Journal of Critical Reviews

ISSN- 2394-5125 Vol 7, Issue 12, 2020

ROLE OF BEHAVIOURAL FINANCE IN PORTFOLIO SELECTION AND INVESTMENT

DECISION-MAKING
1Senthamizhselvi.A, 2Vedantam Seetha Ram,
1Research Scholar, Vitbs, Vellore Institute Of Technology, Vellore.
E-mail: [email protected]
2Asst. Professor (Sr.), Vitbs, Vellore Institute Of Technology, Vellore.

E-mail: [email protected]

Received: 07.03.2020 Revised: 09.04.2020 Accepted: 10.05.2020

Abstract
Behavioural Finance is a psychological study in finance, with a special focus on individual level cognitive biases. It emerged over a period
of time; Behavioural Portfolio Theory acts as a base for behavioural finance concept. The behavioural portfolio theory was formulated by
Hersh Shefrin and Meir Statman (2000) via the theory of needs from Maslow (1943). This alternative formulation called Maslowian
Portfolio Theory (MAPT).The origin of Behavioural finance is divided into Psychological, Financial and Economic. Current study is based
on reviewing empirical, conceptual and literature based studies focused mainly on Behavioural Portfolio Theory and the author used
Emerald insight database which compiles specifically the reputed Investment Journals for the time period 1960-2017.This paper helps in
better understanding about the emergence and evolution of Behavioural Finance and how it helps to understand the orientation of
investors towards their portfolio construction and investment decisions.

Keywords: Behavioural biases, Behavioural Finance, Investment decision making of individuals, Behavioural Portfolio Theory.

© 2020 by Advance Scientific Research. This is an open-access article under the CC BY license (http://creativecommons.org/licenses/by/4.0/)
DOI: http://dx.doi.org/10.31838/jcr.07.12.60

INTRODUCTION application of sophisticated statistical tests and this has

In recent times, capital markets are attracting the attention of challenged neo classical finance researchers preferring
retail investors across the globe and this number is increasing behavioural theories application in economics and finance
due to diversified reasons like declining interest rates, insecurity [Kahneman and Tversky (1979), Fama (1998)].
and volatility amongst fixed income securities, increasing
awareness about investment options, trading through the proper Prospect theory is an example for understanding the importance
means, increasing role of technology in capital markets and their of Behavioural Finance (Kahneman and Tversky, 1979). It is a
tech savvy investors etc. However, to understand this whole descriptive theory of choice under uncertainty based on the
process, behavioural finance acts as a catalyst and helps us as a outcome of numerous experimental psychological studies. In the
medium both for reasons and causes for those reasons. Annual General Meeting of 1984, Fisher Black, the then President
of American Finance Association, has supported the concept of
Behavioural finance refers to the psychology of finance and behavioural Finance and after one year, Journal of Finance has
people dealing in finance. This subject contributes and affects published two papers based on prospect theory to market
finance in multiple ways as it evaluates human desire and the pricing. This theory has become the foundation for behavioural
motivating factors of desire in making investment, there by approach in economics after integrating several psychological
contributing to value maximization of investments made. It is an biases such as loss aversion, conservatism, anchoring, frame
interdisciplinary subject with flavours of psychology, economics dependence and disposition effect. Later in 1980s, behavioural
and sociology (Ricciardi and Simon, 2000). finance concept has come into existence along with financial
economics(Slovic P).Later on, many books and papers have been
Advances in psychology and economics as contributors to one published on behavioural finance that leads to the development
another are coined by researchers decades ago (Simon, Slovic, and progress of this concept(Schleifer.A, 2002).
Kahneman and Tversky, Shefrin2002). Economics does follow
psychology theories and sometimes it so appears that Origins of behavioural finance:
economists as psychologists in their thinking (Adam Smith, Behavioural Finance emergence is based on three aspects namely
1790).Behavioural approach in capital markets has emerged in psychological origin, economic origin and financial origin. The
1980s (Schinckus, 2009). Investor’s behavioural analysis started psychological origin seems to be clear in the minds of
in early 20th century in the book titled “The story of Behavioural theoreticians Thaler and Mullainathan (2000),who explain
Finance” by Adams and Finn (1980). clearly that behavioural finance; comes from an interdisciplinary
field of finance where cognitive psychology and economics,
Importance to psychology in economics started with the together yield effective results. The main paradigm of psychology
observation of anomalies and puzzles faced by theorists in their is cognitive psychology, social psychology, behavioural aspects,
research where the main stream theories couldn’t provide a Freudian psychology and socio linguistics.
solution (Scheilfer, 2000).Efficient market hypothesis (EMH) is Cognitive psychology studies about internal mental process such
an example to this in 1960s. Due to the adoption of EMH theory, as problem solving, language and memory (De Mijolla, 2002). It
earlier theories such as CAPM started showing inconsistent includes various aspects such as perception psychology or
results and neo classical researchers like Ball (1996) were memory learning study. This concept was used in Gestalt
concerned about these anomalies and their influence in psychology in 20th century by Max Wertheimer and Wolfgang
economics studies and started looking for a solution that led Kohler. Through this concept, people can understand the objects
them to understanding behavioural finance as one of the and scenes in the simplest manner. It is also referred to as “Law
solutions. Anomalies’ influence can be minimized with the of Simplicity”. Authors from behavioural finance clearly

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 ROLE OF BEHAVIOURAL FINANCE IN PORTFOLIO SELECTION AND INVESTMENT DECISION-MAKING

mentioned that this field of research comes from cognitive on what investors can do and not on what they ought to do, he
psychology. Behavioural finance should be considered to be provided descriptive approach of behavioural finance. Graham
similar to the paradigm of behaviour, which means a collection of used several themes which focus about the investors’ activity in
assumptions based on comprehending the process of learning in behavioural finance.
terms of behavioural principles and these two are based upon
experimental approach that will not exhibit the results in the Development of behavioural finance theory:
same way. The behavioural finance is emerged as a new field of research of
finance studies after 1990s (Helen and Simon, 2000).Researchers
Behavioural paradigm arrives from the internal human mind, note that the discipline of financial studies developed from an
without recourse of internal introspection. Psychology refers to efficient market hypothesis to behavioural finance theory via the
thought of, something esoteric in its methods. “If anyone fails to supremacy of the theory of rational expectations in the 1970s
reproduce other’s thoughts or findings, it is not due to fault in and a near correlation between the theoretical patterns of that
their approach or the research procedure followed or their time and the available information implemented by changes in
equipment or in control of the stimulus; rather, it is due to the resources and stock systems. (Robert Merton, 1973). Individuals
fact that introspection of the researcher is untrained” (Watson, are key parties in behavioural studies in psychology studies;
1913, p.163). Neglecting the subjective dimensions of human same is the case with behavioural finance. Charles Mackay
behaviour and by focusing only on the results of behaviour, the (1841) explains about crowd mentality and their psychology and
behaviourist approach would probably be closer to neoclassical behaviour in financial markets in his book “Memoirs of
finance (Lewin,1996). Extraordinary Popular Delusions and the Madness of Crowds”.
The economic origin of Behavioural Finance deemed to happen This shows relevancy of divergent studies and their inter
in 1950s and slowly developed as a discipline by connectivity influence on modern day finance over centuries and
1970s.Behavioural approach claims to be more descriptive than decades.
neo classical approach (Solvic et al., 1982); while prospect theory
which can be seen as the first theoretical foundation of Controversy surrounding behavioural finance theory:
behavioural finance (Kahneman and Tversky, 1978). It is the analysis of psychological influence on investor behaviour
Perseverance of psychological approach by economists started or financial analysts. Investors are not always rational; they have
after 1920s only; however, psychology concepts have not their limitations and are also influenced by biases inherent. The
developed enough clarifications through its theories to fulfil all main disadvantage of behavioural finance is standard finance,
the questions that arouse due to the emergence of a cognitive commonly known as modern portfolio theory where investors
approach in economics (Coats, 1976).Behavioural economics are logical, markets are effective, and investors must plan their
concerns with how feelings and human attitude structure affect portfolio construction is based on mean portfolio theory and
the decision-making process (Anger and Lowenstein, 2007). expected portfolio return. For standard finance it is Modern
Portfolio Theory and Efficient Market Hypothesis (Helen and
Some economists denied that psychology could be relevant to Simon, 2000). Such widely accepted theories compare with the
economic theory which had a notion to focus on value and not on behavioural finance ideas, according to which the factors behind
the motivation of people(Coats, 1976; Reynaud,1961 and investors financial decision-making include the emotional
Camerer &Lowenstein, 2002).Some other researchers felt that aspects which influence investors, presence of mind of investors
most anomalies of neoclassical finance have been enhanced due when making investment decisions, and the investment trend
to advances in cognitive psychology and experimental economics that other investors adopt when making the decisions properly.
(Aktas, 2004).
REVIEW OF LITERATURE:
After understanding about economic emergence and
The researchers wants to understand the behaviour of an
psychological aspects of behavioural finance, it is about finance
investor investing in a market which is not developed but
origins of behavioural finance that needs to be understood. In
developing by considering all important relevant factors and
1950’sbehavioural finance was not an identified field; rather, it
important aspects through the lens of Behavioural Portfolio
was a kind of protoscience (Jovanovic, 2008).However, it is found
Theory (Shefrin and Statman, Ahamed Ibrahim and Tuyon ,
that by using Gaussian framework, the founder of cognitive and
2017).
experimental psychology, researchers tried to find statistical
correlations between mass psychology and financial quotations The findings summarized in their Behavioural Portfolio Theory
(Fechner, 1897) and also the psychological dimensions of (BPT) by Hersh Shefrin and Meir Statman (2000) are in
financial markets (Aftalion, 1927, Robert Milles, 1928 and accordance with the more general psychological theory on the
Donner, 1941). There are researchers, who considered the hierarchy of needs as formulated by Abraham H. Maslow (1943)
complexity of human behaviour in financial theory and financial and this has already been noted by Philippe De Brouwer, 2006).
originators in understanding behavioural finance (Selden, 1912, The study by Maslow shows that need hierarchy theory is
Keynes, 1921 and Graham and Dodd, 1934). sufficient to obtain a framework of behavioural portfolio theory
and many practitioners can make use of it.
The advancement of behavioural finance can be found in
Grahams works. He wrote two books which focus particularly on In his research, the authour utilized behavioural portfolio theory
investments: Security Analysis: Principles and Technique to explain the needs of people and their emotional and cognitive
(Graham, 1934) and The Intelligent Investor (Graham, 1949). shortcuts. People are normal, according to Behavioural Finance
The investors’ decision depends on their intelligence and he Theory they build a portfolio as mentioned in Behavioural
reminded the word “Intelligent” used in his second book which Portfolio Theory, where the portfolio of individuals wants to go
explains the capacity of knowledge and understanding. The beyond high expected returns and low risk, such as social
notion Graham used Intelligence refers to personality and status and social responsibility. People save and spend as defined
psychology of investors. Several psychological biases or in the theory of behavioural life cycle, where barriers such as
anomalies used in behavioural finance can be found in the words weak self-control make it challenging to discover and pursue the
of Graham. He wrote “The Speculative public is incorrigible”. right way to save and spend (Meir Statman, 2017).
Graham was a historian and a great psychological thinker who The researcher used behavioural portfolio theory method to
did not consider the financial reality as fixed and a historic but understand the perception of investors has a strong and
rather as an evolving and historic system. Moreover, by focusing

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 ROLE OF BEHAVIOURAL FINANCE IN PORTFOLIO SELECTION AND INVESTMENT DECISION-MAKING

significant impact on financial decision making by using case making proper and absolute investment decisions was explained
study and descriptive analysis method (Raza, 2014) by Robert Olsen (1998).
Depending on behavioural portfolio theory, the idea of People are systematically moving away from judgment and
behavioural finance seeks to add some cognitive psychological decision making. They demonstrate this by integrating aspects of
elements based on investor and manager behavioural human nature into financial models, behavioural finance
observation and examination, using advanced mathematical and enhances economic knowledge. Investors who consider investors
statistical prototypes of modern corporate finance. The model to be savvier are more vulnerable to cognitive bias. The author in
used here in finance and economics should be different from the his book “The courage of misguided convictions”, felt that people
other models and techniques being used in physics and other become overconfident and invest without considering risk
natural sciences. This study had been used to understand the associated in it that affects the rational decision making of
psychological and cognitive thoughts of individuals in investment investors in investment activity (Barber and Odean, 1999).
activity and their portfolio selection based on continuous
observation and examining them (Todorovic, 2011). The authour defines behavioural finance as the psychology and
sociology combination and interaction with practitioners
The American psychologists introduced a new concept of financial habits and outcomes. He also notes that “the mistakes of
"cognitive dissonance theory" in social psychology. When the one investor may turn into the gain of another investor” (Shefrin,
psychologists performed behavioural evaluations, they 2000). “Behavioural finance comes from interdisciplinary
witnessed that the cognitions were inconsistent and proceeded evolution of finance where psychological dimension has been
to understand if this could result in cognitive dissonance and introduced. Psychology is a scientific discipline with different
eventually realized that if the dissonance experience was paradigms which have their own way of thinking which includes
unpleasant, the person may try to reduce it by modifying his or various fields such as cognitive psychology, behaviourism,
her beliefs. (Leon Festinger, Riccken and Schachter, 1956). Freudian psychoanalysis, social psychology or psycho linguistics
represents the main paradigm of this discipline”(Thaler and
Investors will have cognitive and emotional weakness which Mullainathan , 2000).
affects their decision making towards investment activity.
Scientifically, this study shows how investors do not act The emergence of behavioural paradigm in 1980’s as a result of
rationally and clearly explores the relationship between different convergence of psychology and financial economics
demographic factors and investors’ personality (Manish Mittal advancements. Although authors from behavioural finance
Vyas, 2008). mention rightly that their field of research comes from cognitive
psychology, one could think that behavioural finance would be
Based on the investor’s rationality, investment managers should closer to behaviourist paradigm. However it is not the case,
consider the psychology of a person that plays a substantial role because theory must be distinguished from method. Though
in the behaviour in financial market. Cognitive and motivational behavioural and behaviourist paradigm both based on
factors affect the decision making of investors such that the experimental approach, results will not be explained in the same
investment managers can understand the context of their client manner (Adams and Finn, 2006).
(individual investors) better and thereby help the clients better
and bring in a positive change in their investment decision The advances made by psychologists came to the attention of
making based on demographic factors such as age, gender, economists; behavioural finance starts to flourish rapidly.
marital status, level of satisfaction towards investment, annual Despite diversity of theoretical research using behavioural
income, occupation and number of dependents (Mugdha portfolio theory approach, all these works are based on three
Shailendra Kulkarni, 2014). themes. The first one is the existence of bias based on psychology
which influences the human decision-making process. The
The authours focused on prospect theory and examines that second theme is based on these biases cause differences between
when people making financing decisions, they consider the theoretical rational behaviour and individual’s behaviour
riskiness and risk free alternatives, and how it helps to make a observed in reality and the last theme is the decisions taken by
better choice in investment activity (Shefrin, Kahneman and the individuals are based upon heuristics and rule of thumb. This
Tversky, 1971 and 2001). kind of phenomena has been emphasized by cognitive
The cognitive psychologists in behavioural finance and psychology and it can be observed by different biases like
behavioural economics are Daniel Kahneman and Amos Tversky. overreaction, underestimation, regret or conservatism.
In 2002, for his contributions to the theory of rationality in Behavioural finance postulates the human behaviour is
economics, Kahneman received the Nobel Memorial Prize in influenced by formulation of problems (Shefrin, 2002).
Economics. Both Daniel Kahneman and Tversky have based The author explained in his study how the behavioural bias can
much of their work on cognitive biases and heuristics, which be categorized and it depends on the behaviour of investors
implies problem solving strategies that lead people to engage in which is classified namely psychological, demographic, social and
unexplained irrational behaviour. Their research work involves economics. Psychological factors such as overconfidence,
loss aversion and prospect theory. In 1979, Kahneman and disposition effect, herd behaviour, gambler’s fallacy and hand
Tversky focused specific towards behavioural portfolio theory fallacy on Investor’s behaviour in investment activity helps to
and prospect theory, which helps for making better investment understand to take wise investment decisions (Shafi, 2014).
choices. Due to the factors of cognitive bias and heuristics,
investors make irrational decisions. Because of use of mental In a certain literature survey study on 117 peer reviewed papers
shortcuts, intuitive judgment made by investors in investment published on behavioural biases spanning from 1980-2013
activity by following certain strategy or rule of thumb, which published on different databases such as EBSCO, Science Direct,
leads to cognitive bias. The result of their study is that the Proquest and Emerald Insight to understand the impact of
attitude of investors varies when they face uncertain loss or gain. behavioural biases on investment decision making and to assess
why investors behave irrationally. For this, the researchers
The comparison of behavioural finance vs. old school thought of selected four common behavioural biases (Over confidence,
standard finance, the behaviour and psychology that influence herding and disposition effect familiarity and home bias) that
the investors and portfolio managers to make better decisions in encourage investors to deviate from rational behaviour and
terms of risk assessment (Statman, 1995)."New Paradigm" for make them to take irrational investment decisions. The bias of
understanding and forecasting investors systematic behaviour in overconfidence is divided into two groups, such as demographic

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 ROLE OF BEHAVIOURAL FINANCE IN PORTFOLIO SELECTION AND INVESTMENT DECISION-MAKING

variables and trading behaviour, the psychological dimension of be easy to adjust to keep profitable and competitive in order to
the person and trading pattern. The effect of disposition shows satisfy these changes by investors(Alinvi and Babri ,2007).
the effect on expenditure of tax assessment, demographic
variables and investment returns. Herding bias focused towards The researcher tried to categorize investors based on the relative
institutional investors, individual investors’ analyst’s ability to take risks and the type of investment they make.
recommendations and herding in financial markets. Home bias Factors such as Age, income, education and marital status affect
focused towards individual investors and home bias, institutional an individual in investment decisions (Manish Mittal and Vyas,
investors and home bias puzzle and portfolio selection (Satish 2008).
Kumar and Nisha Goyal, 2014). The research is based on the selection of portfolio and provides
Behavioural finance offers an alternative foundation block for the better results like how to diversify the investment options in
each of the foundation blocks of standard finance, incorporating to various aspects namely risk, returns, safety and security
knowledge and people’s wants and their cognitive and emotional (Dr.Nandagopal, Satish.M, Naveen K.J and Jivenatham.V, 2011).
shortcuts and errors. As per behavioural finance, people are The authours studied to understand the various investment
normal; people construct portfolios as described by BPT, where alternatives using tools such as correlation and chi-square which
people’s wants extend beyond high expected returns and low are exists in the financial market. The results of the study are
risk, such as for social responsibility and social status. People female investors are more risk prone in investment activity in
save and spends as described by behavioural life cycle theory, India. Percentage of income invested by the investors depends
where impediments such as weak self control, makes it difficult upon their annual income. As the age of the investors increases
to follow and find the right way to save and spend money. the risk tolerance level decreases. Women investors in the study
Markets are not efficient in the sense that prices equals value in are more attracted towards investing in gold than other
them, but they are efficient in the sense that they are hard to investment options. The decision of the investors should be
beat. By behavioural asset pricing theory, expected returns of based on their own initiative. Most investors’ prefer to park their
investments are accounted for, where differences in expected funds in gold, mutual funds, bank, life insurance since they feel
returns are determined by more than differences in risks, such as that safety and risk factor is low when compare with other
by level of social responsibility and social status (Meir Statman, investment instruments (Dr.S.Suryamoorthy, B.Narayan and
2015). M.Arivuazhagan, 2012).
Behavioural finance is, on the one hand, a relatively new The second generation of behavioural finance offers lessons to
scientific discipline based on behavioural and cognitive financial planners, some old and some new. One lesson rooted in
psychological theories and on the other, conventional economics understanding normal people is to begin by probing clients’
and finance. The latter has the challenge of explaining why some wants and needs, proceed by helping them to satisfy their needs
people make irrational financial decisions (Hellmann, 2016). and wants by avoiding cognitive and emotional errors. For some
Portfolio selection and investment decision making: clients wants to combine wants for wealth with wants for staying
true to values, whether protecting the environment or adhering
Financial market behaviour and consumer expectations on to religion. But many refuse to maximize their wealth first, and
ordinary life insurance purchases has been studied and then use it to satisfying the wants of staying true to values.
concluded that demand for life insurance is inelastic and affects Financial planners do well build portfolios that satisfy clients’
consumer feelings (Headen and Lee, 1974). It is found that age, wants for staying true to values while minimizing injuries to
gender, income and education affects the preference of investors. clients’ wealth.
The pattern of investing, the style of investment and the
orientation towards investment avenues differs based on age and A lesson rooted in behavioural portfolios is to build portfolios as
income (Lewellen et al., 1977). pyramids of mental accounts; each associated with a want,
whether it is retirement income or education for children and
The researcher found the mutual fund's preference for other grand children, and perceives and explains risk as shortfall from
financial assets. He has conducted a survey of household wants, not as volatility or losses.
investors. The study result shows that they are most likely to be
preferred due to some factors that are very easily acceptable to A lesson learned through behavioural efficient markets is to
investors (Gupta, 1994) know the difference between price equals value markets where
bubbles are impossible, and hard to beat markets, where bubbles
The authour found various schemes for the investors to invest in are possible and very hard to identify in time and it dissuades
mutual funds namely equity linked saving scheme is most clients from jumping too fast from the facts that bubbles occur to
advantageous to the investors who invest in this particular the conclusion that they can identify, them in time. In other
scheme (Kulshreshta, 1994). words, markets may be crazy, but this does not make you a
psychiatrist (Meir Statman, 2015).
The authour conducted a survey aimed at understanding the The researcher indicated that there is a significant role of income
behavioural characteristics of the north-eastern region towards and occupation in the selection of investment avenues and the
selecting investment portfolios and assisting them in making risk associated with that by both male and female investors. Age,
sensible investment decisions (Sikidhar and Singh, 1996) Gender, Educational Qualification, Geographical horizon of the
The authour explained about the various investment Strategy, investors, risk tolerance capacity and risk bearing capacity
perception of the investors and factors that motivates the impacts the portfolio selection made by the investors
individuals to make better investment decisions (Shanmugham, (D.Harikanth and B.Pragathi, 2017).
2000)
NEED FOR THE STUDY
The authours studied about the perceptions of various bank With the changing time, money resource, preferences, options in
depositors on quality circles, quality banking, telebanking and market, risk taking levels and returns expectations of investors of
customer needs and preferences in private banks (Sochand diversified class and gender, it is impetus to learn the change
Sandhu, 2000). over time such that an effective investment decision can be made
by individuals while constructing their investment portfolio.
The opinion of the researcher was that investors ' choices and
Hence this study gives clarity about the portfolio selection trend
preferences are constantly changing, and it is the organization to
studies over decades.

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 ROLE OF BEHAVIOURAL FINANCE IN PORTFOLIO SELECTION AND INVESTMENT DECISION-MAKING

OBJECTIVE OF THE STUDY investment avenues (12), pattern of investment (8), decision
To review research papers on behavioural portfolio theory and making of investors (11) and behavioural biases affecting the
understand the orientation of investors towards their portfolio individuals in investment activities (4). Papers examining the
selection and investment decision over six decades using Maslow’s hierarchy needs and how this theory contributes to
empirical, conceptual and literature review based papers. behavioural portfolio theory have appeared more suitable to the
current research study.The study in addition utilises one
METHODOLOGY research paper focused on the theory of behavioural finance
The study is carried out to understand the concept of evolution, emergence and how it contributes to investment
Behavioural Portfolio Theory (BPT) and its role in investment decision making for the individual investors. Emerald Insight and
portfolio selection of individual investors. For this, the Elsevier databases helped the researcher in gathering necessary
researcher used 50 papers which includes empirical, conceptual information. The emergence of behavioural finance to the rapid
and review papers from 1960-2017 period. The reason for development it has achieved through a period of time (1960 to
choosing post 1960s period for the research was due to the 2017) is the focal point of the current study. The research papers
development of the behavioural finance concept over a period of references which have been reviewed to understand the focus
time. Out of 50 papers in total, five papers focus specifically areas of this study is summarised in Table–1. The study spans
towards BPT and its contributions to portfolio construction and around six decades and the below mentioned table helps to
investment decision making by the individuals. The remaining comprehend an overview of the various studies under five
papers (45) used for the study concentrates on other aspects mentioned focus areas in all these years.
such as investment portfolio (10), how the individuals choose the

Table–1: Specific Aspects on Investment Portfolio Selection and Decision making

Sl. No Focus Area Research paper(s) referred
(Number of papers)
1 Behavioural Shefrin and Statman, Ahamed Ibrahim and Tuyon (2017), Raza, (2014),
Portfolio Theory (4) Meir Statman (2017), Todorovic (2011).
2 Behavioural Biases Satish Kumar and Nisha Goyal (2014)
(1)
3 Investment Barberies N and Huang M (2007), Barberies N, Huang and Santos T (2001),
Portfolio Selection Ellsberg D (1961), Kahneman D and Tversky A (1979), Preethi
and Investment Singh(2006),Slovic P, Kahneman D and Tversky A(1982), Sikidhar and
Behaviour (10) Singh (1996), SochandSandhu (2000), Dr.Nandagopal, Satish M, Naveen K.J
and Jivenatham .V (2011), Harikanth.D and Pragathi.B (2017).
4 Investment Decision S.Suryamoorthy, B.Narayan and M.Arivuazhagan(2012), D.Harikanth and
Making (08) B.Pragathi (2017), Manish Mittal and Vyas (2008), Barber and Odean
(1999), Shafi (2014), Gupta (1994), Kulshreshta (1994), Shanmugham
(2000)
5 Behavioural Shefrin (2000), Shefrin H (2002), Adams B and Finn B (2006), Camerer C
Finance, and Loewenstein G (2002), Coats W (1976),De Mijolla (Ed.) (2002), Fama E
Psychology, (1998), Hosseini, H. (2003), Jagadeesh, N. (1995),Thaler R (1999), Thaler R
Economics (22) and Mullainathan S (2000), Tversky A and Kahneman D (1974), Schleifer A
(2002),Shefrin H (2002), Simon H (1976), Statman M(1999), Leon
Festinger, Riccken and Schachter (1965), Mugdha Shailendra Kulkarni
(2014), Robert Olsen (1998), Meir Statman (2015), Hellmann (2016),
Lewellen et al. (1977).
Source: Different papers from databases such as Emerald Insight and Elsevier

Table 1.1: Focused Aspects on Behavioural Portfolio Theory and its outcome
Sl. Focused Time Coverage Total No. of Most popular outcome of the paper (s).
No. Aspects/Theory period papers/Theoretical
Empirical/Review
1 Behavioural Bias, 2000- Investment (4)Review and To analyse the impact of Cognitive
Gender based 2017 Decision making, Empirical biases on trading behaviour, volatility,
behavioural bias/BPT Investment market returns and portfolio
profile and construction during 1980-2013 period
behaviour of based on 117 articles published in peer
individuals with reviewed journals. To know the
demographic behaviour of individuals’ influence on
factors the investment behaviour based on
gender.
2 Investment portfolio 1980- Investment (18)Empirical It helps to analyse the investment
selection, Preference 2017 preference and pattern and style of investors based on
and Investment behaviour based geographic and demographic variables.
Behaviour on It varies according to demographic
demographics, variables. Both male and female have
pattern of tendency to invest and with any
investment educational back ground wish to invest
though the amount may be

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 ROLE OF BEHAVIOURAL FINANCE IN PORTFOLIO SELECTION AND INVESTMENT DECISION-MAKING

disproportionate to their income. This

clearly states that different respondents
wish to invest in different investment
avenues. The respondents after knowing
about the risk and return characteristics
of a particular product in the markets
and will start to invest later.
3 Investment Decision 1990- IDM based on (12)Empirical and Investment decisions of Research in the
making 2017 Demographics Review based field of BF stated that investors are not
and Geographical fully rational and markets are not fully
variables, other efficient. So, the financial managers need
factors which to shape the financial and investment
influences the decisions taking into account of
individuals in irrationality of the investors. Based on
investment demographic factors such as age,
decision making income, qualification and experience
people do not prefer to take risk in
investing in capital markets, investors
prefer to invest in post office savings
securities which is risk free investment
as well as provides more returns back
than bank deposits.
4 Behavioural Finance, 1960- Emergence of BF, (11)Empirical, How the Behavioural finance concept
Psychology and 2016 contributions of conceptual and emerged and to understand in depth
Economics psychology of Review about it.BF has a new paradigm and
investors based model that successfully attempted to
on value and life challenge and defeat with traditional
style and financial theory. Within short span of
behavioural time, it attracts the academia's attention
economics and established itself as new dominant
theory rather than simply an alternative
model for investing. By focusing
individual investors, BF is acknowledged
as a new, more comprehensive and
evolutionary and theoretical framework
that enables enhancing investing
process. The review article which
explains about how the behavioural
finance concept emerge and developed
so far. The study talked about
behavioural economics, finance and
psychology.
Source: Different papers from databases such as Emerald Insight and Elsevier

Table–2 explains in detail about the contributions of BPT and how it helps individual investors in portfolio selection and to make
investmentdecisionsbyindividuals.

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 ROLE OF BEHAVIOURAL FINANCE IN PORTFOLIO SELECTION AND INVESTMENT DECISION-MAKING

Table – 2: Behavioural Portfolio Theory papers and its outcome

Relevancy to the
Title of the Author Outcome linked to objective
Objective(s) Outcome objective of current
paper (s) of current study
study
Behavioura Hersh To describe The result shows that This study It helps to understand how
l Portfolio Shefrin the BPT mean variance concentrates on BPT contributes in portfolio
Theory and theory, an investors cares only BPT theory and construction and investment
Meir alternative for expected returns how it helps decision making by
Statma descriptive and variance of investors in managing risks and focusing
n theory from overall portfolio, not constructing their towards achieving
(2000) Markowitz’s its individual assets. portfolio. investment goals.
mean They have consistent
variance attitude towards risk
portfolio and they are always
theory, it averse to risk,
links between whereas behavioural
construction investors are
of portfolios different, they build
and design of portfolios as pyramids
securities. of assets, layer by
layer associated with
particular goals and
particular attitudes
towards risks.
Portfolio construction
is done based on BPT.
Focused on two
aspects. 1. To provide
a protection layer to
prevent financial
disaster.
2. To become rich in a
short span of time.
Review of Anjum What BF BPT and behavioural BF substitutes BPT Both BPT, mean variance
BF as an Raza offers for finance helps to for mean variance portfolio theory helps BF and
emerging (2014) investment understand the portfolio theory suggests the way for the
field of IDM decision behavioural factors and behavioural investors for portfolio
making? How that investors has and asset pricing model selection and decisions.
and why BF is how it helps them to for CAPM. It
a controversy take investment explores the
in financial decisions. Behavioural domain of finance
decision finance acts as an beyond portfolios,
making? emerging field for asset pricing and
What is financial decisions. market efficiency,
projected savings and
future for BF? spending behaviour
How and explores
researchers financial choices
and financial affected by culture,
theorists social responsibility
works for and emotional
further to wants. BPT explains
value the how to choose a
contribution wise portfolio.
in this field?
BF and Rade BF and the Based on BPT, According to It satisfies the portfolio
investment Rakoce role of risk in Investors have investors’ personal construction and strategies
decision vic et decision diversified portfolios. preferences, to achieve the investment
making al. making, BF Investors should portfolio selection goals in better manner.
(2014) theories follow a strategy for and decision should
helps to take their investment be made. It is clear
better activity. that all necessary
investment information related
decisions. to investments are
not available, so the

Journal of critical reviews 326

 ROLE OF BEHAVIOURAL FINANCE IN PORTFOLIO SELECTION AND INVESTMENT DECISION-MAKING

real investment
strategy should not
only depends on
market efficiency
alone. It is very
hard to study the
behaviour of
investors. It helps
to understand in
depth about the
decision making
process of investors
and their market
strategies.
Institutiona Zamri To analyze Investors' irrational How the BPT by Hersh Shefrin and
l investor Ahmad the BPT behaviour has been behavioural biases Statman (2000) highlighted
behavioura et al. theory and neglected in
and its effects helps the need to manage
l biases: (2017) empirical behavioural finance to concentrate on behavioural risks influences
syntheses evidence of research. Heuristics portfolio to investment portfolio
of theory institutional and behavioural construction how returns through portfolio
and investors bias biases are complex. the role of BF helps selection and diversification.
evidence specifically Understanding about in investment This study helps to
towards behavioural biases,
decision making. understand about the market
investment origin, cause and behaviour and also makes to
activities effects requires know about the direct impact
worldwide interdisciplinary of investment decision
through perspective from the making of irrational
behavioural various fields of investors through
finance sociology, psychology combination of sociology,
paradigm. and biology. To psychology and biological
understand the forces.
investor individual
behaviour through
observations,
interviews and
controlled
experiments. To
recognize the
heterogeneity of
individual, cultural
and institutional
behaviour.
Source: Different papers from databases such as Emerald Insight and Elsevier

Journal of critical reviews 327

 ROLE OF BEHAVIOURAL FINANCE IN PORTFOLIO SELECTION AND INVESTMENT DECISION-MAKING

RESULTS AND DISCUSSIONS how their future policies and strategies will be affected since the
The researcher concentrates on specific aspects to understand investment decision by the investors will determine the
about how the behavioural portfolio theory helps an individual in company’s strategy to be applied.
making portfolio construction and better investment decisions.
For this purpose, the focussed areas are behavioural bias; gender Behavioural finance, psychology and economic aspects also
based behavioural bias, an individuals’ understanding about the influence an individual’s investment decision making, the
behaviour of investors towards investment activity, pattern of authour in this connection found that the role of behavioural
investment, investment preferences, behavioural finance, finance helps an individual in selecting their portfolio and
psychology and economics. The results of each aspect are investment decision making and the reviewed papers explain
discussed below. about two building blocks of BF such as limits to arbitrage and
psychology. This part also focuses on other concepts such as
From the available literature one can understand that individual beliefs, overconfidence, optimism and wishful thinking,
investors have to allow professional experts to manage their representativeness, ambiguity aversion, conservatism,
portfolios that will reduce personal bias in investment. This confirmation bias, anchoring, prospect theory, influence of
aspect can be understood by studying papers relevant to efficient market hypothesis (EMH) theory helps BF to understand
behavioural bias, gender based behavioural bias and BPT as the investment activities and psyche of an individual to analyse
these papers cover overconfidence, heuristics, loss aversion and about the portfolio construction.
representativeness bias of psychology concepts which exists in
individuals and affects their investment decision making. Another observation made during the study is, Emotion and
Psychology of Behavioural Portfolio Theory are the two major
Papers on investment portfolio selection, preference and principles on which the investors base their investment
investment behaviour provide insights to financial planners, decisions. Price and volatility are the elements which an investor
advisors and individuals and the need to consider them to analyse under the principle of emotion, whereas the evaluation
improve the choice of portfolio and its performance. These of the expected returns from an investment is based on investor‘s
papers help understand the investment pattern exclusively in psychology. Maximisation of the value of the expected returns of
investments by individuals as well. As human behaviour is portfolio is the ultimate motivational factor for an investor. Since
affected by emotional process which involves the decision investors have varied goals, and always possess a preference
making process of varying degrees. It is used as a guide for both towards the portfolio which meets their goal. The psyche of
retail investors and fund managers when making investment individuals and portfolio construction are key in the assessment
decisions. The retail investors' self-perceived confidence as a of BPT studies over decades that help researchers in
function of both expected and unexpected changes in the market concentrating more in developing or linking prospective theories
and personal factors largely determines their trading behaviour. in behavioural finance studies.
The purpose of financial advisory services is to understand the
client's behaviour, needs and accordingly provide advice on the CONCLUSION
various aspects of financial planning, wealth management and to With the advancement of cognitive psychology, combined with
identify the right and best investment option for the individuals the development of critic perspective in economics led to the
and helps them for perfect financial planning. It tries to highlight emergence of a new field of research flourish both in academics
the risk tolerance level of the investors and suggest the investors and practice i.e. Behavioural Finance. This study shows the
what is best portfolio to invest? Individuals prefer to invest in starting point for the emergence of Behavioural Finance with the
financial products which provide safe and high returns. help of Behavioural portfolio theory, which was contributed by
various psychologists and economic thinkers. In this study the
As of investment decision aspect, the researcher found that authors identified, in the first part of 20th century the historical
individuals depend not only on safety and security but also roots and evolution of behavioural finance which focused mainly
various other factors such as globalization and other recent on Behavioural Portfolio Theory that helps to make better
changes, people also changed themselves before taking any investment and financial decisions. Current study contributes
investment decisions and taking any investment policy. The most some historical roots to behavioural finance and proposes a kind
important factors that influence investment decision making are of archaeology to this field which makes to remind the advent of
reputation of the firm, firm's status in industry, expected new theoretical field of behavioural finance which is very
corporate earnings, profit and condition of statement, past complex even though after its emergence conditions and helps to
performance of firms’ stock, price per share, feelings on the understand the cognitive emotions of the investors that helps to
economy and expected divided by the investors. The various choose a wise portfolio selection and better investment decision
decisions to be made by the investors based on prevailing factors making studies in future time periods.
and the eventual outcomes for each decision and identify the
most influencing factors on the company's investor behaviour on
Rene stulz (Eds.), Handbook of the Economics of Finance,
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