Literature review behavioural finance

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Download Free PDF. Free PDF. Download PDF Package. Premium PDF Package. This paper. A short summary of this paper. A Literature Review of Behavioural Finance. Journal of Economics Library www. The efficient market hypothesis and behavioural finance theory have been the cornerstone of modern asset pricing for the past 50 odd years. Although both theories are fundamental in explaining modern asset pricing, they are opposing views. The efficient market hypothesis dictates that the price of any asset depends on the information, while the behavioural finance theory dictates that the price depends on the reaction of the market participants to the information.

In this paper, we will critical evaluate the theories influencing the behavioural finance theory. In concluding, we find that although the behavioural finance theory has difficulties in testing and the empirical evidence is mixed. Yet it does explain a number of anomalies in the financial world and is a more accurate view of the real world.

However, a key advantage of using the efficient market hypothesis is that it is a useful benchmark for regulators and central bankers alike. The lack of a uniformed testable model means that the behavioural finance theory as it stands cannot be used as a benchmark.

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Conversely, the key to the behavioural finance theory is in its ability to explain the movement from the benchmark. So in essence, both models are required to explain asset pricing. B13, G02, G03, G12, G Introduction I n essence, this paper is a study of the theories influencing the asset pricing in the global financial market.

In order to understand asset pricing, we must understand the influencing factors underpinning the two fundamental theories of asset pricing: the efficient market hypothesis and behavioural finance theory. As proposed by Malkiel and Famathe efficient market hypothesis argues that the price of any asset must immediately reflect fundamental information about the asset.

Whereas the behavioural finance theory, as argued by Statman and Subrahmanyamstates that in order to truly understand the movement of asset prices there is a requirement to include the psychology of the market participants. Some of the issues regarding the pricing of assets cannot be addressed without a reference to the behavioural finance theory. A criticism for example De Bondt et al. Hence, in order to address these issues there is a requirement to understand the psychology of the market participants.

This led to the alternative theory of behavioural finance being put forward by Statman and Subrahmanyam amongst others. One of these issues is the price deviation from the fundamental value.It would be nice if investors and markets moved solely on the basis of fundamentals and economic and financial analysis of businesses. But at times, investors appear to lack self-control, act irrational, and make decisions based more on personal biases than facts. The study of such psychological influences on investors and, by extension, markets, is called behavioral finance.

You could say behavioral finance came about as a way to explain in a rational way the irrational behavior of markets and investors or, as one acclaimed economist put it, finance from a broader social science perspective including psychology and sociology. Traditional financial theory holds that markets and investors are rational; investors have perfect self-control, and aren't confused by cognitive errors or information processing errors.

Now, according to the Corporate Finance Institute, behavioral finance holds that investors are considered "normal," not "rational;" they have limits to their self-control, are influenced by their own biases, and make cognitive errors that can lead to wrong decisions. The study of behavioral finance, a sub-field of behavioral economics, arose in the s, when cracks began to appear in what was then considered the Efficient Market Hypothesis.

The Efficient Market Hypothesis, or EMH, was an investment theory that held that share prices reflect all information about a particular investment or market at all times, so investors can't purchase undervalued stocks or sell stocks for inflated prices. But if EMH were fact, it would be impossible to outperform the overall market even with expert stock-picking or market timing.

The only way an investor could "beat the market" would be by purchasing riskier investments. Because of this, those with faith in EMH say there is no merit in searching for undervalued stocks or trying to predict market trends through either fundamental or technical analysis. And investors like Warren Buffett have defied EMH by consistently "beating the market," or having better returns, over long periods of time - which would be impossible. Economist and Yale academician Robert J.

In the s some "anomalies," like slight serial dependencies in stock market returns, began to appear as cracks in the hypothesis of efficient markets. He also noted that faith in EMH was eroded by "a succession of discoveries of anomalies, many in the s," and, particularly, evidence of excess volatility of returns.

But it was in the s that the "anomaly represented by the notion of excess volatility" started causing deep rifts in adherence to the theory, greater even than the so-called "January effect," or the "day of the week effect. Shiller, writing after the so-called dot-com boom and subsequent bust, noted that the speculative bubble "had its origins in human foibles and arbitrary feedback relations and must have generated a real and substantial misallocation of resources.

A lawsuit is brought against a company. Investors know from past experience with the company that news of the lawsuit is likely to make the company's share price fall. Many investors sell their holdings of the company, causing a further decline in the asset's value.

Next, investors in other companies in the same industry fear lawsuits, knowing that a lawsuit has been brought against a similar company. Those investors sell their holdings. The prices of shares in other companies in the same industry then also fall.

But none of the companies have taken any action or had a judgment against them. There has been no tangible reason for the price of the stock to fall. Another example of 'herd behavior' is Google. Some investors, unaware of their own biases, may prefer to invest in an alphabetical order, like choosing a contractor based on "AAA" in the phone listing.

There is a reason, for instance, that Apple Inc. And what of Google? Google changed its name to Alphabet inbeing the "umbrella" under which Google operates. Being aware of the precepts of behavioral finance can help investors check their perceptions against facts.

A classic example is anchoring. This is when an investor 'anchors' on the price level of a previous portfolio value, and constantly compares the previous, often higher, value to the current value, without taking into account changes in the market or even outlook.

An investor may also anchor on the price paid for a particular security, and refuse to sell it despite poor performance, hoping to at least break even rather than suffer a loss without carefully assessing the reasons behind its loss of value.

literature review behavioural finance

Herding is another behavior to be aware of and try to avoid in your own investing. Herding is demonstrated exactly in the same way you would think - following the crowd. This is how less sophisticated investors often get into trouble.Studies probing this cardinal activity are diverse. IPO research found a firm ground in some of the well-established finance theories like signaling theory, and capital structure theory. The effect of institutional investors in various aspects of the IPO process is the theme of a relatively new stream of research on public offerings.

A Literature Review of Behavioural Finance

While most of the studies are done in the context of US, an equally rich set of publications can be found in other contexts too. The complexity in decisions relating to the financing aspect of a corporation can be gauged from the available number of sources, instruments and methods of financing.

Academic literature in finance too has moved in tandem with the practice of finance. Many of the theories that form the foundation of finance literature have their link to the financing aspects of the firm, be it the capital structure theories of Durandand Modigliani and Millersignaling theories of Leland and Pyleand Myers and Mujlufagency theory of Jensen and Meclingpecking order theory of Myers or the asset pricing models proposed by Sharpe-Lintner and Fama-French Equity issues as a subset of financing aspect have got their own importance from the academic community.

A firm may choose to go public either through an Initial Public Offering IPO of its shares to retail investors or through mergers and acquisitions, in which the firm will sell itself to an existing listed firm. In the case of a merger, the future investments of the firm is left to the discretion of its new owners who would have made the payment based on strategic fit and synergy estimations.

Second Generation of Behavioural Finance and times of Covid-19

Firms with higher growth rate that face capital constraints will go for equity issue Poulson and Stegemoller, These firms would be characterized by limited credit capacity, which they compensate by compromising on ownership. Ownership dilution has two different options; equity issues through a public offering for sale of shares or through private placement.

Private placement has attractive advantages over the public market like lower cost of raising fund, the practice of dealing with one or a set of investors rather than a big group of small investors, etc. Still the public market has many reasons for being chosen as the preferred mode. Though the ownership has been diluted, the control has not been lost to that extent, as the investors of a public offering are diverse. Most often the public market valuation of a company's stock is considered to be appropriate and higher than the negotiated deals with one or a few buyers and so the issuer may maximize the proceeds through IPO.

The article is arranged as follows: the first part discusses the issues related to ownership and control which need to be sorted out before going for an IPO. It is followed by a discussion on the selection of intermediaries and the involvement of venture capitalists in the IPO process.

Then comes a survey on studies on pricing and valuation.

Literature review of behavioral finance - testede.net

The next part brings out works on managing information and the problems related to asymmetric information. The concluding part summarizes the review by providing a framework for a successful IPO which is followed by the conclusion. Advertise with us Privacy Policy Terms of Use. IUP Publications Online. About IUP. Article Details. For delivery in electronic format: Rs.

To download this Article click on the button below:.The efficient market hypothesis and behavioural finance theory have been the cornerstone of modern asset pricing for the past 50 odd years.

Although both theories are fundamental in explaining modern asset pricing, they are opposing views. The efficient market hypothesis dictates that the price of any asset depends on the information, while the behavioural finance theory dictates that the price depends on the reaction of the market participants to the information. In this paper, we will critical evaluate the theories influencing the behavioural finance theory.

In concluding, we find that although the behavioural finance theory has difficulties in testing and the empirical evidence is mixed. Yet it does explain a number of anomalies in the financial world and is a more accurate view of the real world. However, a key advantage of using the efficient market hypothesis is that it is a useful benchmark for regulators and central bankers alike.

The lack of a uniformed testable model means that the behavioural finance theory as it stands cannot be used as a benchmark. Conversely, the key to the behavioural finance theory is in its ability to explain the movement from the benchmark. So in essence, both models are required to explain asset pricing.

Abreu, D. Bubbles and Crashes. Econometrica, 71 1, doi. Barberis, N. A Survey of Behavioral Finance. Constantinides, M.

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Stulz ed. A Model of Investor Sentiment. Journal of Financial Economics, 49 3, doi. Blanchard, O. Bubbles, Rational Expectations and Financial Markets. Brunnermeier, M. Deciphering the Liquidity and Credit Crunch The Journal of Economic Perspectives, 23 1 Caballero, R.

The Journal of Finance, 63 5 Daniel, K. The Journal of Finance, 53 6 De Bondt, W.Once production of your article has started, you can track the status of your article via Track Your Accepted Article. Help expand a public dataset of research that support the SDGs.

The journal welcomes full-length and short letter papers in the area of behavioral finance and experimental finance. The focus is on rapid dissemination of high-impact research in these areas. Behavioral and Experimental Finance represent lenses and approaches through which we can view financial decision-making Behavioral and Experimental Finance represent lenses and approaches through which we can view financial decision-making. It is open to but not limited to papers which cover investigations of biases, the role of various neurological markers in financial decision making, national and organizational culture as it impacts financial decision making, sentiment and asset pricing, the design and implementation of experiments to investigate financial decision making and trading, methodological experiments, and natural experiments.

Both empirical and theoretical papers which cast light on behavioral and experimental topics are welcomed.

Journal of Economics Library

Papers can be either full-length or short letter 2, words maximum format. In addition, a section is reserved for "Ready-to-use-software tools", where programmable codes that automate experimental and behavioral tests are made available. The journal is also open to review and survey papers on any behavioral finance or experimental finance area; where such papers provide an overview and synthesis of present research. Young researchers, such as advanced graduate students, are encouraged to contact the editor to propose such survey articles and receive initial feedback on the proposal.

Further welcomed are replication experimental finance studies of recently published high impact research in this area.

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These papers should be written as short letter papers, and will be assessed with a focus on methodological appropriateness and with a view to speedily disseminating the findings. In partnership with the communities we serve; we redouble our deep commitment to inclusion and diversity within our editorial, author and reviewer networks. We would like to thank all of our dedicated Editors and board members for their hard work that allowed us to achieve this.

ISSN: Journal of Behavioral and Experimental Finance.

Journal of Economics Library

View Editorial Board. CiteScore: 2. CiteScore values are based on citation counts in a range of four years e.

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CiteScore Tracker: CiteScore Tracker is calculated in the same way as CiteScore, but for the current year rather than previous, complete years. It will continue to update on a monthly basis until the next annual CiteScore calculation. For more information, view the CiteScore help file. CiteScore Tracker 2.

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Supports Open Access. View Articles. Track Your Paper Check submitted paper Check the status of your submitted manuscript in the submission system Track accepted paper Once production of your article has started, you can track the status of your article via Track Your Accepted Article. Order Journal Institutional subscription Personal subscription. Journal Metrics CiteScore : 2. View More on Journal Insights. This free service is available to anyone who has published and whose publication is in Scopus.This chapter is a detailed exploration of the behavioural finance literature relevant to the research objectives.

The author will explore the beginnings and the development of the framework and will critically analyse the points of the literature which are essential for the research conducted in this study. The financial theory based on Modern Portfolio Theory Markowitz, and the Capital Asset Pricing Model Sharpe,has long shaped the way in which academics and practitioners analyse investment performance.

The theory is based on the notion that all investors act rationally and consider all available information in the decision-making process and that therefore investment markets are efficient, reflecting all available information.

According to Baberis and Thalerrationality is defined thus :. Therefore, when an investor learns something new about a future cash flow concerning a particular security, they should respond in an efficient manner to this new information, in turn pushing up the price when the news is good and bringing prices down when news is bad. As a consequence, security prices should fully incorporate all available information almost immediately. Empirical studies discovered anomalies and excess volatility in the stock markets that could not be explained by traditional finance models and suggested that academics should look to other fields of research to explain these discrepancies.

In response to the growing number of problems, a new area of research emerged which offered an alternative explanation to the essential question of why prices deviate from their fundamental values.

literature review behavioural finance

Behavioural Finance is the integration of traditional finance and economics with the psychological and decision making sciences.

Its main argument is based on the claim that human behaviour and perceptions represent two crucial elements of financial decision making Hirshleifer, Behavioural Finance scholars started the search for new models and ideas to help explain and predict investor behaviour. They assumed that investors may be irrational in their reactions to new information and make wrong investment decisions. As a result markets will not always be efficient and asset pricing may deviate from predications of traditional market models.

This review will evaluate the literature in the field of behavioural finance and will focus on the two main building blocks — the limits of arbitrage and investor psychology. In the first section, the limits of arbitrage will be explored, with the main focus on market efficiency and noise traders. In the following section, the focus will be on the psychological aspect of behavioural finance, focusing on the extensive experimental evidence which illustrates how people form their beliefs and make decisions.

This was a very productive time for financial thought with many theorists putting together complex mathematical models to try and explain price behaviour. In these models, human behaviour and reasoning were over-simplified as researchers tried to invent practical empirical models. This theory states that markets are considered to be efficient relative to a given information set, providing there are no abnormal profit opportunities for investors trading on the basis of information Fama, The EMH implies that it is virtually impossible for investors to consistently beat the market, unless by luck.Slideshare uses cookies to improve functionality and performance, and to provide you with relevant advertising.

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literature review behavioural finance

Ramy El-Husseiny. Lin Qi. K- Fen. Show More. No Downloads. Views Total views. Actions Shares. No notes for slide. All Rights Reserved 2. Agenda: The Main Points What is the viewpoint of social science researchers towards risk?

What is the perspective of standard finance academics about risk? What is the viewpoint of behavioral finance academics towards risk?


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