2. Bi-Polar World
• Physical Sciences like
Physics, Chemistry, Mathema
tics-Precision and
Quantitative
• Non-Physical Sciences like
Botany, Zoology, Medicines
and Social Sciences-
Imprecise and Qualitative
3. Bi-Polar Finance
• Standard Finance -Adding Precision to the Art
of Investment-Homo Economicus
• Behavioural Finance- The Imprecise Art and the
Heuristic Attitude
4. Standard Finance
• Modigliani and Miller’s Arbitrage Theory
• Markowitz’s Diversified Portfolio
• Asset Allocation of Sharpe
• Black-Schole’s Option Pricing
6. Harry Max Markowitz
• Modern Portfolio Theory-
Risk, Return, Correlation
and Diversification
7. William Forsyth
Sharpe
• Capital Asset
Pricing Model
• Sharpe Ratio for risk
adjusted
performance
analysis
• Binomial Method of
Option Valuation
• Returns Based Style
Analysis
9. Efficient Market Hypothesis
• People behave rationally (Homo Economicus)
• Maximise the expected profit or utility
• Trying to predict future value of individual securities
• Important current information is freely available to all the
participants (Weak, Semi-Strong and Strong Markets)
• Free Availability of information means there is no cost involved
in getting the information
10. Behavioural Finance
• BF is the study of the
impact created by
psychological factor on the
activities of the investing
public, traders, companies
and the financial
intermediaries
11. Why Psychology?
• Crowd Mentality
• Childishness
• Tension
• Need to be Praised
• Prove Smartness
• Short Term View
• Intolerance
• Moody
• Refusing to Take
Decision
• Acting on Tips
• Escaping from Reality
• TV/Internet
• Individualistic
• Creating a Virtual World
• Destruction of Family
• Diplomacy inside the
House
• Self-Centered Parents
• Nuclear Personalities
• Failing Health
• Blinkers on the Eyes
12. Authorities on Behavioural Finance
• 1896- Gustave le Bon-’A Study of Popular Mind’
• 1912- Seldon-’Psychology of the Stock Market’-price
changes depend upon mental attitude of the investing
and trading public
• 1956- Leon Festinger introduced Theory of Cognitive
Dissonance in social psychology
13. Prospect Theory
• 1974-Amos Tversky
& Daniel Kahneman
described three
heuristics when
making judgement
under uncertainty:
• Representativeness
• Availability:
occurrences
• anchoring and
adjustment
• Risk Aversion
14. Import of the Theory
– Explaining the apparent regularity in human behaviors when assessing
risk under uncertainty.
– People respond differently to equivalent situations depending on whether
it is presented in the context of a loss or a gain.
– Computation is based on losses and gains rather than final asset values
– Investors are risk hesitant when chasing gains but become risk lovers
when trying to avoid a loss
15. Risk
Aversion
&
Risk
Seeking• Situation 1
Option a) A sure gain of Rs.2,000
Option b) 25% Chance to gain Rs.10,000 and 75% chance to gain
nothing
• Situation 2
a) A sure loss of Rs.5000
b) 75% chance to loss Rs.10,000 and 25% chance to lose nothing
16. Richard Thaler: Regret Theory
• Mental Accounting-1980
a) underweighting of
opportunity costs
b) failure to ignore sunk
costs
c) search behaviour,
choosing not to choose
and regret
d) precommitment and self-
control.
17. Further Theories
• 1980- Tversky and Kahneman- Problem
Framing and preferences
• 1981-Shiller- Volatility is too high for the future
dividend
• 1985- F.M.De Pont and Thaler-Overreaction of
Stcok Market
• 1988- Samuelson and Zeckhauser- Status Quo
Bias
• Many other Theories like Overconfidence etc
18. Changes in Stock Market
• Mutual Funds & Other
Institutions
• HNI
• FII Activity
• F & O Market
• Regulation by SEBI
• Monetary Policy of RBI
• Government Policies
• Scams
• Consultants, Advisors and
Media
• Investment Trusts
• Disinvestment
• Technology
• Many Players
• Dominant Financial Services
• Free Pricing of IPOs
• Technical Analysis
• Irrelevance of PE Ratios
• Tips and Sentiments
• Interim Financial Reporting
