Psychological Theories Of Behavioral Finance

On the other hand behavioural finance defines the market dynamics and movement in terms of psychology of the participants in the trading process. Behavioural finance proposes that the amount of information available in the market regarding the factors that determine the output or profitability of a particular investment actually serve to determine the movement and output of the market itself (Fama, E.F., 1998).

Behaviourists focus on the influence of the environment, they chose not to be concerned with the internal mechanisms that occur inside the organism, they believe that your behaviour depends on what factors are present in the environment at any given time. Another big contributor to this approach is Ivan Pavlov who was made famous for conditioning in which he used dogs in an experiment.

Investing behavior should be driven by information, analysis, and self-discipline, not by emotion or ‘hunch.’

A young person’s path is strongly influenced by their education from day one. Starting in kindergarten, they are asked what they want to be when they grow up, which is usually limited to the options of astronaut, doctor, police officer, fireman, or veterinarian. In his essay, “Preparing Minds for Markets,” Jonathan Kozol addresses the issue of limiting people’s options at a very young age, often based on their race. He uses the phrase “school-to-work” to refer to the goal of schools that do not promote the pursuit of higher education and instead prepare their students to enter the corporate world immediately after they reach their minimum education requirement (Kozol 307). The idea of preparing students for the work world is not detrimental

Behaviourists, believe that all behaviour is a result of a response to a stimulus, with emphasis on scientific and objective methods of investigation. They assume that what we do is determined by the environment and

The behaviourist perspective is an idea that we can understand any type of behaviour by looking at what the person has learner. This includes personality traits such as shyness, confidence, optimism or pessimism. Behaviourist psychologists explain all human behaviour as resulting from experience. Two key psychologists are Pavlov and Skinner, although these two theorists believed that different processes were involved, they both explained all types of behaviour as being the result of learning. This is everything from shyness to aggression and happiness to depression.

Behavioural economics is the study of the effects that psychology has on the decision making of the economy. This tends to be the way that people think and feel when they are spending money on a certain good or service. The great economist Adam Smith was the first follower of this idea through his book “The theory of moral sentiments” which dates back to 1759. However, it took over 100 years to get a more clarified meaning of how big of a role the psychology of a buyer plays in economics. In behavioural economics there are seven basic principles which all contribute to the decision making process. Behavioural economics can explain how people will react to different situations such as times when there are no economic problems and times when

Behaviorism is the scientific approach to psychology that is distinguished by logical-theoretical emphasis as is seeks to develop reasons for behavior (Moore, 2013). The theory of Behaviorism was developed by John B. Watson and B. F. Skinner. Uniquely, this theory states that personality is plastic and can be shaped by the environment or situational influences. Another difference from previous thoughts is

Behavioural Psychology originated in the late 19th to early 20th century and was concerned with the prediction and control of the observable, measurable, external aspects of human experience. Behaviourist psychologists rejected the introspective method used by previous philosophers and psychologists and instead relied on using observation and data that was objective and empirical. This is known as an anti-mentalist approach; Behaviourists considered the workings of the mind

“Behaviorism is predominantly concerned with evident and measurable aspects of human behavior. In defining behaviour, behaviourist-learning theories emphasise changes in behavior that result from stimulus-response links made by the learner. Behaviour is directed by stimuli. An individual selects one response instead

Behavioral analysis is how a person’s behaviours are based on the individuals’ personal history and past experiences. This is different then radical behaviorism, which Skinner fell into. Skinner believed that mental events, such as thinking, were not needed to explain behavior.

Finance is the study of applying specific value to things we own, services we use and decisions we make. Financial management is the process for and the analysis of making financial decisions in the business context. The major subareas of finance are investments, financial management, financial institutions, market, and international finance. Risk is a potential future negative impact to value and or cash flow. It is often discussed in terms of probability of loss and the expected magnitude of the loss.

There is a sense of complexity today that has led many to believe the individual investor has little chance of competing with professional brokers and investment firms. However, Malkiel states this is a major misconception as he explains in his book “A Random Walk Down Wall Street”. What does a random walk mean? The random walk means in terms of the stock market that, “short term changes in stock prices cannot be predicted”. So how does a rational investor determine which stocks to purchase to maximize returns? Chapter 1 begins by defining and determining the difference in investing and speculating. Investing defined by Malkiel is the method of “purchasing assets to gain profit in the form of reasonably

This distinctive book called, “Thinking, Fast and Slow” by Daniel Kahneman, is one of very few exquisite readings I’ve completed so far. Daniel Kahneman is a psychologist in Princeton University, and due to his research, he won a Nobel Prize in 2002 in economics. In the beginning of his book, he speaks of our cognitive System 1 and System 2 ways of thinking. System 1 generates feelings, impressions, and memory. It is very instinctive, automatic, and is considered quick thinking. System 2 on the other hand, is alert during complex problem solving, while dealing with facts and knowledge, and is attentive while working with difficult calculations. For example, a problem such as 24 x 13, this takes more time and knowledge to figure out (System 2), rather then recognizing an emotion from face expressions (System 1). When System 1 is strained, your System 2 steps in to help you process through that specific instant. Now aside from the psychological portion of this book, Mr. Kahneman divulges about a consolidated economic analysis with elemental intuitions from the psychological perspective; such as, luck and skill, overconfidence, risks in the stock market, factors of success and the decision making process. This book is overall concluded with the understanding of behavioral economics, which is the social and cognitive components on economic decisions that are defined by individuals and have consequences that reflect from making those decisions and taking those risks.

The efficient market, as one of the pillars of neoclassical finance, asserts that financial markets are efficient on information. The efficient market hypothesis suggests that there is no trading system based on currently available information that could be expected to generate excess risk-adjusted returns consistently as this information is already reflected in current prices. However, EMH has been the most controversial subject of research in the fields of financial economics during the last 40 years. “Behavioural finance, however, is now seriously challenging this premise by arguing that people are clearly not rational” (Ross, (2002)). Behavioral finance uses facts from psychology and other human sciences in order to