Dissertation Sample on Role of Behavioral finance in portfolio investment

This dissertation sample will shed light on the role of behavioural finance on portfolio investment. Starting from the emergence of behavioural finance and recent studies in this field, this solution will take you to the practical application of this concept. This is followed by a striking comparison between Traditional Finance and Behavioral Finance. You will get to know a number of factors that affect investors and their investment decisions. Some of them are risks, returns, overconfidence bias, hindsight bias, excessive optimism bias, anchoring bias and the mental accounting bias. Then it talks about General mistakes by the investors designing the investment portfolio. It also discusses why behavioural finance is opted and what are its implications and principles. Touching several other topics it finally ends up in answering why there is a need for studying behavioural finance in today’s time.
Elaborate on the role of Behavioral Finance in portfolio investment


The entire dissertation will revolve around the role of behavioural finance in portfolio investment. On the other hand, the study will also highlight how the behavioural factors with regards to the individuals and professionals have an effect on the market. It has been greatly witnessed that the investors take necessary decisions by applying a lot of financial tools with regards to the investment. Arguably, the decisions that they make is not at all dependent on these tools but they are dependent on the principles stated by the financial tools. It has been also noticed in the stock market a lot of people become a billionaire and some people vice-versa.
It is not only because of the right type of information is not available to them but the main problem is the decision-making ability and the way they think is responsible for the negative outcome. However, the whole discussion will also focus to identify the behavioural factors that have an influence on the decisions related to the investments, the effect of the biases on the pattern of investment, and to identify the awareness with regards to the behaviour does not have a direct effect on the strategy of the investment, and also to study the psychological effect of the different factors such as regret aversion and loss aversion on the decisions related to investments. Furthermore, the study will also try to throw light on behavioural factors that do and does not have an effect on the decision related to the investment of individual investors.
Behavioural finance generally explains the behaviour of the managers and investors and it also tries to explain the conversation that takes place between the managers and investors in the capital and financial markets. Moreover, it suggests more efficient and effective behaviour for the managers and investors in the long run. Standard finance is also offered by behavioural finance. It is the type of finance that states that the nature of investors is not at all rational but they are certainly normal. The design of the portfolios is done by the investors as per the rules which are applicable for the behavioural portfolio theory not as per the mean-variance portfolio theory. It has been observed that from the last few decades the behavioural has become one of the key elements in the world of investments.

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Behavioural finance has one of the primary goals that are to help the customers for making sound decisions regarding finance and also demonstrate sensible behaviour regarding finance. However, there are a lot of scholars who have argued about behavioural finance to a great extent. One of the world-famous financials has regarded behavioural finance as the combination of economics and psychology that examines what is exactly happening in the marketplace. Furthermore, behavioural finance also tries to explain the reasoning and understanding patterns of the investors. It also includes the emotional process by which the decision-making process of an individual to a great extent. It c be also said that behavioural finance develops a large variety of concepts that falls under three main categories that are: cognitive biases, choice architecture and heuristics. Firstly, on the basis of the cognitive biases it has been witnessed that most of the people unknowingly make an error in the way of their thinking.
Over-confidence can be pointed out as one of the most harmful and damaging thinking with regards to the decision-making process of an individual. There are also a large set of the behavioural scholars who have explained that each and every people has the tendency to overestimate of certain things that will take place in future for example, in financial market an individual invests in some stocks and expects they will also earn a huge amount of money like others and when they do not it is due to their poor decision-making skills. On the other hand, regret aversion is considered to be one of the negative forces that are directly responsible for the bad decision making by an individual. Moreover, it has been strongly noticed that the investors always find it quite easier to invest in the stocks that are quite popular even it is not suitable for them. Hence, the result of such bad decisions takes them directly in the area of losses. Throwing light on the above-mentioned statement, it can be also said that since some of the investors tend to follow the masses they face high-amount of losses which is regretted by them in the future.
In case of the loss, aversion affects it has been observed that in case of the loss aversion affect a person more precisely an investor try to avoid the potential losses that are associated with one of their decision making processes because they dream of gaining some unrealistic profits from the place they have invested their money. In this scenario, it can be said that when a person loses $200 will certainly lose a lot of satisfaction than a person who has gained $200 from their investment.  It is the situation that highlights how much strong impact the loss due to a bad investment decision can have on the individuals. It is the place where behavioural finance can help the investor to make a sound decision with regards to their investment.
Behavioural finance can be regarded as the new stream that seeks to provide a valid and sound explanation to the individual's decisions which are economic in nature. Furthermore, in other words, behavioural finance is also a wise attempt towards resolving the inconsistency in decision making by the investors within the efficient marketplace through the explanation that is completely based on the behaviour of the human beings. Additionally, behavioural finance is also quite successful in assuming the characteristics of the participants in the market that influence the investment decisions of the individuals. Behavioural finance is also the segment that highlights how the investors interpret and perform on information to make sound investment decisions which are informed in nature as well. It has been also noticed that a lot of investors do not behave in a predictable, unbiased or in a predictable manner which is greatly highlighted by the quantitative models.
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Literature review

As argued by some of the eminent scholars, most of the theories surrounding the financial and the economic theories tend to assume that the investors tend to act in a rational manner when they are making any type of decision. On the other hand, it has been also argued that the irrational behaviour of an individual is portrayed when they face some amount of uncertainty in their life. Behavioural finance is mainly the study of the market that highlights the psychology of the human being, also focuses on why the people sell and buy stocks. Additionally, it also explains why people do not sell or buy the stocks at all (Van Rooij, Lusardi and Alessie, 2011). Furthermore, one of the most pathetic challenges that are faced by investors in recent times is in the field of the decisions relating to the investment. It can be also stated by, that the losses or the profits made by the investors can also play as an important element in their decision-making process. It has been also witnessed that when the downfall of the financial market happened in the year 2008 even the most experienced and prominent investors had irrational market behaviour.
Furthermore, there also a lot of economists around the globe who considers that the traditional theories do not help the investors in the current time in their investment decisions so they need studying and applying the theories of behavioural finance in their decision-making process. The traditional finance from a long period of time has only discussed the rationality of the investors. Even there are a lot of traditional theories that have suggested a lot of different assumption about the investors still one rationality was one of the main themes that were common in each of the discussion. As per, it has been stated that the investors are assumed to be rational because they can take a lot of high-intensity right type of decisions in a short period of time. However, an investor can be said rational on the basis of the following: They tend to update their beliefs in a timely manner when they receive the information and then they make certain choices that are quite acceptable by everyone.
The financial crisis that took place in the year 2008 mostly came from the USA and has circulated in the entire world. A large number of economists claimed that a lot of financial institutions and also governments were aware of this situation and if they took a constructive step against it then it would not have been so destructive on the financial market. Even after the crisis took a bad and wrong turn they were unable to analyze how much worse it was for the investors and the financial market. It can be said from the academic point of view that behavioural finance came into existence because there were a large number of problems that were solely faced by traditional theories.
On the other hand, from the science perspective, it can be argued that if the traditional theories did not believe that investors were rational then the situation of their difficulties would have been understood in a better manner. There are also a lot of models which came into existence. Some of the models believed that the investors tend to behave in an irrational way and some of the models highlighted that some of the investors can behave in a rational way but when it comes in the decision-making process with regards to the investment they tend to fail very badly.  It has been also suggested by a lot of economists that behavioural finance does not try to omit the traditional finance instead they act as a supplement to it by merging it with the psychology which is cognitive in nature. Moreover, behavioural finance also tries to create an entire human behaviour model with regards to decision-making. On the other hand, from a viewpoint of a practitioner, behavioural finance recognizes various concepts that that forces a human to behave in an irrational manner which results in the wrong decision-making process. If an investor is smart enough then they will catch the essence of the behavioural finance for reflecting on their own decisions regarding investment.
It has been greatly observed that most of the human beings are quite susceptible to different behavioural anomalies which are one of the biggest barriers when they are trying to maximize their profits.  In the anchoring phenomenon, an individual tries to get stuck on a particular type of information that they even do not look at the possible risks that are associated with it. There are a lot of examples around the globe that suggest when an individual does not accept some of the useful information presently then they face a huge amount of loss in the long-run. Furthermore, the investors who have coined the big name in the marketplace do not have the flaws like the investors who prefer in the anchoring style in their decision-making process because the big investors do not mix their present emotions in the decision-making process as they know it can be harmful to them in the long run.
The experienced and great investors have the following characteristics in them: They tend to understand their psychological and emotional weakness by studying a lot of biases and identify whether they have committed the similar types of mistakes in the past also and if so then they will prepare for the future so that the same mistakes won't be repeated. Secondly, after understanding and achieving the objectives stated in the above-mentioned discussion the irrational behaviour among others is attempted for understanding so that they can get benefitted from their mistakes to a great extent. Additionally, finance can be broadly regarded as the study of how the resources which are scarce are allocated by the individuals and how the proper resources are acquired, invested and managed over a period of time. There are two examples within the theory of finance with regards to its traditional nature.
Firstly, markets tend to be quite effective and efficient in nature: The effective and efficient market hypothesis tells that all the information that is relevant is constantly reflected in the prices in a complete manner. Over the last more than 75 years, the complete emphasis has been given on the testing and development of the different types of models with regards to the assets. According to, the main examples of the finance are: The asset pricing models which are risk-based, the portfolio allocation model based on the risk and return, the contingent explanations about the pricing and the theory of the agency.
According to Virlics, it has been also observed from the last few centuries that traditional finance tend to play a role that is limited in the segments such as the reason behind why the investors involve themselves in the whole trading procedure and the possible reason why the returns with regards to the stock tend to vary from time-to-time other than the risk factor. There are a large number of psychologists have found out the decisions which are economic in nature in that case people tend to be more irrational in these type of above-mentioned decisions to a great extent.  If an investor is extremely emotional for some reason or cognitive emotions can be one of the biggest reasons for their bad investment decisions in the financial marketplace.
Some of the economists in the recent times highlighted the fact that although traditional finance did a great job by explaining and predicting the certain type of events in an individual's life still they did not focus on some of the important aspects which are greatly taken care by behavioural finance. The world-famous academicians also stated that behaviours and anomalies are two of the important aspects that are not explained by the traditional theories. Behavioural finance is such a segment that helps an investor to take decisions in an effective and efficient manner and make them aware also that they do not make the same mistakes that have been already conducted by them previously. It has been already said that decision-making is one of the toughest jobs in the entire world regardless of everything. It is needless to say that the decision-making process in the stock market is even tougher.
There are several difficult and rigid steps that are involved in the decision-making process namely the situational, personal and technical factors. Taking the right type of decision within a short period of time is considered to be one of the greatest difficulties that are faced by the investors especially in today's complicated marketplace. From the technical point of view, the decisions regarding investments can be gathered from various models such as the capital asset pricing model. In other words, it can be also told no decisions should be made without taking into consideration of the certain factors such as market psychology, situational and the current environmental factors (Virlics, 2013).


The investors who are young are more affected by the behavioural factors than the investors who are experienced
There is no apparent herding behaviour in the foreign stock market
The awareness regarding behavioural finance does not influence the decisions regarding the portfolio
Overconfidence bias is one of the most observed behavioural phenomena in all types of investors
The factors of the behaviour do not have an effect on the investment decisions made by the investors


The entire study will be based on behavioural finance and it will also have a research design that is descriptive in nature. In this particular study, secondary data will be used to a great extent. The secondary data that is collected will be mainly from the respective journals, books with regards to behavioural finance. The data which will be collected for the study will also be analyzed thoroughly.
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