University:
McMaster University
Course:
COMMERCE 2FB3 | Managerial Finance
Academic year:

2024
Views:

150

Pages:

1
Author:

Sabrina S.

Lecture Notes: A Behavioral Finance Perspective Introduction to Behavioral Finance ● ● Being the effective branch of finance, behavioral finance investigate how psychological factors influence the behavior of investors. Unlike traditional finance that assumes people are rational, and always make a decision in such a way that will maximize their wealth, behavioral finance takes into consideration the fact that people at times do not behave rationally. Key Concepts: 1. Psychological Biases: These are regularities in the departure from the norm or rationality in decisions. 2. Emotions: Fear and greed are known to make a great impact on the decisions made concerning investments and therefore the results are generally not the best. Common Psychological Biases ● Overconfidence: Self-attribute is likely to lead the investors to overextrapolate their ability to predict the market and indulge in over trading an increased risk taking behavior. ● Anchoring: Heuristics becomes a potential problem when a decision maker falls in love with the first piece of information that he or she comes across - thereby sticking on that piece of information even in light of acquiring new information which goes by the name of ‘anchor’. ● Herd Behavior: After the actions of a larger group, while often not paying attention to one’s analytical capabilities or data. ● Loss Aversion: The inclination to avail of a loss rather than an equivalent gain; people’s intensity of feeling about losses is greater than gains. ● Confirmation Bias: Affirming the facts that support the initial hypothesis, and rejecting the facts which can dispute it. Impact on Investment Decisions A. These lead to costs of being wrong by investing in wrong stocks, at wrong prices, wrong quantity or wrong frequency, wrong timing or wrong products. B. Such biases may affect an investor’s decisions; - therefore, it is crucial to identify these sources of error so as to better control them in the processes of decision making.