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Introduction
1
“One of the funny things about
the stock market is that every
time one person buys, another
sells, and both think they are
astute.” - William Feather
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RESEARCH PROBLEM
Research problem is nothing but the defining and re-defining the objectives till
a proper & consolidated problem can visualize. Research problem of my
study is-
“A Study on Heuristics due to Investors’ Psychology in
Finncil !rding"
Behavioral economists firmly believe that psychological factors influence
investment decisions. They argue that today’s investment decisions demand a
better understanding of individual investors’ behavioral biases.
Psychologicl Fctors A##ecting Behviors o# Individul trders
1. verconfidence
!. "#cessive ptimism
$. "#cessive %essimistic
. 'erd Behavior
(. )nertia
*. +ental accounting
,. Biases
)n this study the aim is to establish the e#istence of fundamental issues
driven by various psychological biases in the investment decision-maing
process.
!
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An O$ER$IE% o# HE&RIS!ICS
Heuristics
“Heuristics are simple efficient rules of the thumb which have been
proposed to explain how people make decisions, come to judgments and
solve problems, typically when facing complex problems or incomplete
information. These rules work well under most circumstances, but in certain
cases lead to systematic cognitive biases” / 0aniel ahneman
Tversy and ahneman identified the influence of human heuristics on the
decision maing process. Tversy defined heuristic as a strategy 2hich can be
applied to a variety of problems that usually/but not al2ays/yields a correct
solution. %eople often use heuristics 3or shortcuts4 that reduce comple#
problem solving to more simple judgmental operations 3Tversy and
ahneman 15614. 'euristic decision process is the process by 2hich the
investors find things out for themselves usually by trial and error lead to the
development of rules of thumb.
'euristics 2hich e#presses that individuals have a tendency to mae
judgments 7uicly are simplifying strategies used to approach comple#
problems and limit e#planatory information. )ndividual investors tend to tae
decisions usually by trial and error method thus developing rules of thumb. To
put it simply investors use rules of thumb in order to process comple#
information so as to mae investment decisions. )t may be possible that
$
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investors have obtained appropriate information and evaluate all these in an
objective manner but it is very difficult to separate one from emotional and
cognitive errors involved in each and every step undertaen by the investor.
8ometimes it may lead to a favorable decision but many a times it may result
in unfavorable and poor decision outcomes.
)n other 2ords it refers to rules of thumb 2hich humans use to made
decisions in comple# uncertain environments +an is not capable to process
all the information that one is presented 2ith on a daily basis. 9hile
accumulating e#perience through the process of doing something those
e#periences gives an impression of ho2 something 2ors. This process creates
rules of thumb that can then be used 2hen a similar situation is encountered.
This phenomenon is called the use of heuristics.
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Behviorl Finnce nd 'ecision M(ing
“ehavioral !inance is becoming an integral part of decision"making
process because it heavily influences the investors# performance”.
)Bner*ee+ ,-../
“$n understanding of how our emotions result in irrational behavior is
indispensable for any investor”. )Pri(h+ ,-../
0ecision-maing can be defined as the process of choosing a particular
alternative from many available alternatives. )t is a complicated multi-step
process involving analysis of various personal technical and situational
factors. There are no e#ceptions in the case of maing decisions in the stoc
marets either. Taing investment decisions is the most crucial challenge faced
by investors. 8ome personal factors are age education income etc. n the
technical side investment decisions can be derived from various models of
finance for e.g. the capital asset pricing model 3:;%+4. 0ecisions should not
be reached 2ithout considering situational factors that tae into account the
environment the maret psychology in other 2ords.
"ffective decision maing in the stoc maret re7uires an understanding of
human nature in a global perspective on top of financial sills. Thus cognitive
(
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psychology should be given importance in the process of decision-maing
3:handra !
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investor can be defined as a one that al2ays 3i4 updates his beliefs in a timely
and appropriate manner on receiving ne2 information@ 3ii4 maes choices that
are normatively acceptable )n 2hat is very liely to be termed as an =anomaly>
by most traditional economic theories the foundations of the 2orld economy
2ere shaen by the Ainancial :risis of !
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3!
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themselves is better than is actually the case. ; common trait among investors
is a general overconfidence of their o2n ability 2hen it comes to picing
stocs and to decide 2hen to enter or e#it a position. These tendencies 2ere
researched by dean 315564 and it 2as found that traders that conducted the
most trades tended on average to receive significantly lo2er yields than the
maret. Aurthermore psychologists have determined that overconfidence
causes people to overestimate their no2ledge underestimate riss and
e#aggerate their ability to control events. 8pecific security selection is a highly
difficult undertaing. )nterestingly this type of activity is precisely the tas at
2hich people e#hibit the greatest overconfidence 3?ofsinger !
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the period Aebruary 156* to ;pril !
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characteristic of its stoc. These companies turn out to be poor investments
more often than not 3Daonisho et al 1554. 16
Herding Bis
'erding in financial marets can be defined as mutual imitation leading to a
convergence of action 3'irshleifer and Teoh !
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individually. ne reason is that people are sociable and generally tend to see
acceptance from the group rather than being a standout. ;nother reason is that
investors tend to thin that it is unliely that a large group could be 2rong.
This could mae him follo2 the herd under the illusion that the herd may
no2 something he does not.
"conomou ostais and %hilippas 3!
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of a partial computation. %n either case, adjustments are typically
insufficient )*lovic and +ichtenstein, -/. That is, different starting points
yield different estimates, which are biased toward the initial values. 0e call
this phenomenon $nchoring.( )!vers(y nd 1hne2n+ .345/6
;nchoring is a psychological heuristic 2hich can be said to occur 2hen
investors give unnecessary importance to statistically random and
psychologically determined Janchors’ 2hich leads them to investment
decisions that are not essentially Jrational’. 9hen re7uired to estimate a good
buy price for a share and investor is liely to start by using an initial value /
called the =anchor> / 2ithout much analysis say for e.g. the (!-2ee lo2 of
the stoc. Then they adjust this anchor up or do2n to reflect their analysis or
ne2 information but studies have sho2n that this adjustment is insufficient
and ends producing results that are biased. )nvestors e#hibiting this bias are
liely to be influenced by these anchors 2hile ans2ering ey 7uestions lie J)s
this a good time to buy or sell the stocF’ or Jis the stoc fairly pricedF’ The
concept of ;nchoring can thus be e#plained by the tendency of investors to
=anchor> their thoughts to a logically irrelevant reference point 2hile maing
an investment decision 3%ompian !
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2ith the help of business administration undergraduate students and results
sho2ed that the participants treated the proposed selling price as an anchor.
;ndersen 3!
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reaching rationali'ations in order to synchroni'e their cognitions and
maintain psychological stability” )Po20in+ ,--7/6
;ccording to %ompian 3!
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mainly because the outcomes of the alternative are visibly better for the
investor to see. The root cause of this type of error is the tendency that
individuals hate to admit their mistaes. Because of suffering from this bias
investors may avoid taing decisive actions for the fear that 2hatever
decisions they mae tae 2ill be sub-optimal in 'indsight. ne potential
do2nside is that this could lead investors into holding onto a losing position
for too long because of un2illingness to admit and rectify mistaes in a
timely manner. ;nother do2nside is that it can stop investors from maing an
entry into the maret 2hen there has been a do2ntrend 2hich is sho2ing
signs of ending and signals that it is a good time to buy. The Aear of Regret
happens often 2hen individuals procrastinate 2hile maing decisions. Larious
psychology e#perimental studies suggest that regret influences decision-
maing under uncertainty.
92:lers’ Fllcy Bis
“3erhaps the most bi'arre argument for being bullish is the belief that
markets can#t go down for four years in a row. This is a prime example of
the ;amblers# !allacy.” Montier ),--;/6
ahneman and Tversy 315,14 describe the heart of gambler’s fallacy as a
misconception of the fairness of the la2s of chance. ne major impact on the
financial maret is that investors suffering from this bias are liely to be
1,
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biased to2ards predicting reversals in stoc prices. Camblers’ Aallacy arises
2hen investors inappropriately predict that trend 2ill reverse and are dra2n
into contrarian thining. Camblers’ Aallacy is said to occur 2hen an investor
operates under the perception that errors in random events are self-correcting.
Aor instance if a fair coin is tossed ten times and it land on heads each time
an investor 2ho feels that the ne#t flip 2ill result in tails can be said to be
suffering from this bias.
Mentl Accounting Bis
+ental ;ccounting 2as coined by Richard Thaler and defined by Thaler
315554 as the “set of cognitive operations used by individuals and
households to organi'e, evaluate, and keep track of financial activities.”
+ental ;ccounting is the set of cognitive operations used by individuals and
households to organize evaluate and eep trac of financial activities. This
result in a tendency for people to separate their money into separate accounts
based on a variety of subjective reasons.
Pros0ect !heory
ahneman and Tversy 315,54 found empirically that people under2eight
outcomes that are merely probable in comparison 2ith outcomes that are
obtained 2ith certainty@ also that people generally discard components that are
shared by all prospects under consideration. The prospect theory describes
ho2 people frame and value a decision involving uncertainty. nder prospect
16
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theory value is assigned to gains and losses rather than to final assets@ also
probabilities are replaced by decision 2eights. ;ccordingly people loo at
choices in terms of potential gains or losses in relation to a specific reference
point 2hich is often the purchase price. ;nd ho2 do people value
gainsMlossesF
They value gainsMlosses according to a 8- shaped utility function as depicted in
the diagram 1 belo2 i.e. %eople feel more pain from a loss than the pleasure
from a similar amount.
'igr2 ,6.
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The utility function is conve# for losses. This means that people e#perience
pain 2hen they lose but t2ice the loss does not mean t2ice the pain.
The utility function is steeper for losses than for gains. This means that people
feel more strongly about the pain from a loss than the pleasure from an e7ual
gainE - about t2o and half times as strongly according to ahneman Tversy.
This phenomenon is referred to as loss aversion .Because of loss aversion the
manner in 2hich an outcome is described-either in the vocabulary of gains or
in the vocabulary of losses - has an important bearing on decision maing.
ahneman netsch and Thaler 3155
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'igr2< !y0icl 0ro::ility =eighting #unctions #or gins )=>/ nd
losses )=8/ in cu2ultive 0ros0ect theory
Source< 0aniel ahneman & ;mos Tversy 315,54 =%rospect TheoryE ;n
;nalysis of Decision under Risk” "conometrica Lol. ,6
!1
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RE$IE% o#
LI!ERA!&RE
!!
“Behavioral fnance is
the study o the
inuence o psychology
on the behaviour o
fnancial practitioners
and the subsequent
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!rditionl !heory o# Finnce
Ainance can be broadly defined as the study of ho2 scare resources are
allocated by humans and ho2 these resources are managed ac7uired and
invested over time. There are t2o ey paradigms 2ithin the traditional Theory
of Ainance E3i4 +aret agents are perfectly rationalE perfect rational behavior
implies that any ne2 available information is interpreted correctly and
uniformly but all maret agents 2hile updating their beliefs and 3ii4 +arets
are "fficientE The "fficient +aret 'ypothesis 3"+'4 states all relevant
information are reflected in the prices instantaneously and completely. 9hen
the hypothesis holds prices are right and there is Nno free lunchN. i.e. there is
no investment strategy 2hich can earn e#cess ris-adjusted average returns
consistently. ver the past fifty years there has been a lot of focus on the
development and testing of various sophisticated asset pricing models.
8ubrahmanyam 3!
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9hile this 2as happening in the financial 2orld researchers in psychology
2ere discovering that people often behave in odd 2ays 2hile maing
decisions 2here money is involved. %sychologists have found that economic
decisions are often made in a seemingly irrational manner. :ognitive errors
and e#treme emotions can cause investors to mae bad investment decisions.
8hiller 3!that :;%+ "+' and other traditional financial theories did a great job in
predicting and e#plaining certain events. 'o2ever academics also started to
find anomalies and behaviors 2hich these traditional theories could not
e#plain. T2o popular e#amples are
3i4 The Kanuary "ffect an anomaly in the financial maret 2here the
prices of a security increase in the month of Kanuary 2ithout
fundamental reasons 3Rozeff and inney 15,*4
3ii4 The 9innerNs :urse 2here the 2inning big in an auction tends to
e#ceed intrinsic value of the item purchased mainly due to
incomplete information and emotions leading bidders to
overestimating the itemNs value. 3Thaler 15664. ;cademics 2ere
prompted to loo to cognitive psychology to account for irrational and
illogical investor behavior 3%hung !!
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!he E##icient Mr(et Hy0othesis
($n >efficient> market is defined as a market where there are large numbers
of rational, profit"maximi'es actively competing, with each trying to predict
future market values of individual securities, and where important current
information is almost freely available to all participants. %n an efficient
market, competition among the many intelligent participants leads to a
situation where, at any point in time, actual prices of individual securities
already reflect the effects of information based both on events that have
already occurred and on events which, as of now, the market expects to take
place in the future. %n other words, in an efficient market at any point in
time the actual price of a security will be a good estimate of its intrinsic
value.( 3Aama 15*(4
The "fficient +aret 'ypothesis 3"+'4 has been a central finance paradigm
for over < years probably the most criticized too. Aama 315,
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-centered on 2hy the hypothesis should hold- developed supported by
immense theoretical and empirical success. The niversity of :hicago home
to the "+' became the 2orld’s center of academic finance.
The theoretical foundation of "+' is based on three ey arguments
3i4 )nvestors are rational and value securities rationally
3ii4 )n case some investors are irrational their trades are random and cancel
each other out 2ithout affecting prices
3iii4 Rational arbitrageurs eliminate the influence of irrational investors on
maret.
The fact that "fficient +aret 'ypothesis 2as not purely based on rationality
alone but also predicted efficient marets in cases 2here rationality did not
e#ist gave the theory a lot of credibility. The empirical evidence from the
15,
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Origin o# the Behviorl Finnce
Behavioral finance is a branch of finance that studies ho2 the behavior of
agents in the financial maret and influenced by psychological factors and the
resulting influence on decisions made 2hile buying or selling the maret thus
affecting the prices. The science aims to e#plain the reasons 2hy it’s
reasonable to believe that marets are inefficient ;ccording to 8e2ell 3!
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“ehavioral finance relaxes the traditional assumptions of financial
economics by incorporating these observable, systematic, and very human
departures from rationality into standard models of financial markets. The
tendency for human beings to be overconfident causes the first bias in
investors, and the human desire to avoid regret prompts the second” ( Barber
and dean 15554.
Thus Behavioral finance can be defined as a field of finance that proposes
e#planation of stoc maret anomalies using identified psychological biases
rather than dismissing them as “chance results consistent with the market
efficiency hypothesis.” ( Aama 15564. )t is assumed that individual investors
and maret outcomes are influenced by information structure and various
characteristics of maret participants 3Banerjee !
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doctrines of the traditional paradigm that is 3i4 agents fail to update their
beliefs correctly and 3ii4 there is a systematic deviation from the normative
process in maing investment choices. 3ishore !
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RE$IE% o# EARLIER RESEARCHES
The ey research 2ors on this area 2as done by 0aniel ahneman and ;mos
Tversy recognized as the Aathers of Behavioral Ainance. )n the 15*
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randomly drawn from a population as highly representative” 3ahneman
and Tversy 15,14.
)n their 15,! publication titled =8ubjective probabilityE ; judgment of
Representativeness> they study the Representativeness bias - 2hich is
e#plained later in this study / and follo2ed it up 2ith a 15,$ publication titled
=n the psychology of prediction> 2hich says that Representativeness play a
ey role in intuitive predictions made by individuals 3ahneman and Tversy
15,! 15,$4.
?udg2ent under &ncertinty< Heuristics nd Bises
)1hne2n nd !vers(y+ .34,+ .34;/6
)n .345 “?udg2ent under &ncertinty< Heuristics nd Bises"+
)1hne2n nd !vers(y+ .34,+ .34;/+ ne of the prominent 2ors 2as
published. They described three heuristics /
Re0resenttiveness+
Avil:ility
Anchoring
They said that “a better understanding of these heuristics and biases to
which they lead could improve judgment and decisions in situations of
uncertainty”.
)n 15,5 their most important 2or titled “Pros0ect !heory< An nlysis o#
decision under ris(" appeared in Econometrica 2hich 2as Ja criti7ue of
e#pected utility theory as a descriptive model of decision maing under ris’
and the alternative model developed 2as called %rospect Theory. ahneman
$1
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2as a2arded the ?obel %rize in "conomics in !Theory.
)n another important paper Tversy and ahneman 315614 introduced the
effect famous as Araming. )t 2as sho2n that 2hen the same problem 2as
framed in different 2ays the psychological principles that governed the
perception of decision problems and evaluation of probabilities and outcomes
produced predicated shifts of preference.
So2e other literry =or(s there =ere revie=ed re
su22ri@ed :elo=<
'offmann 8hefrin and %ennings 3!
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!he i20ct o# :ehviorl #ctors nd investor’s 0sychology on
their decision82(ing
:handra 3!
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Behviorl Finnce8 Student Pers0ective’
8airafi 8elleby and 8tahl 3!
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!he role o# :ehviorl #innce nd investor 0sychology
in invest2ent decision 2(ing
9a2eru +unyoi and liana 3!
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relevance ratings and lo2er investment attractiveness ratings 2hile provided
2ith simultaneous negative information in comparison 2ith se7uential
negative information3consistent 2ith phenomena of multiple loss aversion and
loss buffering4. )nvestors’ relevance and attractiveness ratings 2ere higher
2hen positive information 2as provided se7uentially 3consistent 2ith gain
savoring4. The study categorized investors as current and prospective. )t 2as
e#amined ho2 they evaluate positive and negative information presented
se7uentially or simultaneously aimed to determine 2hether these results can
be generalized to apply to investment related information and 2hether investor
status affects this evaluation.
!he :ehviorl 0tterns ehi:ited :y investors in ris(
situtions+
Crou and Toba 3!
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four e#periments under various settings. Results sho2ed that invested
proportions 2ere significantly higher in no2n distributions. "ven though
students e#hibited ambiguity aversion not many 2ere 2illing to pay a price to
reduce or eliminate the ambiguity
OB?EC!I$ES
OF !HE S!&'$,
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OB?EC!I$ES OF !HE S!&'
Behavioral economists firmly believe that psychological factors influence
investment decisions. They argue that today’s investment decisions demand a
better understanding of individual investors’ behavioral biases.
Psychologicl Fctors A##ecting Behviors o# Individul trders
1 verconfidence
! "#cessive ptimism
$ "#cessive %essimistic
'erd Behavior
( )nertia
* +ental accounting
$6
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, Biases
)n this study the aim is to establish the e#istence of fundamental issues
driven by various psychological biases in the investment decision-maing process.
PRIMAR OB?EC!I$ES
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traders in understanding emotional and behavioral factors need to be
incorporated in the investment strategies.
$lue dded
9ith an objective to create investor’s confidence in the 8toc maret
behavioral issues are the ne2est of the things 2hich must be considered 2hile
formulating investment strategies.
This research 2ill help investment advisors and finance professionals judge
investor’s attitude to2ards ris in a better 2ay thus leading to better
investment decision-maing.
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RESEARCH
ME!HO'OLO9
1
It is the process used to
collect information and dat
a for the purpose
of making business decision
s. The methodology may
include publication researc
h , intervies , surveys and
other research techni!ues ,
and could include both
present and historical
information.
http://www.businessdictionary.com/definition/process.htmlhttp://www.businessdictionary.com/definition/information.htmlhttp://www.businessdictionary.com/definition/data.htmlhttp://www.businessdictionary.com/definition/data.htmlhttp://www.businessdictionary.com/definition/maker.htmlhttp://www.businessdictionary.com/definition/business.htmlhttp://www.businessdictionary.com/definition/decision.htmlhttp://www.businessdictionary.com/definition/decision.htmlhttp://www.businessdictionary.com/definition/methodology.htmlhttp://www.businessdictionary.com/definition/publication.htmlhttp://www.businessdictionary.com/definition/research.htmlhttp://www.businessdictionary.com/definition/research.htmlhttp://www.businessdictionary.com/definition/interview.htmlhttp://www.businessdictionary.com/definition/survey.htmlhttp://www.businessdictionary.com/definition/technique.htmlhttp://www.businessdictionary.com/definition/information.htmlhttp://www.businessdictionary.com/definition/data.htmlhttp://www.businessdictionary.com/definition/data.htmlhttp://www.businessdictionary.com/definition/maker.htmlhttp://www.businessdictionary.com/definition/business.htmlhttp://www.businessdictionary.com/definition/decision.htmlhttp://www.businessdictionary.com/definition/decision.htmlhttp://www.businessdictionary.com/definition/methodology.htmlhttp://www.businessdictionary.com/definition/publication.htmlhttp://www.businessdictionary.com/definition/research.htmlhttp://www.businessdictionary.com/definition/research.htmlhttp://www.businessdictionary.com/definition/interview.htmlhttp://www.businessdictionary.com/definition/survey.htmlhttp://www.businessdictionary.com/definition/technique.htmlhttp://www.businessdictionary.com/definition/process.html
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RESEARCH ME!HO'OLO9
'e#inition o# RESEARCH
Research is a “structured enDuiry tht utili@es cce0t:le scienti#ic2ethodology to solve 0ro:le2s nd crete ne= (no=ledge tht is
generlly 00lic:le"6 Research refers to “ serch #or (no=ledge"6 ne
can also define research as a scientific and systematic search for pertinent
information on a specific scientific investigation. The ;dvanced Dearner’s
0ictionary of :urrent "nglish lays do2n the meaning of research as a careful
investigation or in7uiry Redman and +ory define research as a =syste2ti@ed
E##ort to gin ne= (no=ledge6" 8ome people consider research as a
movement from the no2n to the unno2n. )t is actually a voyage of
discovery especially through search for ne2 facts in any branch of no2ledge.
The procedure used to collect information should be one that 2ill result in
information that is both valid and reliable. To help to ac7uire valid and reliable
information there is liely the usage of series of steps. These steps are as
follo2s.
PRIMAR OB?EC!I$ES
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*. To no2 about ris perception of investors
,. To no2 the understanding of B"';L)R;D A)?;?:" in the
traders.
RESEARCH PROBLEM
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+ost investors and traders that fall into the e#perienced category 2ere not
liely to be as technology perceptive as the average young investor and tend
to do their trading via the broerage floor. 8o hard copies of the 7uestionnaire
2ere distributed among investors.
The young investor 2as liely to favor online trading over floor trading thus
necessitating an online survey
SAMPLI9 !ECHI&E<
:onvenience samplingE :onvenience sampling 2as done for the selection.
S20le Pro#ile
ne of the primary aims of the study 2as to focus on real investors as they
2ere more liely to have limited no2ledge about the application of
behavioral theories in decision-maing and hence gullible to psychological
errors. The sample profile 2as created based on t2o judgment criteriaE age of
the respondent and years of investment e#perience in the stoc maret. ;fter
an analysis of the sample the follo2ing groups 2ere found to be optimalE
3i4 "#periencedE )nvestors aged above $( 2ith at least ( years of investing
bacground
3ii4 OoungE )nvestors aged $( or belo2 2ith less than ( years of investing
bacground
&niverse
The universe is the area in 2hich research is to be conducted. )n this research
universe are the traders trading actively in securities maret.
S20le si@e
The sample size consists of G- res0ondents.
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Period o# Study
This research 2as conducted for (< days from +ar 1! th !
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LIMI!A!IOS OF !HE S!&'
This study has suffered from certain limitations lie any other research.
'o2ever these limitations cannot have a drastic impact on the analysis and
the recommendations of the study as these limitations are 2ithin manageable
limits. These limitations are as follo2sE
The main 2eaness of the study is o2ing to the fact that it aims to study
investor behavioral patterns using 7uestionnaires. +aing financial decisions
can be demanding for various reasons that possibly could push many into
maing irrational decisions at one point or the other. 'o2ever 2hile
ans2ering a 7uestionnaire the same individuals are liely to be rela#ed and in
a better frame of mind hence choosing to give ans2ers 2hich may put them
across in different light especially in conte#t of 7uestions 2hich 2ere
presenting hypothetical situations. To overcome this problem to an e#tent
many 7uestions attempted to mae the participants admit mistaes they have
made in the past.
; second limitation arises out of the fact that )ndia is a vast country and this
study cannot be considered an evaluation of the average )ndian investor. )t
remains to be seen 2hether investors in other parts of the 2orld 2ould e#hibit
a similar behavior as 2ould be found out by this study.
The study carried out 2as a time bounded study 2hich 2as not at all enough to
judge the traders on 2hole.
?on- 8ampling errors 2ere present as < respondents refused to fill the
7uestionnaire.
*
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'A!A AALSIS
I!ERPRE!A!IO
,
$nalysis of data is a
process of inspecting,
cleaning, transforming, and
modeling data ith the goal
of discovering useful
information, suggesting
conclusions, and
supporting decision making
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'A!A AALSIS I!ERPRE!A!IO
;nalysis and interpretation forms a major part of any research as in absence of
analysis the data collected have no utility and no interpretation can be made or
inferences can be dra2n.
To analyze the data first of all ) filtered data collected by me through
7uestionnaire. 0uring this process ) found data related to the psychology of the
investors demographic data data related to their trading habits. 8o for maing
any interpretation these data need to be analyzed separately depending upon
the homogeneity.
8o data analysis of this report 2ill be completed in three phases. These are /
.6 To classify the data relation to-
o "#perienced traders
o Ooung traders
,6 To study behavioral factors of both category of traders.
o 0ifference in trading style due to change in psychology.
o 'euristics.
; Testing of hypothesis
8
6
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Phse .
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Phse ,
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,/ %hose *udg2ent nlysis do you trust 2ost =hile 2(ing invest2entsJ
Are7uency %ercent
8elf 1< !
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;/ 'o you consider the 0st 0er#or2nce o# stoc( :e#ore investing in itJ
Are7uency %ercen
t
;l2ays 16 $*H
8ometimes 1* $!H
?ever 1* $!H
To
tal
(< 1
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5/ I# you 2(e huge loss in 0rticulr shre+ =ill you 0re#er trding it
ginJ
Are7uency %ercen
t
Oes 5 16H
8ometimes 1( $
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G/ ou i22editely need 2oney nd hve t=o shres to sell6one hve
gined ten 0ercent nd nother lost ten 0ercent+ =hich one =ill you sellJ
Are7uency %ercen
t
9inning 8hare $( ,
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This is a common psychology of the investors to boo the profits at early stage
on the 2inning shares in the fear of losing the gains and to hold on losing
shares for a longer period of time in the hope of recovery.
7/ In the :ove cse i# the loss is #ive 0ercent then =ill you chnge your
decisionJ
Are7uency %ercen
t
Oes 1! !H
?o $6 ,*H Total (< 1
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t2ice the loss does not mean t2ice the pain. %eople feel more strongly about
the pain from a loss than the pleasure from an e7ual gain.
4/ ou hve 0oor (no=ledge :out Co20ny ’s stoc( nd re there#ore
uncertin :out investing in it6 Suddenly 2ny o# your co8=or(ers nd
co20etitors strt :uying it6 Ho= =ould this ##ect your ttitude to=rds
’J
Are7uency %ercen
t
%ositive $* ,!H
?egative ! H
?o :hange 1! !H
Total (< 1
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I!ERPRE!A!IO8 Herding Bis
;n investor 2ould be e#hibiting 'erding behavior 2hen he relies more on
information validated by a cro2d rather than on his o2n judgment o2ing to
popular perception that the cro2d cannot be 2rong and also due to being 2ary
of probable ridicule 2hich he might face if the cro2d is actually right. )f
investors are heavily influenced by other investors analysts etc. the ability to
come up 2ith their o2n analyses and judgments get hampered. Aor most part
'erding may 2or fine but the upside is limited since 2hen everyone is
thining alie it is 7uite difficult to mae abnormal profits. n the other hand
2hen a do2nside happens it amplifies the psychological biases and can lead
to abnormal losses especially to private investors 2ho are liely to hold on to
losing stocs out of uncertainty due to lac of o2n vie2s hence possibly
ending up seeing information from many sources.
(,
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/ 'o you :elieve it is 0ossi:le to #ind #uture vlue o# shre through
detiled nlysis o# 0st 0er#or2nceJ
Are7uency %ercen
t
;l2ays !6 (*H
8ometimes 1! !H
?ever 1< !
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I!ERPRE!A!IO8 Re0resenttiveness in 'ecisions
)nvestors 2ho rely on Representativeness heuristic tend to become overly
pessimistic about past losers and overly optimistic about past 2inners. )t can
so happen that they 2ill end up considering past returns to be representative of
2hat they can e#pect in the future.
3/ Ho= esy do you thin( it =s to 0redict the coll0se o# SESE in the
=(e o# the 9lo:l Finncil CrisisJ
(5
Are7uency %ercent
Lery "asy $! *H
"asy 11 !!H
0ifficult , 1H
Total (< 1
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Prediction
er% a&%a&%
Dic3l"
I!ERPRE!A!IO8 Hindsight Bis
)t is a common human trait to reflect on past decisions. 9hile analyzing such
decisions many things seem falsely obvious and easily predictable. 9hen
ased 2hether it 2as easy to predict the collapse of 8ense# in the 2ae of the
!
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--
15
2
Perormance
,3"perfor'
$" ar
#erperfor'
I!ERPRE!A!IO- Overcon#idence Bis
)nvestors tend to be consistently overconfident in their ability to outperform
the maret. 8ome of them believe that based on information they have they
are able to predict the future movements of stoc prices better than others are.
../ 'o you #eel you cn+ on verge+ 0redict #uture shre 0rices :etterthn othersJ
Are7uency %ercen
t
;l2ays $6 ,*H
8ometimes 1< !
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-8
102
Predict Better
$lwa%&
So'e"i'e&
(e)er
I!ERPRE!A!IO8 Overcon#idence Bis
)nvestors tend to be consistently overconfident in their ability to outperform
the maret. 8ome of them believe that based on information they have they
are able to predict the future movements of stoc prices better than others
.,/ On scle o# . to G).< lo= ris(/+ =ht levels o# ris( do you undert(eJ
Are7uency %ercen
t
Do2est ris $ *H
Do2 ris 1$ !*H
*!
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;verage ris 1* $!H
'igh ris 11 !!H
'ighest ris , 1H
Total (< 1
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t
0efinitely 1( $
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to abnormal losses especially to private investors 2ho are liely to hold on to
losing stocs out of uncertainty due to lac of o2n vie2s hence possibly
ending up seeing information from many sources.
*(
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.5/ 'o you #i trget 0rice #or :uyingKselling in dvnce )sy+ :e#ore
strt o# trding dy/J
Are7uency %ercen
t
Oes !( (
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can also happen that investors get fi#ed to a price point 2hich may not be
reached thus missing good investment opportunities.
.G/ I# yes+ =hich o# the #ollo=ing criteri =ill you consider to #i the
0riceJ
Are7uency %ercen
t
(! 9ee highMlo2 5 16H
%riceM"arnings Ratio 3%M"4 6 1*H
;verage %rice in recent past 11 !!H
)ssue %rice 6H;dvice from broer 16 $*H
Total (< 1
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.7/ 'o you use sto0 losses in your trdesJ
Are7uency %ercen
t
;l2ays 1! !H
8ometimes * 1!H ?ever $! *H
Total (< 1
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respondents do not use the stop loss orders in their trades. They believe that
their decision is going to be correct every time.
.4/ Ho= did you rect to the ,-- Crisis nd resulting crsh in SESE
Are7uency %ercen
t
8ell off 8hares 5 (
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Regret ;version occurs from the investor’s desire to avoid the pain of regret
arising from a poor investment decision. ;s a result of this investors could
end up holding on to poorly performing shares because avoiding the sale
avoids the recognition of associated loss and in turn of a bad investment.
./ Consider the #ollo=ing sitution< !he Price o# Blue Chi0 shre is Rs
G--6 !his #lls to Rs .-- s result o# crisis6 Anlysts re neutrl nd
give hold signls6 %ill you 0urchse the shre t the ne= lo=+ (ee0ing in
2ind the recent highJ
Are7uency %ercen
tOes 1 !6H
8ometimes 1 !6H
? !! H
Total (< 1
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14
14
22
Buy At Decline
+e&
So'e"i'e&
(,
I!ERPRE!A!IO8 RECEC BIAS
+ost of the respondents 2ill not prefer to buy a share again 2hich has
declined heavily in the recent past. The judgment is done by observing only
the past price action 2hich in some case is unrealistic. ;fter some huge fall a
share may have some gro2th potential.The effect of happenings in the recent past affects the investment decisions of
the respondents and they do not 2ant to trade in losing shares and hence they
cannot apply buy on dips strategy effectively.
.3/ %ht =ill you do i# you re critici@ed #or investing in losing stoc( or
#or selling o## =inning stoc(J
Are7uency %ercen
t
Kustify 0ecision !, (H
Be disappointed 1$ !*H
Re-thin the decision 1< !
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271-
10
Bad Decision
;3&"if% Deci&io
Be #i&appoi"e#
e
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28*
1-
Toss
Hea#&
=ail&
(o preferece
I!ERPRE!A!IO 8 92:lers’ Fllcy Bis
Camblers’ Aallacy bias arises 2hen investors inappropriately predict a stoc
maret outcome lie a trend reversal etc. This may lead them to anticipate the
end of a series of good 3or poor4 maret returns. ;n investor 2ho suffers from
the Camblers’ Aallacy bias is liely to be biased to2ards predicting a reversal
in the trajectory of a stoc.
,./ On scle o# . to G+ ho= =ould you rte your (no=ledge on
reltively ne= #ield =hich studies #inncil decision 2(ing+ clled
Behviorl Finnce )G’ Ecellent + .’ Poor /
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Are7uency %ercen
t
%oor 1$ !*H
Do2 1* $!H
;verage 11 !!H
Cood * 1!H
"#cellent 6H
Total (< 1
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financial theories as obsolete but sees to supplement the theories by rela#ing
on its assumptions on rationality and taing into consideration the premise that
human behavior can be understood better if the effects of cognitive and
psychological biases could be studied in conte#t 2here decisions are made.
,(
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,,- .hile ma#ing a long/term investment0 do youconsider daily trading volumes1
17
-1
2
Considers !olumes
$lwa%&
So'e"i'e&
(e)er
Inter0rettion8 HER' BEHA$IO&R
Trading volumes gives a clue about the li7uidity of the particular security.it
gives the investor an idea that huge number of buyers and sellers are present in
the maret and the pricing of the security is relatively fair. But considering the
trading volumes only gives a visible clue of herd behavior in the trading style
of the investor. Too much increase in volume indicates that the speculators are
more interested in the securities@ it also indicates fresh buying in bul 7uantity.
,*
Are7uency %ercent
;l2ays 1, $H8ometimes $1 *!H
?ever ! H
Total (< 1
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Testing of hypothesis - Chi-squared Test
Ad0ted :y Anne F6 M:en #ro2 (*tatistics for the *ocial *ciences( :y
$ic(i Shr06
The chi-s7uare 3Q!4 test is used to determine 2hether there is a significant
difference bet2een the e#pected fre7uencies and the observed fre7uencies in
one or more categories. 0o the numbers of individuals or objects that fall in
each category differ significantly from the number you 2ould e#pectF )s this
difference bet2een the e#pected and observed due to sampling error or is it a
real differenceF
Chi8SDure !est ReDuire2ents
1. uantitative data.
!. ne or more categories.
$. )ndependent observations.
. ;de7uate sample size 3at least 1
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In#luence O# Invest2ent 'ecision o# Others On O=n 'ecisions
9hile maing a long-term investment daily trading volumes of the share
ideally should not have much 2eight in the decision because high volumes
usually represent speculators and day traders at 2or. The best case in favor of
trading volume should be to select an optimum entry point 2here the sellers
are possibly e#hausted and prices are not liely to drop much further o2ing to
speculation s2ings. %articipants 2ere ased if they consider the trading
volume of a stoc influenced their decision to invest in it. Table sho2s that
only $H of the investors 2ere al2ays checing the trading volume 2hile
maing investment decisions.
*)"DI+2 B)*A!IO&"
AL.A3S SO4)TI4)
S
+)!A" TOTAL
3O&+2
I+!)STO"S
1- 11 2 26
)5P)"I)+C)
D
I+!)STO"S
4 20 0 24
TOTAL 17 -1 2 50
,6
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!hi"#quared $ests
The follo2ing hypotheses 2ere tested
H-< Both investor types are e7ually liely to e#hibit 'erding behavior
H.< "#perienced investors are more liely to e#hibit 'erding behavior as
compared to young investors.
CALC&LA!IOS8
OBSER$E' FRE&ECIES8
*)"DI+2 B)*A!IO&"AL.A3S SO4)TI4)
S
+)!A" TOTAL
3O&+2
I+!)STO"S
1- 11 2 26
)5P)"I)+C)
D
I+!)STO"S
4 20 0 24
TOTAL 17 -1 2 50
T'" e#pected fre7uencies of the both of the group of respondents are
calculated are given belo2 in the given table.
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EPEC!E' FRE&ECIES
*)"DI+2 B)*A!IO&"AL.A3S SO4)TI4)
S
+)!A" TOTAL
3O&+2
I+!)STO"S
8?84 16?12 1?04 26
)5P)"I)+C)
D
I+!)STO"S
8?16 14?88 ?*6 24
TOTAL 50
CALC&LA!IO OF CHI8S&ARE $AL&ES
Clcultion o# N, =ith the hel0 o# MS ecel
!he clculted $lue o# N, 36,3
Therefore degree of freedom S 3r-143c-14 S 3!4 S !
Devel of significance S
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Result+ clculted vlue o# N, is 36,3 t:le vlue i6e6 G633
Since+ ull hy0othesis is re*ected6
&LL HPO!HESIS8 A?F?1T?2
H-< Both investor types are e7ually liely to e#hibit 'erding behavior
AL!ERA!E HPO!HESIS8 $11?3T?2
H.< "#perienced investors are more liely to e#hibit 'erding behavior as
compared to young investors.
Hence in conclusion 2e can say that the e#perience investors are more
resistant to the herding behavior.
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FI'I9S
6!
'indings are the
results hich are
obtained by
observations and
analysis of data at
various phases.
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FI'I9S O !HE BASIS OF S!&' CO'&C!E'<
n the basis of mathematical results observations and after support &
consultation from training guide ) found follo2ing facts-
+ost of the respondents prefer to invest in the Darge :ap shares. This behavior
can be understood easily because the Darge :ap shares are 2ell no2n to
investors and the investors have faith in them.
+ost of the respondents believe in media e#perts for their investment
decisions apart from doing their o2n analysis.
+ost of the respondents consider the past performance of a share before
investing in it.
+ost of the respondents 2ill not trade the share again in 2hich they have
made huge losses.
+ost of the respondents hold on loosing share and prefer to sell the 2inning
shares.
+ost of the respondents feel the positive behavior if a share is purchased by
their co /2orers .friends relatives.
+ost of the respondents find it possible to predict the future value of shares.
+ost of the respondents found it difficult to predict the collapse of 8"?8"V.
+ost of the respondents thin that their investment 2ill outperform )?0"V
+ost of the respondents thin that they can predict the future prices of shares
better than others.
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+ost of the respondents 2ant to tae the average ris.
+ost of the respondents fi# the prices in advance before trading them and they
depend upon their broers advice for these decisions.
+ost of the traders do not use stop loss in their trading.
+ost of the traders hold on shares even after they tae huge losses. This is
done in the hope of recovery in the losses.
+ost of the respondents 2ill not buy a share again if it has declined heavily in
recent even after the bullish signals of e#perts.
+ost of the traders use to justify their decisions if the decisions are proven
2rong.
+ost of the traders have some preferences even 2hen 2e toss an unbiased
coin. This preference depends upon the past outcomes.
+ost of the respondents have poor or little no2ledge of B"';L)R;D
A)?;?:".
!he (ey HE&RIS!ICS re s #ollo=s8
&verconfidence is expressed through the results from followingG
1- Based on sills investor feels confident to evaluate securities prices in his
investment portfolio by himself.
!- n the stoc maret investors are confident to select securities better than
other investors.
$- )nvestor feels that he can totally control his investment on the stoc maret.
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- )nvestor feels confident in the understanding of the stoc maret.
?xcessive optimism is expressed through the results from following "
1- ;lthough nifty inde# is losing its value investor 2ill continue to increase in
investment on the stoc maret in the ne#t one year.
!- )nvestor believes that the ?ational 8toc "#change is an attractive
investment channel. Then in the ne#t period he 2ill continue to invest in
stoc maret.
$- ;t this time the stoc price is relatively lo2 but investor believes that the
stoc price 2ill increase again in the ne#t time.
- )f )nde# decreases its value by (H tomorro2 investors believe that it 2ill
7uicly recover in the ne#t fe2 days.
/ Herd behavior is expressed through the results from followingG
9hen investor needs to mae decision to buyMsell stocs in a short time
follo2ing other investors’ behavior is fast and certain method. )nformation
from relatives friends and colleagues has high reliability. )nformation about
transactions of foreign investors Recommendations of analysts maret
researchers and stoc broers are highly accurate.
I/ 3sychology of risk is expressed through the results from followingG
1- ; ris- lover investor
!- 9hen stocs’ prices are decreasing@ investor usually holds them longer to
2ait for increasing trend.
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$- )n the maret companies 2hich have prestige or about 2hich investor
no2 more 2ill be raned at the top of his choice.
7/ ?xcessive pessimistic is expressed through the results from followingG
1- There may be the rapid decline in the stoc prices lie in late !
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S&99ES!IOS+
LIMI!A!IOS
COCL&SIOS
6,
This study has suffered
from certain manageable
limitations like any other
research. nder these
limitations some
suggestions are given.These are in support to the
findings. 'inal statement
i.e. conclusion is
summari)ed form of
observations, analysis,
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S&99ES!IOS RECOMME'A!IOS
Suggestions #or Investors
The main suggestion for investors is to mae constant attempts to increase
their a2areness on behavioral finance by educating themselves on the field.
8tudying about the biases and reflecting on their decisions are liely to help
achieve better self-understanding to e#tent and manner to 2hich they gets
influenced by emotions 2hile maing financial decisions under uncertainty.
"ven after satisfactory a2areness is achieved it is highly recommended that
they maintain a chart of the behavioral biases they are liely to be vulnerable
to. This should be revie2ed periodically in order to recollect and refresh their
memory thus giving themselves a better chance to mae improved financial
decisions in the stoc maret. +ost essentially 2hat remains unans2ered is
2hether greater a2areness of investors about behavioral biases is liely to
increase the maret efficiency. ;2areness about behavioral biases and its
application in the course of maing investment decision 2ould be increasing
the rationality of investment decisions thus maing 2ay for higher maret
efficiency.
Reco22endtions #or Econo2icsKFinnce Schools
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Behavioral Ainance should be given more importance in the ;cademic
:urriculum if it has not already been given its due. The schools do an
e#cellent job in e7uipping students 2ith no2ledge of the sciences and various
techni7ues 2hich definitely serves as a foundation to a great career. )f they are
e7uipped 2ith e#cellent no2ledge in Behavioral finance the psychological
aspect of the field 2ould have already helped them achieve better self-
understanding and hence decision maing in pressure situation might not be
as challenging to them as it 2ould be other2ise. no2ing 2hat to do is
important but no2ing 2hen to do 2hat is to be done is priceless.
Reco22endtions #or Acde2ics
Behavioral finance as a field brings psychology and finance together. Arom a
research perspective behavioral finance presents a lot of fresh opportunities
and challenges mainly because it is a relatively young field. +oreover it
offers numerous opportunities for creative thining and e#perimental studies
since there is an opportunity to focus on the human mind and its 2ays. The
field is closely related to behavioral economics 2hich focuses on
understanding the rationale behind economic decisions by researching on
various identified cognitive or emotional biases 2hich people may be
suffering from. "ach of these biases can be studied using multiple variables to
add dimensions to the analysis and techni7ues lie Aactor ;nalysis can be
employed to chec for variability among them as they are liely to e#hibit a
high degree of correlation. The 7uestionnaire survey method 2hich 2as the
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tool employed to gather data 2as one of the main limitations of this study
albeit the only practical option to reach real investors.
LIMI!A!IOS OF !HE S!&'
This study has suffered from certain limitations lie any other research.
'o2ever these limitations cannot have a drastic impact on the analysis and
the recommendations of the study as these limitations are 2ithin manageable
limits. These limitations are as follo2sE
The main 2eaness of the study is o2ing to the fact that it aims to study
investor behavioral patterns using 7uestionnaires. +aing financial decisions
can be demanding for various reasons that possibly could push many into
maing irrational decisions at one point or the other. 'o2ever 2hile
ans2ering a 7uestionnaire the same individuals are liely to be rela#ed and in
a better frame of mind hence choosing to give ans2ers 2hich may put them
across in different light especially in conte#t of 7uestions 2hich 2ere
presenting hypothetical situations. To overcome this problem to an e#tent
many 7uestions attempted to mae the participants admit mistaes they have
made in the past.
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; second limitation arises out of the fact that )ndia is a vast country and this
study cannot be considered an evaluation of the average )ndian investor. )t
remains to be seen 2hether investors in other parts of the 2orld 2ould e#hibit
a similar behavior as 2ould be found out by this study.
The study carried out 2as a time bounded study 2hich 2as not at all enough to
judge the traders on 2hole.
?on- 8ampling errors 2ere present as < respondents refused to fill the
7uestionnaire.
+ethods lie Came Theory and %robabilistic Dogic can be used as inspiration
2hile setting up the premises for a detailed and more advanced study. The
nature of the field promises that a researcher 2ould be presented 2ith many
opportunities to be innovative and creative.
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COCL&SIOS
The research found that unlie the classical finance theory suggests
individual investors do not al2ays act rationally 2hile maing investment
decisions. )ndividual investors suffer from several psychological and
emotional biases. These biases play an integral role in an investor’s
decision-maing. 'euristics such as representativeness overconfidence
regret aversion anchoring and mental accounting 3dra2n from the
%rospect theory4 cognitive dissonance and greed and fear all influence
investor’s perception of ris and subse7uently his decision maing. The
findings of the research are that investors display ris-seeing behavior
and avoid selling stocs 2hen faced 2ith loss. They segregate their
investments into separate mental accounts created to meet a specific
investment objective. Their decisions of asset allocation to their
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portfolios are to great e#tent affected by greed and fear. There is
suggestive evidence that these emotional and behavioral factors need to
be incorporated in the investment strategies formulated for individual
investors. )nvestors 2hile taing investment decisions must consider
these biases as ris factor associated 2ith their investment portfolios.
)t is the individual investors 2ho are the most susceptible to behavioral
anomalies and mental errors. They put their life savings into the stoc
marets so as to earn money.
9ith an objective to create investor’s confidence in the stoc marets
behavioral issues are the ne2est of the things 2hich must be considered
2hile formulating investment strategies for individual investors.
This research 2ill help investors judge their attitudes to2ards ris 2ith a
ne2 perspective and in a better 2ay thus leading to better investment
decision maing.
The study found out that investors suffered from all biases in a significant
manner. ;ll the investors 2ere affected by the various biases 2hile maing
investment decisions but it could not be established that one investor group
had suffered more losses under the influence of these biases.
5$
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BIBLIO9RAPH
AE&RE
5
*orks +ited or *orks
+onsulted is stated in this
section. This section
comprises of list of books, articles , and other
sources used by me in this
research report.
nne-ure of this repot
comprises uestionnaire.
http://homeworktips.about.com/od/libraryresearch/a/findarticles.htmhttp://homeworktips.about.com/od/libraryresearch/a/findarticles.htm
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BIBLIO9RAPH
Andersen+ ?orgen $itting. !
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Monti+ Mrco and Legren@i+ Polo.!Montier+ ?2es. !
KInIping niversity.
Schr#stein+ 'vid S. and Stein+ ?ere2y C.!
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Schindler+ Mr( . !
Shlei#er+ Andrei. !
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%elch+ Ivo. !
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9- .hat 'rice range o shares do you 'reer to invest
in1
High Cap
Mi# CapLow Cap
,- .hose :udgment analysis do you trust most $hile
ma#ing investments1
Self
Broker/Erie#&
Me#ia/!per" opiio&
;- Do you consider the 'ast 'erormance o a stoc#
beore investing in it1
$lwa%&
So'e"i'e&
(e)er
- In the above case i the loss is ?ve 'ercent then $ill
you change your decision1
+e&(o
1
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@- 3ou have 'oor #no$ledge about Com'any 5s stoc#
and are thereore uncertain about investing in it8
Suddenly many o your co/$or#ers and com'etitors
start buying it8 *o$ $ould this afect your attitudeto$ards 51
o&i"i)e(ega"i)e(o Chage
- Do you believe it is 'ossible to ?nd uture value o ashare through detailed analysis o 'ast 'erormance1$lwa%&So'e"i'e&(e)er
- *o$ easy do you thin# it $as to 'redict the colla'se
o S)+S)5 in the $a#e o the 2lobal inancial Crisis1
er% a&%a&%Dic3l"9E- *o$ do you thin# your investments $ill 'erorm in
com'arison $ith S)+S)51
,3"perfor'$" par#erperfor'99- Do you eel you can0 on average0 'redict uture
share 'rices better than others1
$lwa%&So'e"i'e&(e)er
9,- On a scale o 9 to @F9G lo$ ris#-0 $hat levels o ris#
do you underta#e1
9;- .ould you go ahead and invest in a stoc# i your
valuation o a stoc# is diferent rom that made by a
$ell/#no$n e%'ert on some ?nancial ne$s channel or
ne$s'a'er1
1
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Dei"el%Ma%e(e)er
9
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9- .hat $ill you do i you are criticied or investing
in a losing stoc# or or selling of a $inning stoc#1
;3&"if% Deci&ioBe #i&appoi"e#
e
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AE&RE
:')-8;R" 0)8TR)BT)? T;BD"