Download - Behavioural finance b.v.raghunandan
Behavioural Finance-B.V.Raghunandan, SVS College, Bantwal
MBA Department,
Alva’s College of Engineering,
Moodbidri
August 20, 2013
Bi-Polar World
• Physical Sciences like Physics, Chemistry, Mathematics-Precision and Quantitative
• Non-Physical Sciences like Botany, Zoology, Medicines and Social Sciences- Imprecise and Qualitative
Bi-Polar Finance
• Standard Finance -Adding Precision to the Art of Investment-Homo Economicus
• Behavioural Finance- The Imprecise Art and the Heuristic Attitude
Standard Finance
• Modigliani and Miller’s Arbitrage Theory• Markowitz’s Diversified Portfolio• Asset Allocation of Sharpe• Black-Schole’s Option Pricing
Miller-Modigliani Arbitrage
Arbitrage
Theory of
Franco
Modigliani
&
Merton
Miller
Harry Max Markowitz
• Modern Portfolio Theory- Risk, Return, Correlation and Diversification
William Forsyth Sharpe
• Capital Asset Pricing Model
• Sharpe Ratio for risk adjusted performance analysis
• Binomial Method of Option Valuation
• Returns Based Style Analysis
Fischer Black-Myron S.Scholes• Valuation of Options• Hedging• Wide Usage• Option Price Calculator
Efficient Market Hypothesis
• People behave rationally (Homo Economicus)• Maximise the expected profit or utility• Trying to predict future value of individual securities• Important current information is freely available to all the
participants (Weak, Semi-Strong and Strong Markets)• Free Availability of information means there is no cost involved
in getting the information
Behavioural Finance
• BF is the study of the impact created by psychological factor on the activities of the investing public, traders, companies and the financial intermediaries
Why Psychology?• Crowd Mentality• Childishness• Tension• Need to be Praised• Prove Smartness• Short Term View• Intolerance• Moody• Refusing to Take
Decision• Acting on Tips
• Escaping from Reality• TV/Internet• Individualistic• Creating a Virtual World• Destruction of Family• Diplomacy inside the
House• Self-Centered Parents• Nuclear Personalities• Failing Health• Blinkers on the Eyes
Authorities on Behavioural Finance
• 1896- Gustave le Bon-’A Study of Popular Mind’• 1912- Seldon-’Psychology of the Stock Market’-price
changes depend upon mental attitude of the investing and trading public
• 1956- Leon Festinger introduced Theory of Cognitive Dissonance in social psychology
Prospect Theory• 1974-Amos Tversky
& Daniel Kahneman described three heuristics when making judgement under uncertainty:
• Representativeness • Availability:
occurrences• anchoring and
adjustment• Risk Aversion
Import of the Theory
– Explaining the apparent regularity in human behaviors when assessing risk under uncertainty.
– People respond differently to equivalent situations depending on whether it is presented in the context of a loss or a gain.
– Computation is based on losses and gains rather than final asset values– Investors are risk hesitant when chasing gains but become risk lovers
when trying to avoid a loss
Risk Aversion
& Risk
Seeking• Situation 1
Option a) A sure gain of Rs.2,000
Option b) 25% Chance to gain Rs.10,000 and 75% chance to gain nothing
• Situation 2
a) A sure loss of Rs.5000b) 75% chance to loss Rs.10,000 and 25% chance to lose nothing
• A large majority of people Choose A in situation 2(i) and b in situation 2(ii).
• In first situation the sure GAIN OF 2000 seems most attractive whereas in second situation the sure loss is repellent and the chance to lose nothing induces a preference for taking risk.
Richard Thaler: Regret Theory• Mental Accounting-1980
a) underweighting of opportunity costs
b) failure to ignore sunk costs
c) search behaviour, choosing not to choose and regret
d) precommitment and self-control.
Further Theories• 1980- Tversky and Kahneman- Problem
Framing and preferences• 1981-Shiller- Volatility is too high for the future
dividend• 1985- F.M.De Pont and Thaler-Overreaction of
Stcok Market• 1988- Samuelson and Zeckhauser- Status Quo
Bias• Many other Theories like Overconfidence etc
Changes in Stock Market
• Mutual Funds & Other Institutions
• HNI• FII Activity• F & O Market• Regulation by SEBI• Monetary Policy of RBI• Government Policies• Scams• Consultants, Advisors and
Media
• Investment Trusts• Disinvestment• Technology• Many Players• Dominant Financial Services• Free Pricing of IPOs• Technical Analysis• Irrelevance of PE Ratios• Tips and Sentiments• Interim Financial Reporting
THANK YOU