Objective research to aid investing decisions

Value Investing Strategy (Strategy Overview)

Allocations for October 2024 (Final)
Cash TLT LQD SPY

Momentum Investing Strategy (Strategy Overview)

Allocations for October 2024 (Final)
1st ETF 2nd ETF 3rd ETF

Investors Behaving Badly?

| | Posted in: Animal Spirits

“[B]ehavioral finance attempts to explain and increase understanding of the reasoning patterns of investors, including the emotional processes involved and the degree to which they influence the decision-making process. Essentially, behavioral finance attempts to explain the what, why, and how of finance and investing, from a human perspective.” In his March 2005 paper entitled “A Research Starting Point for the New Scholar: A Unique Perspective of Behavioral Finance,” Victor Ricciardi provides a brief history and overview of behavioral finance. He notes that:

  • Behavioral finance investigates the cognitive biases (misorganization of information) and the emotional aspects of the decision-making processes of novice and expert investors.
  • Central to behavioral finance is prospect theory, which holds that: investors are more concerned with losses than by gains, assigning more significance to avoiding loss than to achieving gain (loss aversion); individuals are concerned more with changes in wealth than adjustments in levels of wealth; and, people overweight small probabilities and underweight middle range probabilities.
  • Another important behavioral finance concept is bounded rationality, which assumes that human rationality has limitations, especially under conditions of substantial risk and uncertainty.
  • Behavioral finance is interdisciplinary, as illustrated by the chart below.

The author lists the following topics/terms as important to behavioral finance:

In summary, behavioral finance adds elements of human irrationality to the standard finance foundation concepts of Modern Portfolio Theory and Efficient Markets Hypothesis.

Login
Daily Email Updates
Filter Research
  • Research Categories (select one or more)