How Does the Behavioural Finance Theories Impact the Investor Decision Making: An Empirical Study

Abstract

Considerable number of economic and financial postulations conclude that individuals act rationally in the process of decision-making by considering all available information. But there is corroboration to show recurrent patterns of irrationality in the way humans make decisions and choices when faced with uncertainty. The traditional finance paradigm seeks to understand the financial market using models in which agents are rational. Unfortunately, after years of effort, it has become clear that basic facts about the aggregate stock market, a cross-section of average returns and individual trading behaviour are not easily understood in this framework. Behavioural finance proposes psychology-based theories to explain stock market anomalies, such as severe rise and fall in stock price. The purpose is to identify and understand why people make certain financial choices. Within behavioural finance, it is assumed the information structure and the characteristics of the market participant systematically influence an individual’s investment decision as well as market outcomes. The fact that even the most prominent and well-educated investors were affected by the collapse of the speculative bubble in the 2008 subprime crisis proved that something was fundamentally missing in the traditional models of rational market behaviour. In this paper, behavioural finance theories such as Herding theory, Prospect theory, Regret theory, and Anchoring theory are related to different investment strategies like Buy and hold, Fundamental analysis and technical analysis. In order to achieve this aim, the research on the subject was divided into two stages. The first stage examined the main issues of individual investors and studied their relation to behavioural finance theories. The aim of the final stage was to form a pattern between the most common investment strategies and the four behavioural finance theories. The most significant finding was the correlation between Buy and hold strategy and regret theory.

Keywords: Herding Theory, Prospect Theory, Regret Theory, Anchoring Theory, Buy and Hold, Fundamental Analysis, Investor Decision, Behavioural Finance Theory

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