Behavioral Finance And Its Effects On The Economy

A barter system is where you take a item and another item and trade them and, sometimes you throw in cash

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).

As an investor one needs to be immune to the emotions of greed and fear. In a bull market people fall victim to greed. They are afraid that if they don't sell

Financial Assets: Robert Shiller, a Noble Prize winner in Economics, has the belief that our cultural and psychological thoughts influence our financial behavior. Shiller highlights the key factors of the irrational exuberance that exists in the financial market. In his book, Irrational Exuberance, he argues that investors often make irrational decisions. Throughout the book, he explains that there are twelve factors that impact the market behavior from 1995 to 2005 and that eventually led to a financial bubble. Some of these factors can be linked to the Black Thursday of 1929.

Understanding behavioral economics will also help in making critical decisions like how much a person need to be saving, how much effort we need to put in our works and where we will choose to live in future.

Lets go back to December 5th, 1996 when Greenspan said “Irrational exuberance and unduly escalating stock prices.” Those words alone triggered markets around the world to decline. The Japanese stock market took a 3.2% plunge and the German market fell 4%. When the stock market opened in the United States, the New York Stock Exchange went down 145 points in 30 minutes.

It is often said that perception outweighs reality and that is often the view of the stock market. News that a certain stock may be on the rise can set off a buying spree, while a tip that one may be on decline might entice people to sell. The fact that no one really knows what is going to happen one way or the other is inconsequential. John Kenneth Galbraith uses the concept of speculation as a major theme in his book The Great Crash 1929. Galbraith’s portrayal of the market before the crash focuses largely on massive speculation of overvalued stocks which were inevitably going to topple and take the wealth of the shareholders down with it. After all, the prices could not continue to go up forever. Widespread speculation was no doubt a

This week’s reading Predictably Irrational was very valuable, and informative. While coming up with so many ways of thinking when it comes to behavior, I had no idea even existed. We talked last week about being rational, but this week and this week’s reading it discussed more about irrational, and predictable behavior. At the end of this summary I hope to have showed and understand the difference when it comes to irrational and predictable theories that can disrupt behavior, and decision making.

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

It was previously assumed that economic investors and regulators (agents) utilised all available information and thus market prices were a reflection of this information with assets representing their fundamental value, encouraging the position that agents’ actions were rational. The 2007-2008 Global Financial Crisis (GFC) is posited to have originated from the notion that all available information was utilised, causing agents to fail to thoroughly investigate and confirm “the true values of publicly traded securities,” leading to a failure to register the presence of an asset price bubble preceding the GFC (Ball 2009).

investors are rational and risk averse, meaning they will always value securities with higher returns than securities with lower returns.

Behavioural Economics is extensively being used to inform and develop policy interventions. Behavioral economics brings insights from psychology and other social sciences into economic models. Behavioural insights are also used for economic models of decision-making. A key feature of behavioural economics is its empirical approach. There is a growing scope of the contribution of behavioural economics to the design and improvement of tax policy. Many behavioural economic ideas have helped develop the traditional economic choice framework, in which people are assumed to make rational, self-interested and consistent choices. But that is not always the case behavioural models suggests often different assumptions which make the predictions of the model align more closely to observed outcomes and which explains the pattern of behavioural not easily

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

For instance, like with this case study, if you were given 10,000 dollars to invest what financial investments would you choose; for me my decision would be as follows: First, I’d choose to invest in General Motors stock which currently cost on average about $6.25 a share, and the current quarterly dividend is rounding up to just over 0.37; or about $1.50 yearly. “Thus, growing in profits with ending results in today’s stock market reaching at the end of day at $45.50 -0.46 – 1.01 %, and after hours at $45.50 0.35 0.78% with an ending volume at 71,447, accordingly, up since the