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Behavioral Finance Model

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Introduction
Behavioral finance is a modern approach that exists in financial markets and is coming in response to the difficulties faced by the long term investors. In broad terms, it argues that some financial phenomena can be better understood using models in which some agents are not fully rational. More specifically, it analyzes what happens when we relax one, or both, of the two concepts that underlie individual rationality. In some behavioral finance models, agents fail to update their beliefs correctly. In other models, agents make choices that are normatively questionable. It gives a glimpse to behavioral finance, describes the background, aim and objectives of the paper. It begins with a description of standard as well as behavioral …show more content…

It provides complete direction of what a behavioral investing is and various components involved in it. It explains in very details various psychological pitfalls, biases and mistakes done by investors. Montier is a experienced practitioner and he has provided many recommandations and real life cases of great investors regarding how one can safeguard self against some of these problems/biases. Many of the suggestions can improve your investing performance no doubt.
Jay R. Ritter (2013) provides a brief introduction to behavioral finance. According to the author, Behavioral finance encompasses research that drops the traditional assumptions of expected utility maximization with rational investors in efficient markets. The two building blocks of behavioral finance, mentioned in the article, are cognitive psychology (i.e., how people think) and the limits to arbitrage (i.e., when markets will be …show more content…

But the author argues that the term “market efficiency” has two meanings. One meaning is that investors cannot systematically beat the market. The other is that security prices are rational. Rational prices reflect only practical characteristics, such as risk, not value-expressive characteristics, such as sentiment. Behavioral finance has shown, however, that value-expressive characteristics matter in both investor choices and asset prices.
Richard Fairchild (2011) introduces the concept of behavioral finance and capital budgeting models, and explains the relation between the two. It focuses on the effects of managerial irrationality in Capital budgeting. The author has developed a model, and an experiment, that tests three specific behavioral factors:Reciprocal trust between an investor and a manager, Framing behavior resulting in irrational commitment to a project that should be abandoned, andFraming behavior combined with managerial overconfidence resulting in excessive effort

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