Question

: What can behavioural finance teach us about finance?

Answer 1

Behavioral finance is based on human psychology. Behavioral finance teaches us about finance that in real world, people are not always rational therefore there are deviations from the efficient markets hypothesis. The investor’s psychology also plays an important role in financial market; sometime investors are bias in their approach therefore sometime it is difficult for investors to take advantage of mispriced securities. Sometime they get trapped in to some misinformation and not able to analyze the situation. The behavior of investors is different in different market conditions.

There are three types of biases that are self-attribution bias, overconfidence and hindsight bias.

• Self-attribution bias is related to individual’s tendency to overestimate their talent at the time of success and at the time of failure they blame it to other factors.
• Overconfidence is related to overestimation of their abilities to predict or time the market
• Hindsight bias is the tendency of individuals where they think that they have performed better than actually they do or they have predicted it before it actually happened. This process hinders their abilities of future learning.