Behavioural finance News, Research and Analysis - The Conversation (2024)

FAQs

What are the 2 pillars of behavioural finance? ›

And yet, there is no dearth of investors making irrational decisions. Clearly, something else is at play here – cognitive bias and limits to arbitrage. These are the two pillars of behavioural finance. Both offer answers to how emotions and biases affect share prices and financial markets.

Behavioural finance aims to explain and increase people's understanding of the emotional aspects and psychological processes that affect people who invest in financial markets. Overconfidence, cognitive dissonance, regret theory, and prospect theory are four themes in the field of behavioural finance.

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Behavioral finance uses financial psychology to analyze investors' actions. According to behavioral finance, investors aren't rational. Instead, they have cognitive biases and limited self-control that cause errors in judgment.

The key concepts in behavioral finance, such as bounded rationality, heuristics, prospect theory, mental accounting, and biases like overconfidence, confirmation bias, and loss aversion, highlight the irrational financial choices people make, deviating from the assumptions of traditional finance models.

CHARACTERISTICS OF BEHAVIOURAL FINANCE

Four Key Themes- Heuristics, Framing, Emotions and Market Impact characterized the Field. These themes are integrated into review and application of investments, corporations, markets, regulations, and educations-research.

The key criticisms of behavioral finance theory are that its assumptions about individual behavior are descriptively false and incomplete, and it often lacks predictive power.

Availability bias, representativeness bias, overconfidence bias, market factors, herding, anchoring, mental accounting, regret aversion, gamblers' fallacy, and loss aversion are some of the dimensions of behavioral biases that have a substantial impact on investors' decisions (Abdin et al., 2017;Jain et al., 2021). ...

Heuristics are mental shortcuts for solving problems in a quick way that delivers a result that is sufficient enough to be useful given time constraints. Investors and financial professionals use a heuristic approach to speed up analysis and investment decisions.

Practical Examples of Behavioral Finance

An investor in the stock market may opt-out because of the financial crisis. read more affecting the stock market, thinking that the problem will take longer to resolve and recur in the future.

Who is the father of Behavioural finance? ›

All three of these men, Amos Tversky, Daniel Kahneman, and Richard Thaler, are today considered to be among the founding fathers of behavioral finance.

Behavioral finance asserts that rather than being rational and calculating, people often make financial decisions based on emotions and cognitive biases. For instance, investors often hold losing positions rather than feel the pain associated with taking a loss.

But over the decades, the work of Herbert Simon, Daniel Kahneman, Amos Tversky, Robert J. Shiller, and Richard H. Thaler, among others, challenged this orthodoxy and demonstrated that market and investor behavior are often much more ambiguous than these theories would suggest.

The Rule of 72 is a calculation that estimates the number of years it takes to double your money at a specified rate of return. If, for example, your account earns 4 percent, divide 72 by 4 to get the number of years it will take for your money to double. In this case, 18 years.

These factors, known as the emotional gap, can cause investors to make irrational decisions based on their emotions rather than focus on hard facts and professional advice. For example, an investor's desire to "get rich quick" can cause them to make risky investments for a promise of fast returns.

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He formulated two principles of functional finance: government should spend more if there is unemployment, and government should supply more money (reserves) if interest rates are too high.

Behavioral finance helps us understand how financial decisions around things like investments, payments, risk, and personal debt, are greatly influenced by human emotion, biases, and cognitive limitations of the mind in processing and responding to information.

Two key aspects of financial planning are cash planning and profit planning. Cash planning involves the preparation of the cash budget and profit planning involves preparation of pro forma statements. To make cash budget and pro forma statements for a firm, accounting knowledge is needed.