PARIPEX - INDIAN JOURNAL OF RESEARCH | Volume - 11 | Issue - 02 |February - 2022 | PRINT ISSN No. 2250 - 1991 | DOI : 10.
36106/paripex
ORIGINAL RESEARCH PAPER Commerce
KEY WORDS: Behavioural
finance, traditional finance,
BEHAVIOURAL FINANCE – A REVIEW PAPER
Modern finance, behavioural
economics.
Research Scholar, Department of Commerce, Central University of Haryana,
Mohit Fogaat* Mahendragarh, Haryana. *Corresponding Author
Sangeetha Research Scholar, Department of Commerce, Central University of Haryana,
Sharma Mahendragarh, Haryana.
ABSTRACT
The current research examines the evolution of behavioural finance over the span of financial history. It contains the
earliest records of stock market behaviour oddities recorded by researchers. Traditional finance is discussed first,
followed by an examination of traditional ideas in instances when they are judged inadequate. The study then discusses
the importance of behavioural finance and its key role in creating a connection between real-world scenarios and
classical assumptions.
INTRODUCTION – to forecast a 'black swan' occurrence, but it is conceivable to
Behavioural finance is the mixture of conventional economics compare earlier markets as they navigate these important
and finance with thinking and decision-making process and it anomalies, because everything in our world is a fresh news
try to explain how investors thoroughly errors in judgement event that follows a predictable pattern[9].
or mental mistake[1]. Behavioural finance talks about how
individual's behaviour influence from behavioural finance The epidemic of COVID-19 has an unusual impact on the
biases when they are making financial decisions or investing world financial market, and as a result of the global market
decisions. In the subject of economics and finance, interruptions, India's financial market has also responded to
behavioural finance is a dynamic and rapidly evolving field. the pandemic, with market turmoil[10]. Because of the
Beginning in the early 1970s, Daniel Kahneman and Amos unpredictability and volatility in the stock and commodities
Tversky pioneered the behavioural finance revolution[2]. In markets, we decided to investigate the influence of COVID-19
recent years, interest in the combination of psychology and on the Indian commodity and stock markets, as well as
economics known as "behavioural economics" has grown, compare the volatility of stock markets in other South Asian
and as with many seemingly sudden positive stories, this one countries[11]. No one can predict how long COVID-19 will
has been in the works for quite some time[3]. Overconfident have an impact on the economy, which is causing issues in
investors exaggerate the accuracy of their understanding evaluating both medium-term and long-term growth rates.
about a financial security's pricing, and they exaggerate the With a lower projected growth (as the future is did work out),
likelihood that their own evaluations of the security's price are the subject Company has become less appealing to
more correct than someone else' opinions[4]. People do not prospective buyers as the inconsistencies that may affect the
always act rationally, and while deviations from rationality can company grow over time[12].When the number of individuals
be random, they are frequently systematic, as evidenced by trying to sell a stock outnumbers the number of individuals
the fact that significantly more people overestimate rather wanting to acquire it (there is more supply than demand for
than underestimate their driving ability[5]. As we know that that specific stock), the stock price drops, and the presence of
human posses' feelings which can affect their choices. anomalies has been widely acknowledged in financial
Decisions made by emotionally lead us to irrationality and it
markets over the past 2 decades[13]. Many behavioural
can lead us to big crash in stock market. There are two school
finance biases show their presence in this pandemic where
thought in behavioural finance one is traditional finance and
investors started making mistake. Many behavioural finance
another is modern finance. Traditional finance assumes that
biases occurred in this pandemic like risk-aversion, herd
all market participants are fully rational and they not need to
behaviour, overconfidence, illusion of control, overreaction
any suggestion or recommendation from others. In Modern
and self-attribution etc. These biases directly affect investors
finance, we talk about that financial decision is affected by
choices of investment. As we know that a normal investor
psychological factor and investor makes mistake when they
are making financial decision. The concept of a rational hesitates to taking risk and this pandemic makes investor
investor dominant in behavioural economics more than 50 more sophisticated to take risk because most of investor lost
years. A rational man expected to be cost-effective, rationality their strong portfolio investment and economy of nations
in decision making process, expert in calculating the chances came down to negative GDP growth rate from their strong
of each substitutes and choose the best alternative which GDP growth rate.
gives the best utility at low cost[2]. A myopic investor is one
who interprets prior outcomes narrowly and constantly We don't live in such world where market is informationally
evaluates his profits and losses. Narrow decision-making and efficient. The market mostly inefficient because after 1960
narrow outcome-making tend to go along, and the mix of some research work showed us that investors are not fully
these characteristics constitutes a myopic investor[6]. rational and they make mistake in financial decision process
Investors trade quite so much, purchase or sell at the wrong because of behavioural finance biases. Thus, investors have to
moment, allow emotions to override rationality, and be understood the such market anomalies' which directly
underestimate probability due to inefficiencies in applying affect investment decision.
rules[7].
Behavioural finance is emerging topic for research where
Traditional economic and finance philosophies made on the researcher can investigate about new concept of behavioural
hypothesize of rational human behaviour entitlement that finance biases and recommend to investors for better
families maximise their utility function over their life cycle[8]. investment decisions. Behavioural experts understand the
Recent unprecedented event COVID-19 where all over the different biases of behavioural finance and suggest to the
world peoples suffering from deadly pandemic and financial investors to avoid making mistakes when they are making
market of many countries was badly affected. There is no way financial decision.
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PARIPEX - INDIAN JOURNAL OF RESEARCH | Volume - 11 | Issue - 02 |February - 2022 | PRINT ISSN No. 2250 - 1991 | DOI : 10.36106/paripex
Traditional finance versus Moder n Finance or rather than perceived losses[18]. Prospect theory is inspired
behavioural finance – by the fact that, in practice, decision makers violate both
Traditional finance holds the concept that investors are fully utility and probability rational thought hypotheses, and these
rational and they have fully capable for making their breaches are merged into accumulated prospect theory as a
investment decision. In the traditional finance it is assumed non-linear utility function and a non-linear probability
that market and investors are perfectly rational and they truly weighting operate effectively, which are advancements over
care about utilitarian features. Individual are sometimes the initial suggestion to confront infractions of random walk
referred to be "rational expectations wealth maximizers," dominance limitations[19].
which indicates they establish unbiased aspirations and then
buy and sell assets at values that they believe will enhance Another foundation of prospect theory is the Value Function.
their holdings' future value[1]. It is assumed that investor have In anticipated utility theory, the value function varies from the
fully discipline in investing decision and they are not utility function due to a frame of reference for by intuitive
disordered by cognitive errors or information processing understanding of individual desires. The slope of the utility
mistakes. The efficient market hypothesis and modern function in value function continues to climb for income level
portfolio theory are at the heart of conventional finance. In underneath the reference point and lower for income level
1952, Harry Markowitz pioneered modern portfolio theory. after the reference point, but the utility function in anticipated
utility theory is concave negative for all levels of income. As a
Modern portfolio theory is concerned with the anticipated result, each person chooses his or her own comparative point.
return of a stock or a portfolio, as well as its standard deviation At income level underneath this reference point, investors
and connection with other securities in the holdings[14]. take risks; however, at income level further than this reference
Another important notion in conventional finance is the point, the value function is negative, as classic theories
Efficient Market Hypothesis. According to EMH, all proof has forecast, and investors are risk averse.
already been represented in a security's level or market rate,
and the stock or bond's current price represents its fair In a nutshell, Prospect Theory defines how people assess
value[14]. Proponents argue that when securities are at their profit and loss. Editing and Evaluation are two distinct
fair value, active dealers or professional investors cannot cognitive processes in this approach. During the Editing step,
produce larger returns over time that outperform the market. the investor ranks the options using a simple "Thumb Rule," as
opposed to an elaborate algorithm.
As a result, they argue that rather than attempting to make a lot
of money, investors might as well just own the overall market. A time reference is applied to compute gains and losses and
to express loss aversion throughout the assessment process.
Traditional behavioural theories [15] A value function passing throughout this starting point and
In traditional theoretical approaches, John Stuart Mill was the providing a "Value" to every good or negative result is S
first to establish the notion of the "Economic Man or homo formed and asymmetrical[20]. The S-shaped value
economicus," in 1844. In 1954, Bernoulli proposed the represented in the prospect theory is its most important
"Ber noulli Hypothesis." In 1944, Von Neumann and component.
Morgenstern also performed a utility function. Harry
Markowitz published the "Markowitz portfolio theory" in 1952.
"Capital Asset Pricing Model (CAPM)" was developed by
Treynor (1962), Sharpe (1964), Lintner (1965), and Jan Mossin
(1966). Eugene Fama presented "Efficient market theory" in
1970.
Modern or behavioural finance –
Modern finance holds the concept that investors are not fully
rational. An individual possesses the emotional and
psychological factor in their mind when they are making
financial decisions. According to traditional finance each
investor is fully rational but in reality, if each investor is fully
rational then we don't have any market crash, any market
anomalies, market bubbles and market overreaction or
underreaction. Behavioral finance claims that certain aspects Figure – 1 Prospect Theory Value function, Source - [20]
of asset pricing are better described as departures from core
value, but that these deviations are driven by the presence of Modern behavioural theories [15]
non-rational investors[16]. In 1955, Herbert Simon proposed "Models of limited
rationality" in current behavioural theories. The "Theory of
Evidence is accumulating that the CAPM, the market Cognitive Dissonance" was published in 1956 by Festinger,
equilibrium model used in traditional finance to determine Riecken, and Schachter. Tversky and Kahneman published
risk and anticipated returns, is not a reliable representation of "Introduced heuristic biases: availability representativeness,
reality[17]. An individual investor tends to make mistake and anchoring, and adjustment" in 1973 and 1974. "The prospect
it leads market disruptions or big crashes in market. theory" and "Introduced loss aversion bias" were both
published by Tversky and Kahneman in 1979. They also
Daniel Kahneman and Amos Tversky these two authors who "introduced framing bias" in 1981. Richard Thaler coined the
brought the concept of behavioural finance in early 1970. phrase "introduced mental accounting bias" in 1985. In 1985,
They also known for father of behavioural finance or De Bondt and Thaler published "Theory of Overreaction in
economies. They published around 200 research paper Stock Markets." In 1998, Barberis, Shleifer, and Vishny
regarding behavioural finance. Daniel Kahneman received proposed the "Investor sentiment model for stock price
Nobel Prize for his contribution in behavioural finance. Daniel underreaction and overreaction." Meri Statman proposed the
Kahneman gave “Prospect theory” which provided basic concepts of "behavioural asset pricing theory and
groundwork to the field of behavioural finance. In comparison behavioural portfolio theory" in 1999. "Linkage of
to the expected utility theor y, they established a behavioural finance with efficient market theory to establish
psychologically more accurate portrayal of decision making. that stock markets are inefficient," says Andrei Shleifer.
People value losses and gains inversely, according to this "Incorporation of prospect theory in asset pricing" was
notion, and will make decisions based on perceived gains presented by Barberis, Huang, and Santos in 2001.
2 www.worldwidejournals.com
PARIPEX - INDIAN JOURNAL OF RESEARCH | Volume - 11 | Issue - 02 |February - 2022 | PRINT ISSN No. 2250 - 1991 | DOI : 10.36106/paripex
"Importance of behavioural finance and its emphasis on [17] M. Statman, “Behavioral Finance versus Standard Finance,” AIMR Conf. Proc.,
vol. 1995, no. 7, pp. 14–22, 1995, doi: 10.2469/cp.v1995.n7.4.
departure from 'homo economicus' or traditional paradigm to [18] M. Studies,“F I N A N C I A L M A R K E T: T h e s i s Doctor of Philosophy ( Ph . D
more realistic paradigm," Hubert Fromlet wrote in 2001. ) Under the Supervision of ( Associate Professor ) Department of Business and
Grinblatt and Keloharju published their paper "Role of Financial Studies Faculty of Commerce and Management Studies
Department of Business and Financial Studi,” vol. 190006, 2016.
Behavioral variables in influencing trading behaviour" in [19] A. J. Keith, “Operational Decision Making under Uncertainty: Inferential,
2001. Barberis and Thaler published "Survey of Behavioral Sequential, and Adversarial Approaches,” p. 293, 2019.
finance" in 2003. "Effect of behavioural biases on stock prices [20] S. R. I. C. Saraswathi and V. M.Vidyalaya,“' Behavioral Finance - a Special Study
on Investor Psychology ,'” p. 2015, 2015.
and the price reversal for biased investors is faster than for
unbiased ones," Coval and Shumway found in 2006.
Avanindhar Subrahmanyam discovered the "Normative
implications of behavioural finance on individual investors
and CEOs" in 2008. Richard Thaler discovered "Impact of
mental accounting on consumer decision behaviour" in 2008.
"Comparison the behavioural and traditional finance method
in understanding market inefficiencies," by Rober
Bloomfield, was published in 2010. "Practical implications of
behavioural finance and investor feelings in value investing,"
according to Parag Parikh, was discovered in 2011. Uzar and
Akkaya published a paper in 2013 that "explores the
emergence of behavioural finance from traditional finance.”
CONCLUSION -
Behavioural finance is the study of individual behavior and its
relevance in the investment judgment process. As we all know,
this notion is developing, and it will be extremely beneficial to
investors if they detect and eradicate any behavioural biases
in order to make a fair selection. Behavioural finance
challenges all previous ideas and introduces a novel
paradigm in which investor behaviour has a direct impact on
investment decisions. Individuals are compelled to make
poor decisions as a result of investor behaviour. These
unfavorable circumstances must be addressed since they
have a negative influence on the financial situation of
investors. They also have an impact on the country's economic
situation. These safeguards can only be achieved if all
behavioural exper ts are more aware of their own
psychological knowledge and behavioural finance
prejudices. Finally, we may state that in today's society, more
experimental study in behavioural finance is essential.
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