Behavioural Finance Overview
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Questions and Answers

Which of the following is NOT a stated objective of behavioral finance?

  • To guarantee risk-free investments (correct)
  • To enhance the skill set of investment advisors
  • To identify investor's personality
  • To understand the reasons for market anomalies

    • The ideas of behavioral finance gained momentum before the 1970s.

    False (B)

    Who introduced the notion of 'mental accounting'?

    Richard Thaler

    Behavioral finance assumes that investors are not ______ in the real world.

    <p>rational</p> Signup and view all the answers

    According to behavioral finance, investor decisions can be influenced by:

    <p>Psychological and mental filters (A)</p> Signup and view all the answers

    Behavioral finance suggests that investors always make rational decisions.

    <p>False (B)</p> Signup and view all the answers

    What publication by George Seldon in 1912 relates to behavioral finance?

    <p>&quot;Psychology of the Stock Market&quot;</p> Signup and view all the answers

    Match the following people with their contributions to behavioral finance:

    <p>George Seldon = Wrote 'Psychology of the Stock Market' in 1912 Daniel Kahneman &amp; Amos Tversky = Proposed that investors make decisions based on subjective reference points Richard Thaler = Introduced the notion of mental accounting</p> Signup and view all the answers

    Which personality factor is closely related to Neuroticism?

    <p>Investor Confidence (A)</p> Signup and view all the answers

    According to the Efficient Market Hypothesis (EMH), what is true about stock prices?

    <p>Stocks always trade at their fair value. (D)</p> Signup and view all the answers

    Self-efficacy in investing refers to an individual's general self-esteem.

    <p>False (B)</p> Signup and view all the answers

    Behavioral finance suggests that investors always make rational decisions based on logic.

    <p>False (B)</p> Signup and view all the answers

    What is the term for when an investor views investing more like gambling?

    <p>Investor judgment</p> Signup and view all the answers

    What is the main goal of behavioral finance?

    <p>To understand why individuals make the decisions they do and why the market does not act how expected.</p> Signup and view all the answers

    Risk perception is an investor's current ________ or mood about investing.

    <p>feeling</p> Signup and view all the answers

    What is a key consequence of information overload?

    <p>Choice deferral (C)</p> Signup and view all the answers

    Most investors tend to buy ______ on speculation and sell low in panic mode.

    <p>high</p> Signup and view all the answers

    Match the following concepts with their definitions:

    <p>Risk Personality = Propensity to make decisions without a clear outcome Risk Preference = General preference for a certain level of risk Volatility Composure = Emotional reaction to changes in the market</p> Signup and view all the answers

    Match the following concepts with their descriptions:

    <p>Investor Confidence = Ability to emotionally manage investment declines Investor Judgment = Views on long-term investing, often affected by attitudes toward gambling Risk Perception = Current feelings or mood about investing Information Overload = Too many choices leading to decision fatigue</p> Signup and view all the answers

    Which of the following can lead to an investor being prone to biases, like herd mentality?

    <p>High confidence, low volatility composure and low judgement. (D)</p> Signup and view all the answers

    What is the primary way an investor can obtain higher returns according to the EMH?

    <p>By purchasing riskier investments. (B)</p> Signup and view all the answers

    Investor personality is also referred to as behavioral risk tolerance.

    <p>True (A)</p> Signup and view all the answers

    The concept of 'overchoice' is associated with increased happiness and better decision-making.

    <p>False (B)</p> Signup and view all the answers

    What type of academic discipline is behavioral finance?

    <p>Academic discipline that applies psychology to an understanding of behavior in financial markets.</p> Signup and view all the answers

    Study Notes

    Behavioural Finance Definition

    • Behavioural finance studies how psychology influences financial decisions and market outcomes.
    • Traditional economics assumes rational decision-making, while behavioural finance acknowledges irrationality.
    • People often make financial decisions based on emotions rather than logic.

    Scope of Behavioural Finance

    • Understanding market anomalies: Standard finance often fails to explain market oddities (bubbles, calendar effects, etc.) but behavioural finance provides explanations.
    • Identifying investor personalities: Recognising diverse investor types can help develop targeted financial instruments.
    • Improving investment advisor skills: Behavioural finance enables advisors to understand and manage investor biases.

    History and Objectives of Behavioural Finance

    • Behavioural finance emerged from studies like "Psychology of the Stock Market" (1912).
    • Daniel Kahneman and Amos Tversky's work in 1979 highlighted the influence of subjective reference points in financial decisions.
    • Richard Thaler's concept of "mental accounting" illustrates how people view money differently depending on its purpose.
    • Behavioural finance aims to understand investor psychology and use that to refine and improve financial strategy.

    Assumptions and Characteristics of Behavioural Finance

    • Reflexive decision-making: Fast, intuitive choices based on gut feelings.
    • Reflective decision-making: Logical decisions based on careful analysis.
    • Loss aversion: The fear of loss is stronger than the desire for gain.
    • Bounded rationality: People make decisions with limited information and cognitive constraints.
    • Denial of risk: Individuals may disregard statistical odds or obvious risks.
    • Framing: How a decision is presented significantly impacts choices.

    Cognitive Information Perception

    • Information overload: Too many choices can lead to decision fatigue or poor decisions.
    • Limited information: People need sufficient experience and effective feedback to make good decisions. This particularly applies to issues like climate change or health.
    • Information avoidance: Avoiding potentially negative information can lead to poor decisions, like the "ostrich effect" in investing.

    Factors that Affect Investor Psychology

    • Stable characteristics: Risk preference, risk tolerance / risk aversion, volatility composure, investor confidence, and investor judgment affect long-term investment decisions.
    • Unstable characteristics: Investor perceptions and moods can significantly influence investment decisions, as these are dynamic and often unreliable.

    Conclusion

    • Behavioural finance challenges the assumption that people make rational financial decisions.
    • Behavioural factors profoundly affect investment decisions, impacting their timeliness and outcomes.
    • Investments should be made not only rationally but also by taking into consideration human psychology and emotions.

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    UNIT 1 Notes on Behavioural Finance

    Description

    This quiz explores the fundamentals of behavioural finance, focusing on how psychological factors impact financial decision-making and market behavior. It covers the history, scope, and key objectives of behavioural finance, along with the implications for investors and financial advisors. Test your knowledge on this critical aspect of finance!

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