Behavioral Finance: Is Investor Psyche

Driving Market Performance?

By Raluca Bighiu Qawi

Abstract:

An empirical approach to understanding investor behavior and biases and the effects of irrational
decisions over market performance

April 30, 2010

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 I. Motivation for writing and research:

I am a human working with humans and one thing that has become clear over the years is

that we all come with “baggage”: a collection of inherent biases and heuristics we

subconsciously amass since birth. These filter information we absorb in our daily life and attach

emotion to our judgment and actions. I have been working in banking and finance for more than

10 years and there was not a day in these years that I thought money was not an emotional asset.

Money means different things to different people: a way to live from paycheck to paycheck for

some or an inherited play-object that carries a distorted sense of value for others. Regardless of

its physical serving purpose, money bears profound emotional connotations for its owners which

cannot be ignored nor measured. So how do we account for emotion?

Everything I learned related to finance has somehow been mathematically proven and

distilled in a formula aiming to explain asset pricing, market movements, values; there is one

missing variable: humans are not rational beings. Given the same set of information but under

different circumstances the outcome is significantly different. Consider this: you got a new job,

making more money than ever and the markets are handsomely rewarding risk by performance,

the news you hear are positive and everyone around you believes there wasn‟t a better time than

now to invest. Flip the coin: the economy has slowed to a halt, your job security is questionable

and those who have taken risks seem to have been punished by the “bear”. You think this may be

possibly the worst time to invest. Now let‟s go back to “given the same set of information”:

would the decision about investing for the future be the same in the two extremes above? More

often than not, it would differ since people are emotional beings and their behavior reflects their

primal instincts. This is why I become interested in Behavioral Finance.

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 II. A Brief History of Behavioral Finance:

Definition: Behavioral finance is a field of finance that proposes psychology-based

theories to explain stock market anomalies. Within behavioral finance, it is assumed that the

information structure and the characteristics of market participants systematically influence

individuals' investment decisions as well as market outcomes.

Since the mid 1970‟s hundreds of academic studies have been conducted beginning with

Paul Slovic‟s work performed at Decision Research, an organization he founded. Risk

perception-based decisions have been analyzed and risky behaviors considered within financial

decisions people make. According to Victor Ricciardi “the different behavioral finance theories

and concepts that influence an individual's perception of risk for different types of financial

services and investment products are heuristics, overconfidence, prospect theory, loss aversion,

representativeness, framing, anchoring, familiarity bias, perceived control, expert knowledge,

affect (feelings), and worry”(2008).

Moreover, Hunton et al stated that “behavioral finance introduces many aspects of human

behavior into traditional finance to improve our understanding of analysts and investors” (2001).

III. Neo-classical vs. Psychological Finance Study:

There are two main directions accepted in the field of finance study currently. First is the

traditional and widely accepted approach of the fully rational agent and decision making based

solely on available data and mathematically proven concepts. The downside of this framework

consists of incomplete information, abbreviated assumptions of reality and disregard of human

element. On the positive side, the benefits of this structure also appear from its simplified

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assumptions and the ability to apply the existing formulas and drive results with significantly

similar outcomes.

The psychological approach to financial analysis is relatively new (Slovic, 1972) and it

brings human behavior elements in investment decision making. The benefits of this recent

development in the field encompass the use of more complete information, accounting for biases

and understanding anomalies. The downside presently stems from the lack of formulas

integrating the new variables in traditional analysis. One important development in the field of

behavioral finance would be the adaptation of the Capital Asset Price Model to account for

anomalies and psychological factors. Whether investor irrationality and market anomalies could

be modeled within the same formula or separately remains to be developed in this emerging

science.

IV. Research findings

This paper is intended to show through a variety of pre-existing academic research and

personal experience in the investment management field that investor‟s individual beliefs,

opinions and values could influence those of a group, be influenced by social factors and in

effect change outcomes in the markets.

1. Unconscious herding behavior:

Robert Prechter studied human behavior and concluded that it provides a psychological

basis for financial market performance. His 2001 article in the Journal of Psychology and

Financial markets introduces a very basic human behavior function: herding, based on

“impulsive mental activity” and in response to the actions of others. Human genetic make-up

subjects us to act emotionally faster that rationally, due to the biological response time within our

brains in challenging situations. In support of this thesis, the concept of the Triune Brain is

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further explained: the human brain can be divided in three components, the brain stem, the

limbic system and the neocortex. The limbic system is the primitive brain responsible for

emotional response while the neocortex is the generator of rational responses and reason.

The affect context applies to financial markets and herding causes “mass emotional

changes” (Prechter, 2001). Since the origin of the emotional responses are in the limbic system,

the cortex (rational brain) cannot control them or match the response speed. Herding behavior is

rooted in the limbic system and it is impulsive, uncontrollable and immutable (Prechter, 2001).

Financial professionals are a close group, sharing information in real and virtual space,

thus becoming prone to emotional herding. The behavior of analysts for instance is closely

observed by others and their opinions influence the investing public. Most people in the

investing public form their beliefs on information gathered from media, reading industry

publications, etc. Thus the actions they take in the market are driven by emotions or thoughts of

others, not by independent thought, according to Prechter. The reason behind this type of herding

is simply lack of knowledge and a powerful social tendency to follow the crowd. Observation of

real time investing along with experiments show that the masses commit more funds to investing

as markets rise and less as markets fall (Prechter, 2001). Interestingly enough financial

professionals follow patterns of herding behavior within their profession perhaps due to the

human need for consensus, the author states. When the opinions of analysts converge, the bias

increases and the forecasts become less accurate. The herding behavior in “rational” thinkers,

highly educated professionals comes as a result of a person‟s ability to have opposite views

concomitantly generated by the rational and primitive brain components. However, this creates

cognitive dissonance and therefore the need for financial professionals to have an explanation for

choosing one over the other and to relieve emotional stress. Tendencies to go with the group are

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observed in human behavior primarily because people feel the need to self preserve and seek

positive reinforcement rather than standing out as different.

Furthermore, there is a discomfort in being alone and that accounts for individuals failing

to make buy or sell decisions that largely contradict the decisions of their peers, even though

there is rational evidence to support their independent actions. This ultimately causes trends in

the markets to last longer than they would otherwise exist and to exacerbate the result either in a

bubble proliferation or a crashing downturn. Consequently, human herding behavior while

important for survival and preservation of self, is highly unproductive in the financial markets in

general. The financial markets participants are a close group which shares information, watches

the same news and stock ticker price quotations. Inevitably the participants receive feedback

generated by their own opinions and the information cycled through the group becomes more

convincing as the groups cohesiveness is growing.

2. Thought contagion:

Thought contagion is a peril of financial markets as shown in studies conducted by

Frankfurter and McGoun prior to 2000. According to Frankfurter and McGown, the thought

contagion notion was first introduced formally in 1996 as part of an emerging biology subfield

called “memetics”. Several modes of thought contagion have been identified in their research:

 Quantity parental mode: children are influenced first by parents and “the more

children of same parentage the more meme are transmitted to society”.

 Efficiency parental mode: deals with the safety of information being transmitted

and ensuring that offspring follows family values

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  Proselytic mode: this is very frequent and has been categorized as mass

persuasion. Involves the transmission of family values to society members other

than family.

 Preservational mode: promotes ideas to influence existing theories

 Adversative mode: deals with unacceptance of competing ideas. Typically

mainstream publications only publish work that goes along with the generally

accepted principles and what does not get published is deemed as not „quality”

 Cognitive mode: getting increased support for an existing idea despite evidence

that anomalies exist. An example is CAPM according to Frankfurter (1995).

 Motivational mode: seen as related to the adversative mode and suggests that one

would join a certain idea so that self improvement is achieved.

The thought contagion modes highlighted above support the theory that new financial or

economic thinking are slow to penetrate the “normal” and that, while we witness the anomalies

in the market and cannot explain them by CAPM, there is not a definite financial model that

encompasses human behavior.

3. Risk taking and risk aversion:

Previously we looked at herding behavior and thought contagion. Risk taking propensity

is another variable of human behavior that appears in individual decision making or a group

setting. In his 1972 article, Slovic showed that people that adopt riskier behavior in some

situations may take more risks in investment management. The author makes an observation that

risk taking behavior increases in groups. The possible explanation to this phenomenon is that the

group provides the individual a distribution of risk among members, thus less responsibility falls

on one individual when compared with the same individual making the decision alone. This type

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of responsibility diffusion among group members has been called risky shift (Slovic, 1972).

Additionally, people have a tendency to compare their thinking to that of the group. In instances

where the individual investor made decisions carrying less risk than the group, typically the

individual will revise their own decisions to an increased level of risk to follow the group

thinking.

Studies also confirm that risk taking or aversion change with reference point. Prospect

Theory was first introduced by Kahneman and Tversky in 1979 and it illustrates the preferences

for risky behavior in contradiction with utility maximization function. The utility theory

suggested that investors should be indifferent between choices with equal expected utility

(Hunton et al, 2001). Prospect theory suggests that the utility curve is a concave function in the

domain of gains and convex in the domain of losses. That is investors perceive losses and gains

of same magnitude differently, being less likely to accept losses of equal absolute value to gains.

In addition, prospect theory proposes that attitudes toward losses and gains change based on

reference point (circumstance). Risky behavior is influenced by recent personal history, either

optimism or pessimism felt in relation to investment performance.

Traditional finance assumes analysts are rational thinkers whose predictions of future

earnings and performance are strictly based on data. However, studies show that inefficiencies

exist in forecast as analysts‟ biases interfere with data included in their research. As such, it has

been inferred that analysts either over-react or under-react to recent data available based on

previous history of their own forecasts for subject companies. The authors suggest that analysts

who foresee a loss due to their previous forecasts are likely to opt for riskier behavior in the

future thus over-estimating earnings (Hunton et al, 2001).

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 Contrary to the classic mean variance theory (Markowitz), practice shows that typical

investors display inconsistent attitudes toward risk. In 1987 Sharpe notes that while most

portfolio optimization programs assume constant attitudes towards risk, experience shows that

attitudes are not constant. Generally, people have two goals: security and potential maximization.

The goal of risk-averse investors is security while the risk takers want to maximize potential.

Although these goals are contradictory, practice establishes that they exist in all investors

concomitantly; however, one or the other takes precedence based on circumstances and available

funds to invest relative to goals to be met.

4. Investor sentiment:

While risk choice behavior changes with circumstance, Dreman et al found in 2001 that

investor sentiment surprisingly remained constant in the bull market of 1998 and the decline of

2001. Investor sentiment is the measure associated with positive or negative feelings triggered by

large movements in the prices of stock either up or down. In the wake of March 2001 market

decline, there were numerous speculations about long term investor sentiment changes and how

they may affect future portfolio allocations between stocks and bonds and risk behavior.

The authors‟ research involves several investor surveys, first taken during 1998 while the

stock market was on the rise and subsequently in 2001 when the market was in a rapid decline

period. The research was prompted by wide spread Wall Street conviction that the investors are

going through a major change in investment sentiment and that reductions in allocation to stocks

in future portfolios were likely. The surveys yielded results that were mostly counter-intuitive to

the above thinking and showed that the investors were holding similar attitudes towards long

term investing, the asset allocation between stocks and bonds, buying on down markets and

views on risk willing to take.

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 The results obtained were analyzed also by age, gender and income. Several differences

were observed. Gender differences appeared in the 2001 survey showing that men were more

likely to monitor portfolio performance daily, weekly or monthly – 77% vs. 63% women

(Dreman et al, 2001). Additionally, men showed inclination to raise the stock holdings

percentage in the next 12 months while women would take the opposite view. The men surveyed

showed higher confidence in stock performance in the future and more likely to accept larger

losses in market value. This data shows that there are risk aversion discrepancies between men

and women, with men ranking higher in risk appetite.

The next subcategory analyzed is income level. The higher income respondents to the

survey monitored their portfolios more often than those with income level below $40,000

annually. The future returns expectations were similar across income groups for long term

investing; however, the higher income investors expected higher returns in the near term.

Furthermore, the higher income investors viewed dips in the stock market as opportunities to buy

stock on a higher percentage than the lower income investors. The attitude toward risk varied

with lower income respondents being more risk averse.

Another analytical division was made by age group and investors responding to the

survey were grouped in above or below 60 years of age. The older group showed less active

involvement in portfolio management, expected lower stock returns in the near future, and

surprisingly planned to increase their allocation to stocks in the future. While both age groups

showed similar confidence in future performance of US market, the older group was less likely

to accept large swings in portfolio value in correlation with their retirement cash flow needs.

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 5. Cash availability and optimism:

An important factor in asset pricing and also related to investor optimism level is the

availability of cash in system. Caginalp conducted several experiments to establish a relationship

between the availability of cash and overreaction in the financial market. Typically two theories

apply to markets: the “invisible hand” and modern portfolio theory. The distinction is made that

the invisible hand applies efficiently to the consumer market particularly since consumers buy

products and services to satisfy a need or want. Ultimately the supply and demand reach

equilibrium and prices reflect available information in the market. The asset market, however, is

fundamentally different in that investors often buy assets with an expectation for future profit

(Caginalp, 2002). Secondly, Modern Portfolio Theory applicable to asset markets assumes that

investors balance risk and reward in purchasing securities to maximize utility.

Consequently, prices for consumer goods have been relatively stable in the US and the

developed economies for decades, while security prices fluctuate not on supply and demand but

on “expectations and motivations of others” (Caginalp, 2002). Experiments have shown that

price trends vary based on the information available and interpretation of information at personal

level. Ultimately the prices reflect all the information available; however, before reaching the

“equilibrium” price investors make decisions using hints based on movements of others.

Caginalp‟s study would seem to infer that the cash supply in the market influences

security prices based on the willingness of the investors to buy and sell, ultimately inflating

prices when cash levels are high and confirming the role of excess cash in financial bubbles. A

good example would be the tech stock bubble of 1999 when excess cash became available due to

new investors attracted in the mix, easy monetary policy by Fed as response to long term capital

management problem and Y2K, and tax changes (Caginalp, 2002). Typically the momentum

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investors (buyers in the bubble) fuel the reverse trend of selling when markets change direction,

increasing the downside effect of the bubble burst.

6. Affect pricing model:

While the willingness of investors to buy and sell can be analyzed as a function of cash

level, affect pricing model is another approach to exploring the purchase of stock by individual

investors. Just like any other “thing” people can possess, stock can be perceived as good or bad,

in other words exuding “affect”. Statman et al explore how perception based purchase or sale of

stock can influence the price of the stock. In 2002 Kahneman described “affect heuristic” as one

of the most important advance in the field of heuristics study in the recent years. In their article

“Affect in a Behavioral Asset-Pricing Model” Statman et al note that the standard finance

theories, such as CAPM do not take in consideration the affect people have toward stock of

various companies although it is largely accepted that people display affect toward other

possessions such as homes, cars, jewelry, etc. The article continues to focus on the role emotion

plays in asset pricing models and not market efficiency; however, Statman sees the two as

related. Studies show that higher stress levels related to certain decisions to be made by the

subjects derived emotional responses rather than rational responses. Typically for the average

investor, choosing the stocks to invest in carries a significant level of stress. This could be caused

by insufficient knowledge, impact of decision results on subject‟s net worth, risk aversion, etc.

To further demonstrate the relationship between affect and asset pricing, Statman et al

show an analysis of two portfolios created based on Fortune magazine‟s 100 company ratings.

The portfolios were equally weighted 50 -50 companies; however, one portfolio had the top 50

rated companies and the other the bottom 50 rated companies, thus called the “admired” and the

“spurned” portfolios. Additionally they focused on the “long term investment value” (LTIV)

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attribute of the stocks. This attribute reflects the perception of the participants about the rated

companies and for the long run should be the same regardless of company rating based on the

efficient market theory. Their findings show that respondents to the survey attributed higher

LTIV to some companies versus the others. The authors back-tested the two portfolios for

various time intervals and concluded that the “spurned” portfolio resulted in higher performance

in the studied cases. In the process, they learned that the higher returns were related to the

portfolio that had both the higher objective risk (measured by standard financial metrics) and

higher subjective risk measured by the lower LTIV scores (negative affect) assigned by

respondents.

Indeed this finding seems to agree with the accepted risk reward trade off, so that the

higher the risk (low LTIV and negative affect) the higher the expected return. Conversely,

positive affect signifies lower risk and lower returns. Thus the behavioral asset pricing model

takes in consideration two main factors: objective risk (measured by beta) and subjective risk

(measured by affect). Another factor that influences the model is short term momentum for

which the rationale does not mimic that of the affect factor. The behavioral asset pricing model,

while not superior to other pricing models such as CAPM, should be considered in practice.

Aspects of the behavioral asset pricing model are directly related to the various types of affect,

such as social responsibility, prestige, etc. Therefore, its application may not be universal and it

may include factors weighted differently.

7. Charts and the effect of past performance over future uncertainty:

Affect pricing model considers the emotional attachment of the investor to a company

stock. The buying or selling decision is also influenced by the price comparative decision-

making – extreme prices, prior purchase price, or social comparison. A typical investment related

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disclosure is that “past performance is not a guarantee of future results”. Despite this statement

one of the tools used to showcase investment performance over time are charts depicting stock

prices in relation to time and particular “trigger events” that could have changed the course of the

stock at given times (i.e. political unrest, elections, commodity related crises, etc). Charts are

widely used in media and business news and investors perceive them as good sources of

information on market or individual securities‟ performance. Investment decisions are typically

complex because their outcome could be significantly changing one‟s net worth either positively

or negatively. Additionally, although not advisable as an investment management strategy,

timing of entering the market is an important factor in portfolio performance. Charts condense

stock movements in a relatively succinct output and investors reading them form an expectation

of that stock‟s future behavior.

Mussweiller and Schneller (2003) compare results of interpreting charts with a salient

high (a clear high depicted in stock trend) versus charts with a salient low (a clear low depicted

in the trend). They found that investors were more likely to invest in the stocks with salient high

then those with salient low, although the actual performance of the stock could have been equal

over time. They concluded that investors were thinking comparatively and therefore formed an

expectation that the stock would perform similarly in the future thus being less inclined to invest

in the one with a clear low in the past. Additionally, when asked to provide a future target price

investor associated higher future prices with salient high stocks and lower prices for the opposite

trend.

Moreover, an observation was made that extreme points on the charts were used as

reference points for future decision. Investors tend to remember and compare the high and low

points to currently available data and thus making an investment decision weighted more on

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stock price than trend. Another important comparison point for the purchase of a stock is the

purchase price he investor may have paid previously for the same stock which would now be

held in the portfolio. Assessment of stock‟s worthiness or performance potential doesn‟t only

include the prices of that stock from charts or personal experience. The notion of social

comparison is introduced such that investors compare their stock purchases to those of their

friends or peers.

8. Social responsibility in investment decisions:

Another facet of social behavior is the recent trend of adopting socially responsible

investing. While this trend slightly changes portfolio make-up and choices for individual

investors, the more important shift is observed in strategic corporate management in light of

social unacceptability.

In their article, “Investing in Frankenfirms: Predicting Socially Unacceptable Risks”

(2001), Fischhoff et al focus on the effects of social unacceptability on the profitability of

companies. Currently there are two forms of “organized distaste”: consumer boycotts and

investment screening criteria that selects socially responsible companies. If sufficient number of

people stop investing in companies considered socially unacceptable, inevitably the profitability

of the companies suffer and they could disappear.

This trend generated a distinct way to invest using Socially Responsible Investments

(SRI). Following public concerns about the ethical behavior of companies, the assets steered

toward SRI have grown and the demand for SRI increased. Additionally, the investing or

consumer public may end up paying a premium for the investments of products of the preferred

companies.

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 The dilemma at hand is that social unacceptability or the extent to which it affects

companies is hard to predict. Some events generate losses in profitability beyond their real

impact to consumer safety. Some examples are auto recalls involving gas tank explosions or

sudden acceleration (Audi or most recently Toyota). The consensus that emerges is that the

perception of risk and the quality of communications with the public are essential parts of risk

management for companies since the reflection of public concern is directly seen on revenues.

The effect of reduced demand generated either by direct impact of investors screening for

SRI or consumers boycotting products, shows in the company‟s profits. This establishes a

relationship between public opinion and performance of an investment. Therefore investors

should carefully analyze potential investment from a SRI perspective. Typical factors that may

cause a firm to become socially unacceptable are activities that the company engages in and

which may cause health, safety or environmental risks. While it would be difficult to predict

socially unacceptable risks, staying abreast of company strategy and understanding how the

public would perceive its effect, may allow an investor to proactively manage risk associated

with individual firms.

9. Analysts: unbiased experts or self-serving opportunists

Most investors rely on the advice of analysts in making investment decisions such as

screening socially unacceptable risks. The danger that lies beneath the surface of analyst

recommendations consists in the motivation surrounding the analysis outcome. Brian Bruce takes

a critical look at financial analysts and brings to question the quality of information provided by

analysts based on motivational forces behind their forecasts. First approached is the buy-sell

recommendation which have been under scrutiny for some time. The author mentions consistent

observations over time that several analyst firms average less than 2% “Sell” ratings versus 50%

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or more “Strong Hold” or “Buy” ratings. Certainly in reality more than 2% of companies in

existence at any given time would deserve the sell rating. The issue that emerges is analyst bias

and causes of it.

Typically analysts work for firms that are investment banks and which solicit

underwriting business from companies. The analyst‟s main source of information consists of

financial statements provided by the subject company. Concomitantly the investment bank that

employs the analyst may solicit business from those companies. A conflict of interest arises

between the analyst‟s would-be unbiased recommendation and their employer‟s sales efforts.

The overriding goal of the investment bank influences the analyst forecast. According to Bruce,

another variable in this equation consists of the compensation many analysts receive from

investment management firms for the research provided.

Going back to the initial finding that less than 2% of ratings are “sell”, Bruce finds that

many analysts claim to work under considerable pressure from management asking them to

cover potential clients who generate significant amounts of fee revenue in capital markets

transactions. Thus the analysts find themselves in a conundrum and are reluctant to disappoint

potential or current clients of the firm by issuing unfavorable ratings on their stocks. An example

the author highlights is the collapse of Enron. Analysts continued to maintain their buy or hold

recommendations while the company was posting significant losses. Perhaps their affection was

fueled by the fact that Enron completed more than 41 merger and acquisition and generated

significant fee revenues for their firms.

Another important factor in analyst work is the quality of information provided by the

subject companies. CFOs could and typically have tweaked the “books” under GAAP to make

earnings looks smoother and more predictable. This was in response to investors‟ perception of

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financial stability of companies and willingness to invest on stocks with steady growth and

dividends. There is a conditional relationship between earnings forecasts quality and what an

analyst stands to gain from it. Therefore investment advice is not free of bias and self serving

interest and most of the time information could be inaccurate or conflicting.

V. The Case for Behavioral Finance

Rational investors would not overreact to market news and conditions with blatant

disregard to financial standards and training. However, it has been noticeable that investors and

financial professionals are subject to psychological fluctuations, emotions and irrational choices

in their judgment. These types of influences over rational thought made it possible for extreme

conditions to take place in the market and bubbles to form. While each time a bubble “bursts” we

expect to have learned a valuable lesson, history repeats itself in a different setting. Examples

include the utility, radio and auto stocks in the 1920s, uranium, TV and bowling stocks in the

1950s, and technology stocks in the 1960s and later in the early 2000s. And most recently the

2008 real estate bubble that was part of a global financial downturn.

Investors, analysts and academia sense that the traditional ways of thinking and gauging

market performance are somewhat obsolete as they do not account for the emotional based

overreaction and affective connection with stock price movements. The psychological swings in

investment decision making we observed in the last decades have implications both in the

financial markets and in the broader behavioral studies field. Some experiments show that

investors witnessing a sharp price change of a stock within one day immediately assume that

there has to be a fundamental reason for it. With enough participants thinking similarly

momentum is building and it inherently fosters bubble proliferation.

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 While only in the early stages of understanding behavioral finance, progress has been

made in comprehending and partially explaining investor and advisor conduct. One important

finding in the broader psychological arena is the simplified method of processing complex

information that people use – heuristics. Otherwise known as “rules of thumb”, these

mechanisms are developed over time and used in complex situations involving decisions with

outcomes that possess high level of uncertainty. Investment related decisions are often complex

and the information associated with the various stocks, funds or other vehicles could be

overwhelming for the average investor.

In an editorial commentary found in the Journal of Psychology and Financial Markets

(2000) Brian Bruce provides a quick inventory of heuristical errors. The first major heuristical

issue is the availability bias – the tendency to recall recent events over older ones or the events

that carry a higher emotional charge, such as significant losses. Thus the more current and

significant an event is the higher the likelihood of it influencing decision making. Another

heuristical fault is representativeness which statistically shows that people then to associate two

events (author‟s example: market environments) and deem them identical when in reality they

may not be similar in any respect but appear to be superficially. Thirdly, anchoring stands for the

use of current events or information as reference point for making decisions. And finally

hindsight bias as investors have an easier time realizing that the markets were over or under

priced in the past but are encountering problems seeing the same for current events.

Bruce also addresses social reality, a psychological feedback system in which the

individual investor is influenced by the group thinking and the group receives new information

from individuals. This pool of information can be a compilation of beliefs, attitudes and opinions

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and the accuracy of information suffers. The need to validate personal beliefs against those of the

larger group stands true for the average investor and for the expert advisor.

VI. Closing thoughts

The disparity between the scientific rational thought and the subjective behavioral driven

decision process remains unsolved until CAPM and other elegant formulas can be tweaked to

account for the human factor. Although several factors influencing investor decision-making or

changes individual investors bring to the market have been highlighted herein, not every aspect

of importance in the broader behavioral study field was covered.

In conclusion, Shefrin‟s words resonate with my decade long experience as advisor:

“behavioral finance is everywhere that people make financial decisions. Psychology is hard to

escape […]. Financial practitioners need to understand the impact that psychology has on them

and on those around them (2000).”

VII. Acknowledgments:

My research would have not been possible without the help and encouragement of Dr.

Richard Fendler, Finance Professor at the Robinson College of Business of Georgia State

University. My thanks go to Dr. Gerald Gay, Chair of the Finance Department of the Robinson

College of Business of Georgia State University for allowing me to register my research as part

of the Finance program of study while a student of RCB. My inspiration comes from listening to

Dr. Shabnam Mousavi lectures. Her passion for Behavioral Finance encouraged me to go

forward in my pursuit.

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Financial Markets. Vol. 3; No. 4, 198-201.

Bruce, B. (2003). “The Old Psychology Behind “ New Metrics””. The Journal of Behavioral

Finance. Vol. 4; No. 3, 121-130.

Caginalp, G. (2002). “Does the market have a mind of its own, and does it get carried away with

excess cash?”. The Journal of Psychology and Financial Markets. Vol. 3, No. 2, 72-75

Dreman, D., Johnson, S., MacGregor, D. and Slovic, P. (2001). “A Report on the March 2001

Investor Sentiment Survey”. The Journal of Psychology and Financial Markets. Vol. 2,

No. 3, 126-134.

Fischhoff, B., Nadai, A., and Fischhoff, I. (2001). “Investing in Frankenfirms: Predicting

Socially Unacceptable Risks”. The Journal of Psychology and Financial Markets. Vol. 2,

No. 2, 100-111.

Frankfurter, G. and McGoun, E. (2000). “Thought contagion and Financial Economics: The

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201.

Hunton, J., McEwen, R., Bhattacharjee, S. (2001). “Toward an Understanding of the Risky

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Financial Markets. Vol. 2, No. 4, 182-189.

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Mussweiller, T. and Schneller, K. (2003). “What Goes Up Must Come Down – How Charts

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