areas of finance areas of finance areas of finance
- 1. Areas of Finance Personal Finance (individuals) Corporate Finance (businesses) Social Finance ( Social enterprises) Financial Markets Public Finance (Governments) International Finance Behavioral Finance
- 3. Behavioral Finance 1- The study of the influence of psychology on the behavior of investors or financial analysts. 2- It also includes the subsequent effects on the markets. 3- It focuses on the fact that investors are not always rational, have limits to their self-control, and are influenced by their own biases.
- 5. A suboptimal result in an investment decision can stem from one of two issues: You made a good decision, but an unlikely negative event occurred. OR You simply made a bad decision.
- 6. • 6 Nobel prizes have been awarded for behavioral research ( i.e.Shiller 2013 – Thaler 2017)
- 7. Traditional Financial Theory Traditional finance includes the following beliefs: • Both the market and investors are perfectly rational • Investors truly care about utilitarian characteristics • Investors have perfect self-control • They are not confused by cognitive errors or information processing errors
- 8. Behavioral Finance Theory Now let’s compare traditional financial theory with behavioral finance. Traits of behavioral finance are: • Investors are treated as “normal” not “rational” • They actually have limits to their self-control • Investors are influenced by their own biases • Investors make cognitive errors that can lead to wrong decisions
- 10. Decision-Making Errors and Biases • Behavioral finance views investors as “normal” but being subject to decision-making biases and errors. We can break down the decision- making biases and errors into at least four buckets.
- 12. #1 Self-Deception The concept of self-deception is a limit to the way we learn. When we mistakenly think we know more than we actually do, we tend to miss information that we need to make an informed decision.
- 13. How you can overcome self-deception: • When making investment decisions, try to gather as much data and as many differing viewpoints as possible to make a well-rounded decision that takes in almost all available information and perspectives.
- 14. #2 Heuristic Simplification We can also scope out a bucket that is often called heuristic simplification. Heuristic simplification refers to information-processing errors.
- 15. How you can overcome heuristic simplification: • To avoid this group of behavioral errors in your financial journey, it makes sense to put extra thought into making any decision related to your portfolio and finances and resist the urge to make in-the- moment decisions based on defaults or rules of thumb.
- 16. #3 Emotion Basically, emotion in behavioral finance refers to our making decisions based on our current emotional state. Our current mood may take our decision-making off track from rational thinking.
- 17. How you can reduce emotional decision making: • A simple way to avoid making emotional decisions is to have a diverse set of asset classes and assets (diversify your portfolio). This could allow you to make fewer decisions according to emotion and more according to the strategy you've already put in place.
- 18. #4 Social Influence What we mean by the social bucket is how our decision-making is influenced by others.
- 19. How you can reduce social influence on investment decisions: • You can minimize the effects of social influence on your investment decisions by thinking of your finances from a subjective point of view. Making investment decisions based on your risk tolerance and goals can help you reduce the effects of external influence on your financial journey.
- 20. Top 10 Biases in Behavioral Finance • Behavioral finance seeks an understanding of the impact of personal biases on investors. Here is a list of common financial biases. • Overconfidence and illusion of control • Self Attribution Bias • Hindsight Bias • Confirmation Bias • The Narrative Fallacy • Representative Bias • Framing Bias • Anchoring Bias • Loss Aversion • Herding Mentality