Course Catalogue - Behavioural Finance (CMSE11408) (2024)

FAQs

What is the course content of behavioral finance? ›

Behavioral Finance Course Overview

In the course, you will learn about the wide range of decision-making biases and information processing errors that influence our financial decision-making. We'll start the course with what behavioral finance is and its impacts on financial markets.

Behavioural Finance (BF) is the study of investors' psychology while making financial decisions. Investors fall prey to their own and sometimes others' mistakes due to use of emotions in financial decision-making. For many financial advisors BF is still an unfamiliar and unused subject.

Behavioural finance aims to explain and increase people's understanding of the emotional aspects and psychological processes that affect people who invest in financial markets. Overconfidence, cognitive dissonance, regret theory, and prospect theory are four themes in the field of behavioural finance.

The former, during the money management, rely on the rationality, while the latter — on the irrationality. In turn, behavioral finance is an interdisciplinary subject based on theories and methods of research from a wide range of decision-making areas, such as psychology, sociology, and finance.

And yet, there is no dearth of investors making irrational decisions. Clearly, something else is at play here – cognitive bias and limits to arbitrage. These are the two pillars of behavioural finance. Both offer answers to how emotions and biases affect share prices and financial markets.

Behavioral finance consists of three themes: (1) heuristic‐driven bias; (2) frame dependence; and (3) inefficient markets.

In conclusion, behavioral finance is both a science and an art. Its scientific foundation is built on empirical research, data analysis, and predictive modeling, while its artistic dimension involves interpreting human behavior, crafting investment strategies, and adapting to changing financial landscapes.

The key concepts in behavioral finance, such as bounded rationality, heuristics, prospect theory, mental accounting, and biases like overconfidence, confirmation bias, and loss aversion, highlight the irrational financial choices people make, deviating from the assumptions of traditional finance models.

Example: Another classic example of behavioural finance in action is the tendency for investors to practice Loss Aversion. Many investors hold on to losing stocks for too long, hoping for a rebound.

What does the rule of 72 determine? ›

The Rule of 72 is a calculation that estimates the number of years it takes to double your money at a specified rate of return. If, for example, your account earns 4 percent, divide 72 by 4 to get the number of years it will take for your money to double. In this case, 18 years.

Ultimately, behavioral finance is important because it helps investors recognize how psychology affects their financial decisions and gives them tools to address irrationality. It provides a better understanding of why investors make confident financial decisions and helps them better manage their investments.

Understanding the various money personalities helps with investing, spending, saving, and finances. Five common money personalities are investors, savers, big spenders, debtors, and shoppers. Debtors and shoppers may tend to spend more money than is advisable.

Behavioural finance theory ignores the impact of social status on investment decisions. Some investments are made only to increase social status and investors do not care about the economic impact of such investments e.g. people purchase expensive houses and other goods to to 'keep up with the Jones's'.

Heuristics are a subfield of cognitive psychology and behavioural science. They are shortcuts to simplify the assessment of probabilities in a decision making process. Initially, they dealt with cognitive biases in decision making, and then encompassed emotional factors.

The key concepts in behavioral finance, such as bounded rationality, heuristics, prospect theory, mental accounting, and biases like overconfidence, confirmation bias, and loss aversion, highlight the irrational financial choices people make, deviating from the assumptions of traditional finance models.

What Does Behavioral Finance Tell Us? Behavioral finance helps us understand how financial decisions around things like investments, payments, risk, and personal debt, are greatly influenced by human emotion, biases, and cognitive limitations of the mind in processing and responding to information.

On successful completion of this Programme, students will be able to: · Apply analytical skills for financial decision making. Identify the behavioural bias and psychological characteristics of investors. Develop strategies to manage wealth effectively and wisely from mispriced assets.

Behavioural finance focuses upon how investor interprets and acts on information to take various investment decisions. In addition, behavioural finance also places emphasis on investor's behaviour leading to various market anomalies.