Notes on Behavioral Finance and its Impact on Investment Decisions

Notes on Behavioral Finance and its Impact on Investment Decisions
  • 54

By Azad Ahmad Wani

Which came first? Throughout ages, the question of the chicken or the egg has led to many debates and even more questions. This essay is not about chickens or eggs, but it is about the order that we should think about financial issues and investment decisions. The study that influences the psychological behavior of financial practitioners and the subsequent effect on markets is called Behavioral finance. The term is of interest as it helps to make clear how and why markets might be unproductive. Behavioral finance is somewhat a fresh and new field of finance that originates from behavioral economics, psychology and conventional finance. Its aim is to recognize the irrationalities, biases, favoritism and errors in human decision-making correlated to financial and economical questions, and recommend ways to deal with these to achieve better decision making.
To understand the organized and efficient market implications of agent’s psychological traits is one of the main objectives of behavioral finance. In reality, behavioral finance is a powerful means or instrument not only in understanding the deeper intuitive causes of some of our activities linked to financial choice or decision making, but also, in addressing them efficiently in day to day life. The study of behavioral finance gives power to investors and professionals to achieve a deeper understanding of the drivers of their decisions and those of their clients and customers. Behavioral finance tries to find how investment decisions are affected by the emotions, feelings and psychology of investors.
To understand the role that behavioral finance plays on modern financial markets and active professional’s on these markets, we must first be aware of the origin of behavioral finance. We know that Efficient Market Hypothesis is considered to be one of the basics of modern finance. But , this hypothesis fails to give the explanation of irrationality, because it takes for granted or supposes that the market price of a security reflects the impact of any and all relevant information as it becomes available. The inadequacy and the shortcomings in Efficient Market Hypothesis in explaining the behavior of financial experts or investors is the basic and main cause for the emergence of behavioral finance.
The process of decision making helps bosses, managers and business experts to solve difficulties by examining alternative choices and deciding on the best and suitable route to take. The step-by-step approach is an efficient way to make thoughtful, informed decisions that have a positive impact on organization’s to achieve the short- and long-term goals. Experts in the field of decision making process have divided it into seven steps. To improve the effectiveness and clear understanding of decisions, managers may make use of these steps.
The steps of decision making process are as:

√ Identify the decision
√ Gather information
√ Identify alternatives or substitutes
√ Weigh the evidence
√ Choose among alternatives
√ Take action
√ Review your decision

The allocation of resources and the expected effect to recover the investment costs and have a high profit is called investment. The expected results of investment decisions are uncertain due to the economic and financial environment influences. To understand investment decision, it is necessary to study the theory of investment processes in practice. The outcome of practical analysis may help complete or correct the theory regarding the investments, or simply understand them better. From the other point of view, the correct and effective empirical analysis and research of investments can be made based on the theories of investment behavior. The investor should be aware of possible opportunities for a high-quality investment decision in a standard method, and should not make the decisions in a hurry. To achieve the maximum value from the appraisal method, it is essential to understand the fundamental ideas of the investment decisions. An incorrect investment decision could ruin the companies and investors. The investor has to decide, to proceed instantly or pass the time, without knowing whether the further information will verify the level of risk or not.
The cognitive intuition of business decisions conglomerate the effect of risk and bridle the profits in accordance with the laws of metaphysics. The duality gap between idea towards business and reality for business is filled by the subject of behavioral finance. Lesser the duality gap more , the prospects of human endeavor. In nutshell behaviorism is an abstract idea to shape the real business establishments and reduce the duality gap between idea and reality.

The author is a Research Scholar (Economics) at Aligarh Muslim University. He can be reached at: