental accounting concerns the frequency with which accounts are evaluated and 'choice bracketing'.
Self Control:
Conclusion :
Conclusion Though the above examples of illusions are widely observed, behavioural finance does not claim that all the investors will suffer from the same illusion simultaneously.
Behavioural factors play a vital role in the decision making process of the investors. Hence the investors has to take necessary steps to minimise or avoid illusions for influencing in their decision making process, investment decisions in particular.