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Review Paper
Review Paper
*Neha, **Tanu
Abstract
Behavioral finance explores the psychological factors influencing investment
decisions. This review paper delves into the key principles of behavioral finance
and its impact on investment and its impact on investment decision-making. It
examines cognitive biases, emotional influences, and heuristics affecting investor
behavior. Through empirical evidence and case studies, it elucidates how these
behavioral aspects drive deviations from rational decision-making in financial
markets, impacting asset pricing and portfolio management strategies.
Understanding these behavioral patterns can aid investors, financial advisors, and
policymakers in making more informed and rational investment decisions.
Key words: finance, decision-making, investors, portfolio and policy makers
1. INTRODUCTION
Behavioral finance stands at the intersection of psychology and finance, offering a
profound understanding of how human behavior influences investment decisions.
Traditional financial theories often assume rationality in decision-making, but
behavior influence recognizes that human emotions, cognitive biases, and social
factors significantly impact investment choices. This field delves into the
deviations from rationality, exploring biases such as overconfidence, loss aversion,
and herding behavior that affect investors’ judgment. Understanding these
behavioral patterns is critical as it elucidates why markets aren’t always efficient
and why investors might make suboptimal choices.
This review paper aims to dissect the key concepts in behavioral finance, shedding
light on how psychological factors shape investment decisions. By examining
behavioral biases and their implications for investment strategies, this paper seeks
to provide insights into navigating the complex landscape of financial markets
while considering human behavior as a crucial determinant in investment decision-
making.
This introduction briefly introduces the concept of behavioral finance, highlights
its significance in understanding investment decisions, and adjustments and
expansions can be made as er the specific focus and direction of the paper.
2.Evaluation of behavioral finance
Behavioral finance provides a valuable lens through which to understand the intricacies of
human decision-making in financial contexts. By acknowledging and studying behavioral
biases, heuristics, and emotional influences, it offers a more nuanced perspective compared
to traditional finance theories. This approach contributes to explaining market anomalies
and investor behavior that can't be fully accounted for by rational models. However, while
behavioral finance enriches our comprehension of financial decision-making, it also poses
challenges in quantifying and integrating these insights into predictive models, requiring a
delicate balance between theory and practical application.
4. Literature review
• Kahneman, (1979): Introduced prospects theory, challenging the traditional
economic rationality assumption by emphasizing how individuals make
decisions under uncertainty.
• Thaler (1980): Expanded on behavioral finance concepts, particularly
focusing on how cognitive biases affect economics decision and investor
behavior.
• Orum De Bondt and Thaler (1985) studied why investors sometimes behave
in certain ways and found that when stock prices revert to their average
values, it shows that investors tend to overreact. This means they put too
much importance on recent performance of companies when predicting
future performance.
• Gupta (1990) conducted a survey of households who invest money. The
goal was to gather information about what kinds of investments people
prefer, such as mutual funds (MFs) and other financial assets. The results of
the survey were useful for policymakers and mutual funds because they
helped them create better financial products for the future.
• 1996, Madhusudhan V Jambodekar conducted a study to understand how
much people knew about mutual funds (MFs), what influenced their decision
to buy them, and why they chose one fund over another. The study found
that during that time, people preferred Income Schemes and Open-Ended
Schemes more than Growth Schemes and Close-Ended Schemes because of
the market conditions. Investors were most concerned about the safety of
their money, how easily they could access it (liquidity), and the potential for
their investment to grow. They mainly learned about mutual funds through
newspapers and magazines, and they also considered the quality of investor
services when choosing a mutual fund scheme.
• Odean (1999): Explored the “disposition effect,” showing how investors
tend to sell winning stocks too early and hold onto losing ones for too long,
thus deviating from rational decision-making
• Shleifer (2000): Examined the role of overconfidence, herd behavior, and
investor sentiment in market inefficiencies, highlighting behavioral aspects
impacting investment choices.
• Barbies (2003): Explored the implications of prospect theory in shaping
investor preferences and market anomalies, contributing significantly to the
understanding of behavioral finance.
• Kahneman (2006): Investigated the practical application of behavioral
finance in assets management, illustrating how biases affect investment
strategies and portfolio management.
• Genaille (2017): Explored how cultural and societal factors influence
financial decision-making, expanding the scope of behavioral finance
beyond individual biases to include broader environmental influences.
5. Behavioral Biases in Decision Making: Human psychology plays a significant
role in financial decision making, leading to various biases such as confirmation
bias, overconfidence, and loss aversion. These biases often cloud rational
judgment, affecting investment choices and risk assessment.
Emotional Influences on Investment Decisions: Emotions like fear, greed, and
sentiment significantly influence financial decisions. Fear can lead to selling assets
prematurely, while greed may drive individuals towards risky investments.
Understanding and managing these emotions are crucial for sound investment
strategies.
Herd Mentality and Market Trends: The tendency to follow the crowd or 'herd
mentality' impacts investment decisions, leading to market bubbles or crashes.
Analyzing the impact of social influence on investment behavior and its
consequences on market trends is imperative
Decision Making Under Uncertainty: Financial decision making is often carried
out amidst uncertainty. Behavioral economics delves into how individuals make
decisions under uncertain conditions and the subsequent effects on investment
choices and portfolio management.
Conclusion
Behavioral finance offers valuable insights into the psychological factors that
influence financial decision making. This field not only identifies the biases and
behavioral patterns that hinder optimal decision making but also provides avenues
for developing strategies to navigate these challenges. Understanding human
behavior in financial contexts is indispensable for enhancing investment outcomes
and promoting better financial stability and security for individuals and institutions
alike.
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