BEHAVIOURAL FINANCE: VARIOUS TOPICS

Psychological Theories - Institutional & Agency Factors

Behavioural finance provides psychological explanations of investor behaviours. Behavioural finance specifically challenges the mainstream assumption of financial theory that investor behaviour is characterized by extreme rationality. Thaler stated that some financial phenomena can be plausibly understood using models in which the behaviours of some agents are not fully rational.

Several psychological behaviours are associated with financial agents by behavioural finance theorists. Barberis and Thaler categorized these psychological motivations for investor behavior as (a) beliefs and (b) preferences. The relevant beliefs and preferences are as follows:

Overconfidence on the part of investors: evidence indicates that investors overestimate the probability of occurrence of outcomes they believe to be likely, while underestimating the probability of occurrence of outcomes they believe to be unlikely; additionally, investors hold an irrational belief related to the accuracy of their assessments

Unsupportable optimism (wishful thinking: Evidence indicates that most inv

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y information to support the "winner" and "loser" designations. The support of "winner" designations demands an over-valuation of positive information related to "winners" and an under-valuation of negative information related to "winners". The support of "loser" designations demands an under-valuation of positive information related to "losers" and an over-valuation of negative information related to "losers". The result of the functioning of the over-reaction and under-reaction hypothesis more often than not is the choppy up-and-down market performance of publicly-traded stocks. The performance patterns do not reflect so much a failure by the investor herd to consider all available information. Rather, the performance patterns reflect (a) the failure of the herd to value all information appropriately and (b) the resulting over-reactions and under-reactions based on the inappropriate valuation of available information. Investors whose strategies are characterized by the over-reaction and under-reaction hypothesis are frequently referred to as irrational investors. The irrational designation stems from the failure to correctly value all information related to publicly-traded stocks. Momentum Patterns Momentum patterns ref
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Approximate Word count = 2262
Approximate Pages = 9 (250 words per page)