THE IMPACT OF BEHAVIORAL FINANCE ON STOCK MARKETS

R Gowri Shankar
Assistant Professor, Department of Tourism ,Christ University

Girish Babu
Ass istan t Professo r Th e O x fo r d C o lle g e o f Bu s in e s s Ma n a g e m e n t

Abstract:
This article presents a new approach in the analysis of capital markets, namely
behavioural finance. Behavioural finance is the study of the influence of the psychological
factors on financial markets evolution. Investors fall prey to their own and sometimes others'
mistakes due to the use of emotions in financial decision-making. Investors are people with a
very varied number of deviations from rational behaviour, which is the reason why there is a
variety of effects, which explain market anomalies. Classical finance assumes that investors are
rational and they are focused to select an efficient portfolio, which means including a
combination of asset classes chosen in such a manner as to achieve the greatest possible returns
over the long term, under the terms of a tolerable level of risk. Behavioural finance paradigm
suggests that investment decision is influenced in a large proportion by psychological and
emotional factors and even group behaviour.
Key words:Behavioural finance, Classical finance, Market efficiency, Investment decision,
Psychological factors, Capital market, Rational behaviour

INTRODUCTION
In the fields of psychology and

financial markets as an aggregate of

evolution, there is a large body of theory and

statistical

observations,

evidence on how individual behaviour

fundamental analysis. A rich view of

differs from group behaviour, particularly

research

for performance and risk-taking activities.

understanding of how financial markets are

Even so, relatively little attention has been

also affected by the 'financial behaviour' of

devoted to this topic for research on

investors.Behavioural finance is no longer as

managed portfolios. Analysts seem to treat

controversial a subject as it once was.

waits

this

technical

and

sophisticated

Behavioural
investors'

finance
psychology

is

the

study

Thus,

behavioral

finance

combines

making

principles from the fields of individual and

financial decisions. Investors fall prey to

social psychology with classical financial

their own and sometimes others' mistakes

theory to understand and highlight the

due to the use of emotions in financial

performance of stock markets.According to

decision-making. Behavioural finance tries

some researchers, behavioural finance states

to

forget

the features of interpretation and action

fundamentals and make investments based

based on the data for organized investing

on emotions. Strictly speaking, behavioral

decisions by individuals. Particularly this

finance represents an area of research that

study deals with the attitude of individual

attempts to understand and explain how

investors with respect to demographic

reasoning or cognitive errors influence

factors and basic heuristic factors.

understand

how

while

of

people

investor decisions and stock market prices.

HEURISTIC DRIVEN BIASES
1. Herd Instinct
A mentality characterized by a lack
of individuality, causing people
to think and act like the general
population.Herd behavior describes
how individuals in a group can act
together without planned direction.
2. Important Heuristics
Affect :The affect heuristic concerns
goodness and badness. Affective
responses to a stimulus occur rapidly
and automatically: note how quickly
you sense the feelings associated with
the stimulus words treasure or hate.
Availability: Availability is a
cognitive heuristic in which a
decision
maker
relies
upon
knowledge that is readily available

rather than examine other alternatives

or procedures.

Similarity:The similarity heuristic

leads us to believe that like causes
like and appearance equals reality.
The heuristic is used to account for
how people make judgments based
on the similarity between current
situations and other situations or
prototypes of those situations.
3. Self-serving bias
A self-serving bias occurs
when people attribute their successes
to internal or personal factors but
attribute their failures to situational
factors beyond their control. The selfserving bias can be seen in the

10

common human tendency to take

credit for success but to deny
responsibility for failure. This effect
is also called "illusory superiority"
has been found when people rate
their own driving skill, social
sensitivity, leadership ability and
many other attributes.

to the calendar. Such effects include

the apparently different behaviour of
stock markets on different days of the
week, different times of the month,
and different times of year. The term
sometimes
includes
multi-year
effects, such as the 10-year (decadal)
cycle. It also sometimes includes
time of day effects

4. Anchoring or focalism
7. Gamblers Fallacy
Anchoring or focalism is a
cognitive bias that describes the
common human tendency to rely too
heavily, or "anchor," on one trait or
piece of information when making
decisions. During normal decision
making, individuals anchor, or overly
rely, on specific information or a
specific value and then adjust to that
value to account for other elements of
the circumstance. Usually once the
anchor is set; there is a bias toward
that value.
5. Loss aversion
Loss aversion is a concept of
social psychology as much as
economics. It is not the reality of loss
that matters but the perception.
Nations have gone to war until their
doom because of loss aversion. It
simply means you refuse to admit
you made a mistake.
6. Calendar effect
A calendar effects is any
economic effect, particularly in stock
markets, which appears to be related

When an
individual erroneously believes that
the onset of a certain random event is
less likely to happen following an
event or a series of events. This line
of thinking is incorrect because past
events do not change the probability
that certain events will occur in the
future
8. Market Psychology
The overall sentiment or feeling that
the market is experiencing at any
particular
time.
Greed,
fear,
expectations and circumstances are
all factors that contribute to the
group's overall investing mentality or
sentiment.
9. Market Sentiment
The feeling or tone of a market (i.e.
crowd psychology). It is shown by
the activity and price movement of
securities.

11

10. Media Effect

A theory that relates how stories
published in the media influence or
amplify current trends. Borrowers or
investors will read an article and be
influenced to act quickly on the news.
The media effect is often seen in the
mortgage market, when prepayment
rates can sharply increase following
specific news stories.
11. Rational Behaviour
A decision-making process that is
based on making choices that result
in the most optimal level of benefit or
utility for the individual. Most

conventional economic theories are

created
and used
under
the
assumption that all individuals taking
part in an action/activity are behaving
rationally
12. Reflexivity
The idea that a person's thoughts and
ideas tend to be inherently biased. In
other words, the values and
thoughts of a person will be
represented in their work. In the
context of finance, the theory of
reflexivity states that investors' and
traders' biases can change the
fundamentals
that
assist
in
determining market prices

OBJECTIVES
To identify the major factors responsible for determining the attitudes and trading
behaviour of stock market investors.
To measure the confidence the investors have regarding their investment in stock
market.

LITERATURE REVIEW
Hong
et
al.,
(2001)
conducted a study wherein they
proposed that stock market
participation is influenced by social
interaction. According to them any
given social investor finds the
market more attractive when more of
his peers participate. They tested this
theory and found that social
households those who interact with

their neighbours, or attend church

are substantially more likely to
invest in the market than non social
households, controlling for wealth,
race, education and risk tolerance.
Another study conducted
by Barberis and Huang (2001)
suggests that loss aversion the
tendency to be more sensitive to
losses than to gains and narrow
framing the tendency to focus on
narrowly defined gains and losses

12

play an important role in determining

how people evaluate risky gambles.
Kahneman and Tversky
(1979) found that contrary to
expected utility theory, people
placed different weights on gains and
losses and on different ranges of
probability.
They found that
individuals are much more distressed
by prospective losses than they are
happy by equivalent gains.
Wood R (2004) studied
attitudes and trading behaviour of
stock market investors by conducting
a study among 90 individual
investors and identified four main
segments of individual investors as:
risk-intolerant traders, confident
traders, less risk-averse young
traders and conservative long-term
investors. His cluster segmentation
analysis shows that each segment
purchases different types of stock
and had different levels of trading
behaviour.
n another study, Meng Chen
Gong et al. (2004) tested how

investor
experience
influence
investing behaviour and trading
performance. The study shoes that
experienced investors are more
inclined toward making trading
mistakes and suffering from the
representative ness bias.
Barber and Odean (2001)
by
examining
the
personal
characteristics of investors argued
that investing is traditionally a
masculine task in the U.S and
therefore, as a group, men can be
considered to be more in tune to
investing than women. Their study
also shows that men do show more
overconfident characteristics, such as
excessive trading and higher risk
trading.
Schiller (2000) strongly
advocated that the stock market is
strongly governed by the market
information which directly affects
the investment behaviour of the
investors.

Research methodology
Primary data is collected from the individual investors with the help of structured
questionnaire. Secondary data is collected from the published source and through
internet. Random and convenient sampling is used and the sample size is 50 respondents.
Demographic variables play a major role in the risk taking capability of an individual as
well as on the confidence level of individual, thereby influencing his/her investment
decision. In this paper the researcher proposes to test whether the demographic variablesgender, age, income-have an impact on the risk taking capability as well as on the
confidence level of the investors.

13

Limitations of the Study

These results are based on a small section of investors in trichy town and
warrant further study. The time duration is not sufficient to study the entire
complex decision making behaviour of individual investors in various angle.
Many respondents are not interested to reveal certain data regarding their
behavioural aspects. Many investors felt that the questionnaire was too heavy.
Some questions were answered with bias and without care by the investors.

DATA ANALYSIS AND INTERPRETATION

Total Variance Explained
Initial Eigen values
Componen
%
of Cumulative
t
Total
Variance
%
1
6.132
15.330
15.330
2
3.439
8.598
23.928
3
3.167
7.917
31.844
4
2.835
7.088
38.932
5
2.634
6.585
45.517
6
2.454
6.135
51.651
7
2.049
5.123
56.774
8
2.001
5.002
61.777
9
1.635
4.088
65.865
10
1.496
3.739
69.604
11
1.333
3.332
72.936
12
1.267
3.167
76.103
13
1.228
3.070
79.173
14
1.096
2.741
81.914
15
.887
2.219
84.132
16
.789
1.971
86.104
17
.758
1.896
88.000
18
.678
1.694
89.694
19
.642
1.605
91.299
20
.536
1.339
92.638
21
.434
1.086
93.724

Extraction Sums of Squared Loadings

%
of Cumulative
Total
Variance
%
6.132
15.330
15.330
3.439
8.598
23.928
3.167
7.917
31.844
2.835
7.088
38.932
2.634
6.585
45.517
2.454
6.135
51.651
2.049
5.123
56.774
2.001
5.002
61.777
1.635
4.088
65.865
1.496
3.739
69.604
1.333
3.332
72.936
1.267
3.167
76.103
1.228
3.070
79.173
1.096
2.741
81.914

14

22
23
24
25
26
27
28
29
30
31
32
33
34
35
36
37
38
39
40

.368
.311
.293
.249
.242
.190
.170
.149
.117
.103
.075
.060
.057
.037
.036
.022
.019
.010
.006

.919
.776
.731
.622
.605
.475
.424
.372
.292
.257
.187
.149
.141
.092
.090
.056
.048
.025
.014

94.643
95.419
96.150
96.772
97.377
97.852
98.276
98.648
98.940
99.197
99.384
99.534
99.675
99.767
99.857
99.913
99.961
99.986
100.000

Extraction Method: Principal Component Analysis (Source: Primary data

15

TABLE (Component Matrix)

Wealth
inflation and
commitments
and expenses
build a corpus
0%-15%
15%-30%
30%-50%
greater than
pf
pf
pf
pf
capital
negative
higher return
maximising
capital gains
Jeopardise
moderate risk
and capital
some risks
large capital
stocks ups and
deep drop
sensex
sensex
sensex same
get out and
a and b stock
stock price in
pessimism in
stock market
back up
Decline
Better
sell it
hold it
buy more
better and ok
ok and better
analysts and
own , friends
and
Friends

Comp
onent
1
2
3
4
5
6
7
8
9
10
11
12
13
14
0.481 0.007 0.079 0.045 0.295 0.104 -0.29 0.302 -0.32 0.383 0.063 0.035 -0.2 0.195
0.619 0.028 0.268 0.282 -0.14 -0.08 -0.33 0.162 -0.29 0.109 -0.1 -0.14 -0.12 0.017
0.206
0.743
0.562
0.476
0.301
0.384
0.531
0.373
-0.1
-0.01
0.037
0.615
0.389

0.326
-0.23
0.215
0.313
0.528
0.326
-0.03
-0.03
0.453
0.297
-0.31
0.142
0.016

-0.09
0.195
-0.43
-0.08
0.148
0.331
-0.35
0.1
0.565
0.643
0.401
-0.14
-0.59

0.216
-0.03
0.267
0.304
0.019
0.026
0.301
0.248
0.307
0.191
0.067
0.266
0.227

-0.59
0.042
0.288
0.218
0.227
-0.12
-0.26
-0.49
0.207
0.135
-0.08
0.137
0.123

-0.11
-0.22
0.083
-0.38
-0.19
-0.4
-0.27
-0.31
0.19
-0.23
0.19
0.077
0.265

0.148
-0.01
-0.01
0.25
-0.31
0.059
0.175
0.151
-0.21
0.037
0.092
0.401
-0.17

0.243
0.256
0.193
0.004
-0.31
-0.26
-0.02
0.083
0.175
0.126
0.41
-0.09
-0.04

-0
-0.11
-0.11
0.004
0.148
0.351
-0.15
-0.03
0.083
0.352
-0.21
0.179
0.103

-0.04
-0.03
-0.29
0.096
-0.18
-0.02
-0.05
-0.11
-0.28
0.013
-0.26
-0.16
-0.22

-0.03
-0.2
-0.04
0.176
0.335
-0.02
0.035
0.33
0.059
-0.07
-0.04
-0.15
-0.09

-0.18
-0.12
-0.15
0.234
-0.1
0.165
-0.05
-0.07
0.008
-0.12
0.287
-0.04
-0.19

0.064
0.199
0.1
-0.21
-0.06
0.047
-0.23
-0.25
-0.06
0.111
0.227
0.091
0.082

-0.37
-0.02
-0.14
-0.11
-0.02
0.184
-0.02
0.061
-0.05
-0.26
0.087
0.181
0.299

-0.06 0.609 -0.34 0.062 0.217 -0.12 -0.02 0.005 0.071 0.318 -0.33 0.021 0.185 0.056
0.005 0.054 0.163 -0.03 -0.65 0.036 0.457 -0.09 -0.17 0.189 0.166 -0.11 0.007 0.258
0.696
0.674
0.18
0.449
0.402
0.269
0.182
0.275
0.239
0.431
0.21

0.148
-0.23
0.307
-0.35
-0.15
-0.26
-0.32
-0.29
0.27
0.365
-0.1

-0.3
-0.09
0.454
0.148
-0.16
-0.11
0.202
0.248
0.127
-0.13
0.143

-0.13
-0.2
-0.29
-0.15
-0.36
-0.1
-0.04
-0.01
0.374
-0.53
-0.18

-0.21
-0.27
-0.09
-0.16
-0.16
0.337
0.12
0.001
-0.12
-0.26
0.451

0.153
0.091
0.388
-0.03
-0.17
0.012
0.286
0.205
0.026
0.222
-0.2

0.072
-0.05
-0.3
-0.24
-0.15
0.208
0.368
0.403
-0.18
0.065
0.376

-0.29
-0.04
-0.1
0.115
0.516
0.294
0.097
-0.17
0.115
-0.11
0.436

0.083
0.11
0.023
0.234
0.076
0.258
0.44
0.245
0.241
-0.16
-0.01

-0.15
-0.12
-0.03
-0.02
0.184
0.245
-0.3
0.475
0.13
-0.15
-0.09

0.015
-0.11
0.216
-0.22
-0.01
0.497
-0.07
-0.19
0.003
0.147
0.136

-0.04
0.221
-0.19
-0.23
0.336
0.186
0.23
-0.27
0.287
0.167
-0.34

0.011
0.088
-0.05
0.253
-0.12
0.055
-0.17
0.035
0.228
0.228
0.115

0.127
-0.24
0.194
0.027
0.108
-0.1
-0.1
0.019
0.256
0.081
0.256

0.4
0.29
0.247
0.352
0.259
0.185
0.136
0.447
0.47
0.469

-0.4
-0.46
0.279
-0.33
-0.19
0.255
0.505
0.327
0.167
-0.37

0.097
0.162
0.485
0.016
-0.06
-0.04
0.217
-0.32
0.001
0.207

0.108
0.196
-0.43
0.279
0.221
0.525
-0.06
-0.53
-0.48
-0.14

0.273
0.117
0.069
0.201
0.169
0.031
-0.08
0.104
0.179
-0.32

-0.33
-0.46
0.065
0.404
0.602
0.387
0.218
0.067
0.036
0.132

-0.13
-0.22
0.224
0.056
0.022
0.076
0.197
-0.1
-0.15
-0.38

-0.26
-0.33
-0.1
-0.12
-0.07
-0.11
0.281
-0.02
0.169
-0.21

-0.32
-0.1
-0.35
-0.1
0.006
0.002
-0.27
-0.05
0.248
0.25

-0.16
0.043
-0.08
0.185
-0.19
0.421
0.004
0.162
0.104
0.133

0.053
-0.18
0.013
0.376
-0.11
-0.03
-0.39
0.088
-0.02
-0.06

0.12
0.094
0.092
-0.33
0.161
0.269
-0.06
0.087
-0.14
-0.06

0.335
-0.15
0.19
0.131
-0.39
0.23
-0.25
0.082
-0.31
-0.07

0.008
-0.05
-0.11
-0.28
-0.03
-0.04
-0.15
-0.37
0.108
-0.14

0.365 -0.03 0.437 0.203 0.077

0.3
0.1 -0.3 -0.24 0.095 0.012 0.15 -0.07 0.094
0.227 0.012 0.115 -0.42 0.458 -0.24 0.349 -0.39 -0.14 0.014 -0.22 0.014 -0.18 0.012

16

Naming the factor

Factor 1
Variables under factor 1 that have
significance value are P2 (.619), P4
(.743), P5 (.562), P9 (.531), P14
(.615), P18 (.696) and P19 (.674). All
these factors relate to the level of risk
taking ability of the individual
investors. So this factor can be named
as risk taking ability.
Factor 2
It has three significant values under
it. P7 (.528), P16 (.609) and P35
(.505) have significant values in this
case. All these factors relate to the
high return expectation of investors.
Thus this can be named as return
expectation.
Factor 3
It has three significant values under
it. P11 (.565), P12 (.643) and P15 (.593) have significant values in this
case. Thus this can be named as
conservative
category
of
investors.P15 is negatively correlated
with the factor in this case.
Factor 4
It has three significant values under
it. P27 (-.525), P34 (.525) and P36 (.530) have significant values in this
case. Thus this can be named as high
risk and high return category.P27 and
P36 are negatively correlated with the
factor. The factor can be named as
confidence level of investors.

Factor It has two non significant

values under it. P3 (-.586) and P17 (.647) have non-significantvalues in
this case. Even the values were
negatively correlated and so we can
leave this factor.
INTERPRETATION
From this study it is found out
that Gender plays an important role
in stock market investments and most
of the respondents are male. Most of
the investors are long term investors.
Most of the investors have little
experience in the stock market.
Among the various attitudes of
investors some of the attitudes which
are highlighted through Factor
Analysis in this study are risk taking
ability,
return
expectation,
conservatism, confidence level and
the wavering attitude.Gender and risk
tolerance are not significantly relate
to each other which is identified
through ANOVA test. There is no
significant relationship among ages,
income with risk taking capability.
Most of the stock market investors
are middle age and middle income
group investors. Almost all the
respondents are literate. Income plays
an important role in decision making
and it is found in the ANOVA table.
Equal number of respondents comes
under the category of government
and professionally qualified people. It
is also found that confidence level of
investors vary from their investment
experience. It is found from the study
that in gender & age are not

17

significantly
correlate
with
confidence level of investors. It is
explicit from this study that people
believe the information of the
investment analysts and advisors
when they trade their stocks.
CONCLUSION
If you see people in the stock
market you will observe that they
move in herds and this influences
stock prices. To put it slightly
different, theoretically, markets are
efficient but in practice, they never
move efficiently. For example, if a
company announces mega investment
over the next few years in an
emerging area, the stock price of the
company
starts
moving
up
immediately without looking into the
prospects, returns or the amount of
investment to be made in this project.
That is how the behaviour of
investors moves the stock price .Most
of us is not blessed with the
intellectual or physical competence
of the various market players (fund
managers and analysts). Therefore,
one should simply work out a longterm investment policy, which is
right and be committed to it. This is a
very straightforward and an untiring
approach. At the same time it is an
emotionally difficult approach.
From this study it is clearly
found out that demographics like age,
gender, income, experience and
education plays a major role in the
risk appetite of individual investors
and in their confidence level also.

These findings also contrast and

contradict some of the previous
research made in this area previously.
This study identified the major
factors responsible for determining
the attitudes and trading behaviour of
stock market investors. The most
important factors that affects the
attitude and trading behaviour of
stock market investors as obtained
from factor analysis is as below:
confidence level that an investors has
in himself/herself as compared to
formal sources, risk taking ability,
more expectation and return oriented
and conservative mentality.
Bibliography
C.S.Shylajan and Sushama Marathe,
A study of attitudes and trading
behaviour of stock market investors,
The icfai university press (2006).
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