Behavioral Finance

Psychology of risk

Is the study of how people perceive, evaluate, and respond to risk.

Psychology of risk

It explains why people sometimes makes risky or overly cautious decisions.

Psychology of risk

Emotions, experience, and beliefs influence risk-taking behavior.

Overconfidence Bias

Believing we know more than we actually do.

Availability Bias

Judging risk based on recent or memorable events.

Confirmation Bias

Looking only for information that supports our beliefs.

Psychology Concepts

Are the basic ideas used to understand how people think, feel, and behave.

Cognitive Dissonance

Is the uncomfortable feeling a person gets when their thoughts do not match their actions.

Halo Effect

It is judging someone or something based on one positive trait and assumes they’re good in others too.

Inattentional Blindness

Is the failure to notice something because attention is focus on something else.

Operant Conditioning

Is a learning process where behavior is influence by its consequences.

Groupthink

Is an irrational decision making due to the desire to maintain group harmony instead of logical decision making.

Emotional Contagion

Is the phenomenon where people automatically “catch” and share the emotion of others, such as happiness, excitement, fear, or sadness.

Learned Helplessness

Is when a person believes they cannot improve their situation after experiencing repeated failure.

Behavioral Biases

Are the tendency of people to act or decide in a certain way because their mind and emotions influence there judgment.

Emotional Biases

Are decisions influenced by feelings, emotions, and personal preferences rather than logical analysis.

Cognitive Biases

Are errors in logic, memory, or information processing.

Regret Aversion Bias

The tendency to avoid making decisions because of the fear of feeling regret later.

Loss Aversion Bias

The tendency to fear losses more than valuing possible gains.

Status Quo Bias

The tendency to prefer things to stay the same because change feels uncomfortable or risky.

Endowment Bias

The tendency to value something more simply because you own it.

Self-Control Bias

The difficulty of controlling impulses when making decisions.

Fear and Greed Bias

Decisions are affected by extreme fear or excitement.

Overconfidence Bias

The tendency to believe that your knowledge, skills, or predictions are better and more accurate than they actually are.

Confirmation Bias

The tendency to look for and believe information that supports your existing opinions while ignoring information that disagrees with you.

Anchoring Bias

The tendency to rely too much on the first information received when making decisions.

Availability Bias

The tendency to judge situations based on information or examples that easily come to mind.

Hindsight Bias

The tendency to believe that an event was predictable after it already happened.

Representativeness Bias

The tendency to judge something based on similarities or past experiences instead of complete information.

Behavioral Finance

Studies how psychology and human behavior influence financial decisions and market outcomes.

Asset Pricing

Determines the value and expected return of financial assets.

Behavioral Asset Pricing

Focuses on how emotions, beliefs, and psychological biases influence asset prices and returns.

Overconfidence Bias

Occurs when investors have excessive confidence in their knowledge, skills or ability to predict market movements.

Loss Aversion Bias

Refers to the tendency of investors to feel the negative impact of losses more strongly than the positive impact of equivalent gains.

Herding Behavior

Occurs when investors follow the actions or decisions of other investors instead of making independent judgments.

Representativeness Biass

Occurs when investors judge an investment based on recent experiences or patterns and assume that these pattern will continue.

Anchoring Bias

Occurs when investors rely too heavily on a specific piece of information when making investment decisions.

Overreaction

Happens when investors become too emotional and react too strongly to news.

Underreaction

Happens when investors react too slowly to important news.

Limits to Arbitrage

Are the risks and costs that prevent rational investors from immediately correcting mis-priced assets.

Momentum Effect

Stocks that have recently performed well may continue to perform well for a period of time.

Reversal Effect

Stocks that have experienced extreme price increases or decreases may later move in the opposite direction.

Excessive Volatility

Assets prices may fluctuate more than can be explained by changes in fundamental information alone.

Market Bubbles and Crashes

Strong investor optimism may push assets prices to extremely high levels, while sudden changes in sentiment may contribute to sharp price declines.

Prospect Theory

Is a theory of behavioral economics and behavioral finance.

Prospect Theory

It is sometimes referred to as the loss-aversion theory.

Prospect Theory

The theory was introduced by two psychologists, Daniel Kahneman, and Amos Tversky, to describe how humans make decisions when presented with several choices.

Daniel Kahneman

He is professor emeritus (person retired from professional life but permitted to retain as an honorary title the rank of the last office held) of psychology and public affairs at Princeton University's Princeton School of Public and International Affairs

Amos Nathan Tversky

Was an Israeli cognitive and mathematical psychologist and a key figure in the discovery of systematic human cognitive bias and handling of risk.

Prospect Theory

Is a psychology theory that describes how people make decisions when presented with alternatives that involve risk, probability, and uncertainty. It holds that people make decisions based on perceived losses or gains.

Editing Phase

Refers to how people involved in decision-making characterize the options for choice or the framing effects.

Evaluation Phase

Refers to how people involved in decision-making characterize the options for choice or the framing effects.

Evaluation Phase

The phase uses statistical analysis to measure and compare the outcomes of each prospect.

Value Function

Gives the value attained by the objective function at a solution.

Weighting Function

(which is not defined near the end points), which are used to compare the prospects.

Certainty

When presented with several options to choose from, humans show a strong preference for the option with certainty. They are willing to sacrifice the option that offers more potential income in order to achieve more certainty.

Small Probabilities

People tend to discount very small probabilities even if there is a possibility of losing all their wealth.

Relative Positioning

Means that people tend to focus less on their final income or wealth, and more on the relative gains or losses that they will get.

Relative Positioning

This means that people tend to compare themselves to their neighbors, friends, and family members, and are less interested in whether they are better off than they were some years back.

Loss Aversion

Is a cognitive bias that describes why, for individuals, the pain of losing is psychologically twice as powerful as the pleasure of gaining.

Loss Aversion

People tend to give more weight to losses rather than gains made by taking a certain option.

1.Overconfidence Bias

2.Availability Bias

3.Confirmation Bias

 

COMMON PSYCHOLOGICAL BIASES:

1.Investing Money

2.Driving a vehicle

3.Starting a business

4.Choosing a career

5.Making health decisions

 

RISK IN DAILY LIFE:

1.Cognitive dissonance

2.Halo Effect

3.Inattentional blindness

4.Operant conditioning

5.Groupthink

6.Emotional contagion

7.Learned helplessness

EXAMPLE OF PSCHOLOGICAL CONCEPT:

1.Emotional biases

2.Cognitive biases

TWO MAIN CATEGORIES OF BEHAVIORAL BIASES:

1.Regret aversion bias

2.Loss aversion bias

3.Status quo bias

4.Endowment bias

5.Self-control bias

6.Fear and greed bias

 

KINDS OF EMOTIONAL BIASES:

1.Overconfidence bias

2.Confirmation bias

3.Anchoring bias

4.Availability bias

5.Hindsight bias

6.Representativeness bias

KINDS OF COGNITIVE BIAS:

1.Increase self awareness

2.Gather more information

3.Think slowly and carefully

4.Use data and evidence

5.Consider different perspectives

6. Seek advice from others

WAYS TO REDUCE BEHAVIORAL BIASES:

1.Poor decision making

2. Finacial losses

3.Missed opportunities

4.Increased risk-taking

5.Poor business performance

IMPACT OF BEHAVIORAL BIASES:

1.Emotions

2.Personal beliefs

3.Cognitive biases

4. Social influences

5.Investor sentiment

FACTORS INFLUENCING INVESTOR BEHAVIOR:

1.Overconfidence bias

2.Loss aversion

3.Herding behavior

4.Representativeness bias

5.Anchoring bias

PSYCHOLOGICAL FACTORS AFFECTING ASSET PRICING:

1.Momentum effect

2.Reversal effect

3.Excessive volatility

4.Market bubbles and crashes

BEHAVIORAL ASSET PRICING ANOMALIES:

1.Editing Phase

2.Evaluation Phase

PHASES OF PROSPECT THEORY:

1.Certainty

2.Small probabilities

3.Relative positioning

4.Loss aversion

FEATURES OF PROSPECT THEORY: