In the last decades many financial crises have emerged, like the stock crash of 1987, the Asian crisis in 1997 and the global financial crisis that started in 2008. Although those crises occurred for different reasons, they all proved financial markets to be inefficient. Not all traders think rationally. Behavioural patterns cause irrationality amongst traders. Even after decades of research in this field, financial crises like the latest one in 2008 still develop out of a combination of different behavioural patterns like herding. As a consequence those patterns deserve an in-depth analysis that is conducted by the author in this work.
In order to find out to what extent behavioural finance influences the decision –making process of traders and investors the seven most relevant behavioural patterns have been identified and analysed through qualitative research in form of primary research. The informal interview with the sophisticated trader Thomas Vittner serves as empirical evidence for the significance of the determined behavioural patterns. To find out, whether public investors and traders showed a herding behaviour towards analysts’ stock recommendations in the financial crisis and its recovery, quantitative research has been made by conducting an experiment. Stocks performances in relation to analysts’ recommendations were analysed and evaluated.
The author’s selected behavioural patterns are influencing traders’ and investors’ decision-making processes to a large extent as their majority trades irrationally. The herding behaviour to follow analysts’ stock recommendations only holds partially in the crisis and in the recovery phase. The results show that whereas 100% of analysts’ recommendations matched with market trends before the crisis, only 50% matched during the crisis and its recovery. People tended to follow the general signals of the market, rather than to recommendations given by analysts.
Table of Contents
1 INTRODUCTION
1.1 Background
1.2 Research Question
1.3 Structure
2 LITERATURE REVIEW
2.1 Efficient Market Hypothesis
2.2 Behavioural Finance
2.3 From Expected Utility Theory to Prospect Theory
2.4 General Analysis Methods
2.4.1 Technical Analysis
2.4.2 Fundamental Analysis
2.5 Rational versus Irrational Investors
2.6 The Limits of Arbitrage
2.7 Principal-Agent Problems
3 METHODOLOGY
4 ANALYSIS OF BEHAVIOURAL PATTERNS
4.1 Confirmation Bias
4.2 Conservatism Bias
4.3 Overconfidence
4.4 Mental Accounting
4.5 Representativeness
4.6 Anchoring
4.7 Herding and Stock Market Recommendations
5 EMPIRICAL EVIDENCE OF BEHAVIOURAL PATTERNS
5.1 Evaluation of Experiment
5.2 General Discussion of Behavioral Patterns
6 CONCLUSION
Research Objectives and Themes
The primary objective of this dissertation is to investigate the extent to which behavioural finance influences the decision-making processes of traders and investors. Specifically, the study examines whether herding behaviour, characterized by following analysts' stock recommendations, persists during periods of financial crisis and subsequent recovery.
- The impact of psychological biases on investor decision-making.
- A comparative analysis of Efficient Market Hypothesis vs. Behavioural Finance.
- Experimental evaluation of herding behaviour across different market phases.
- The role of professional analysts' recommendations in market volatility.
Auszug aus dem Buch
4.1 Confirmation Bias
Confirmation bias is a type of cognitive bias. “It refers to a tendency for decision-makers to seek information that is consistent with their pre-existing beliefs.” Any information that disagrees with their own opinion is ignored and information confirming their own opinion is overweighed and might lead to wrong decisions. (Koonce & Mercer, 2005)
In 1979 Doherty et al. have conducted an experiment in order to explore people’s behaviour, when seeking information, to make judgment under uncertainty. They argue that confirmation bias can be inferred from two different forms of behavior, namely the unwillingness to change one’s opinion and the selection of data favoring one’s hypothesis. Participants in their experiment had to search for information to determine which of two islands produced a hypothetical artifact. Although the participants had no external motivation they tended to confirm rather to properly test the validity of their beliefs. They did this by consistently using confirmatory search strategies to investigate. (Doherty, Mynatt, Tweney, & Schiavo, 1979)
Especially people who are trained in the scientific method evaluate evidence that disconfirms one’s opinion more critically than information in favour of one’s hypothesis. Edwards and Smith argue that given a hypothesis against prior beliefs leads people to investigate intensively in a deliberative search of memory for material that undermines the argument simply. This time-consuming approach is often used instead of accepting the hypothesis and searching material in favour of the given hypothesis. The outcomes of their findings are that people even engage in a more radical position of their opinion than before and hence two opposing groups will diverge even more. This contradicts the EUT that stated that people will choose the option with the highest expected utility. When concurring with an argument people will not question the hypothesis any longer and the EUT holds, but if they do not accept the hypothesis people tend to choose the time-consuming search for a fallacy in the hypothesis in order to prove the given hypothesis wrong. This approach does not lead to the highest expected utility and therefore in this case the EUT does not hold. (Edwards & Smith, 1996)
Summary of Chapters
1 INTRODUCTION: Outlines the background of market inefficiencies and presents the research questions regarding behavioural finance and herding behaviour.
2 LITERATURE REVIEW: Discusses the theoretical foundations, contrasting the Efficient Market Hypothesis with behavioural finance, and explores analysis tools and investor types.
3 METHODOLOGY: Details the qualitative and quantitative research strategies employed, including the rationale for an inductive and deductive approach.
4 ANALYSIS OF BEHAVIOURAL PATTERNS: Provides an in-depth identification and examination of seven key cognitive biases influencing trader and investor decisions.
5 EMPIRICAL EVIDENCE OF BEHAVIOURAL PATTERNS: Presents the results of the experiment regarding analyst recommendations and discusses findings from the interview with a professional trader.
6 CONCLUSION: Synthesizes the findings, confirming that psychological factors significantly influence financial decisions and that herding behaviour patterns fluctuate based on market trust.
Keywords
Behavioural Finance, Efficient Market Hypothesis, Herding, Confirmation Bias, Conservatism Bias, Overconfidence, Mental Accounting, Representativeness, Anchoring, Rational Investors, Noise Traders, Prospect Theory, Financial Crisis, Technical Analysis, Fundamental Analysis
Frequently Asked Questions
What is the core focus of this research?
The research investigates the influence of behavioural finance on the decision-making processes of traders and investors, specifically focusing on how cognitive biases and psychological patterns lead to irrational behaviour in financial markets.
What are the primary thematic fields covered?
The work covers market efficiency theories, the psychology of investing, specific behavioural patterns (such as herding and overconfidence), and practical analysis tools like technical and fundamental analysis.
What is the central research question?
The study primarily asks to what extent behavioural finance influences investor decisions, and secondarily whether herding behaviour based on analyst recommendations persists during a financial crisis.
Which research methods are employed?
The author uses a mixed-method approach: qualitative research through an informal interview with a professional trader and quantitative research by conducting an experiment evaluating stock performances against analyst recommendations.
What does the main body address?
The main body examines theoretical contrasts between the Efficient Market Hypothesis and behavioural finance, explains seven specific cognitive biases, and provides empirical evidence through an analysis of market responses to analyst advice.
What are the characterizing keywords of the work?
The work is characterized by terms such as Behavioural Finance, Herding, Noise Traders, Cognitive Bias, Market Efficiency, and Psychological factors.
How does the author define a "Noise Trader"?
A noise trader is described as an irrational investor who trades based on perceived information (noise) rather than actual, fundamental information, which contributes to market imperfections.
What was the outcome of the experiment regarding analyst recommendations during the crisis?
The experiment showed that during the financial crisis, the public's trust in banks diminished, leading to a lower recall ratio of correct analyst recommendations (50%) compared to stable times (100%).
What role does Thomas Vittner play in this dissertation?
Thomas Vittner, an experienced Austrian trader, serves as the primary subject for the qualitative interview, providing empirical insight into how these behavioural patterns manifest in real-world trading.
- Citar trabajo
- Patrick Kemtzian (Autor), 2009, Finance and Psychology – A never-ending love story?!, Múnich, GRIN Verlag, https://www.grin.com/document/200201
