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• Identify the decision problem: Be careful in stating the problems and avoid
unwarranted assumptions and option-limiting prejudices.
• Specify your objectives: Determine what you want our to accomplish and which of
your interests, values ,concerns ,fears and aspiration are the most relevant.
• Create imaginative alternatives : your decision can be no better than your best
alternatives
• Understand the consequences: determine how well different alternatives satisfy all
of your objectives
• Grapple with your tradeoffs : Since objectives frequently conflict with each other, it
becomes necessary to choose among less-than –perfect possibilities
• Think hard about your risk tolerance: In order to choose an alternative with an
acceptable level of risk ,Become conscious of how much risk you can tolerate
Behavioural finance is based on psychology which suggests that human decision processes
are subject to several cognitive illusions. These illusions are divided into four categories:
Heuristic Approach: Heuristics theory finds an easy-going approach which helps in making
decisions easier especially in complex and uncertain environment. the three factors which
are related to heuristic theory as follows:
• Representativeness
• Availability bias
• Anchoring
Herding Effect: Herding effect explains that the investors believe on collective information
as compared to private information which can result in the price deviation of the securities
from fundamental value that can impact the investment. Herding impacts on stock price
changes influence the attributes risk which untimely impact on the asset pricing theories
• Neurophysiology is the stream of physiology which deals with the study of functioning
of the nervous system. Neurophysiology seeks inputs from various other fields such
as neurobiology, psychology, cognitive science, biophysics, and mathematical biology.
Neurophysiology in investment environment can be well explained in form of
neuroeconomics.
Emotions
• Usually we find that positive emotional states such as excitement leads the investor
to take risks and to become overconfident in their ability to evaluate investment
options, while negative emotions such as anxiety have the opposite effect.
Beliefs
• Beliefs are mental state which force to maintain a positive emotional state by
ignoring information that contradicts the prior choices of individuals .
• Neuroeconomics
Questions such as :
Now we will discuss the feelings with reference to neurophysiology and their implication
on investor behaviour .Neurophysiology deals with the structure and secretion of the
brain responsible for investor behaviour.
• Role of Amygdala : Almond –shaped body situated in the brain temporal medial
lobe is responsible for feeling of emotion such as fear,pleasure, developing phobia
stress.
• Passive Managers : They believe that markets are efficient and they cannot beat the
market.
• Active Managers: who believe that the right market strategies can lead to
outperformance of portfolio.
• Active Investors : are those who have earned money in their lifetimes and then
taken risks on the capital for wealth creation.
• Passive Investors : who earned money by taking lesser risk or take risk on someone
else’s money
Abelard, Biehl, and Kaiser’s Five-Way Model: In their research works, Bailard, Biehl, and
Kaiser in 1986 coined a model on investor’s personality. And in this model the behaviour of
investor is judged on the basis of two parameters, which are as follows:
• Level of confidence
• Method of action
• The Adventurer: Confident about their skills and believe that they don’t require
any advise.
• The Celebrity: Don’t have ideas of their own. Follow herd bias
• The Individualist: Make good money because of their strategies and analytical skills
• The Guardian: Investors usually belong to retired or pension drawing senor citizen
.They are risk-averse.
• The Straight Arrow : This category belongs to most balanced class of investors who
are confident of their strategies and take balanced risk for their portfolio.
• Cautious
• Emotional
• Technical
• Busy
• Casual
• Informed
• Conscientious Personality : They have a strong need for achievement and are
generally impulsive and perfectionist by nature.
• Follower is a type of investors who are affected by herd behaviour and self-
attribution bias, causing them to follow investment decisions of their friends,
colleagues, relatives etc. This behaviour places on High risk but low returns
• Guardian : who is under the influence of ambiguity aversion and mental accounting
• Situations : who is under the influence of status quo and endowment bias. Because
of these biases investor access different investment options differently at different
times.
• Adventurer
• Optimists
• Individualist
• Orthodox