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behavioral finance - Assignment Example

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Finance & Accounting
Pages 10 (2510 words)


BEHAVIORAL FINANCE Date PART 1 Section A Behavioral finance refers to the study of the influence of psychology on people in the financial sector and its perceived overall influence on financial markets. This in essence means it is a combination of finance and psychology to determine and explain how and why people tend to make illogical and inherent decisions when it comes down to saving, spending money…

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behavioral finance

Modern financial economics are pegged on the assumption that financial practitioners act both meticulously and with rationale. However as evidenced and earlier stated, this is not always the case. These deviations from the norm are not rampant and inherent but follow a systematic chain of events. With this information in mind it is possible to incorporate these systematic human deviations into the standard model of financial markets (Rutledge 264). In so doing, two commonly overlooked mistakes come to the foreground: Financial practitioners tend to indulge in excessive trading with belief that the next trade will rake in more lucrative returns. This is irrational trading and is propelled by emotion rather than rational thinking. The human trait of being too overconfident or corky in this case is the key driving motivation behind this bias. Some financial practitioners are also in the habit of holding on to losing stocks while at the same selling their winning stocks. This again is instigated by lack of confidence and the need to avoid both failure and regrets coupled with poor judgments. Behavioral finance contributes to asset pricing in two major dimensions. ...
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