The first chapter presented an introduction and to some extent, an overview of what is to be expected in the rest of the study. Specifically, it provided the basic premise for this study, the basic research aims and objectives as well as the research question, which are invaluable for the pursuit of the study objectives. In this section, effort was directed in building a strong theoretical foundation and providing a framework for data analysis. In addition to this, the literature review will afford us the opportunity of knowing what others have done on the topic or related topics, their findings, recommendations and how all these relate to the present study.
A comprehensive literature review about behavioural finance in general is beyond the scope of this research. Also, the results of some empirical studies about individual investor behaviour will be highlighted. A substantial amount of attention has been given by researcher to individual investor behaviour, whereas less attention has been given to the institutional investor behaviour. Behavioural finance is defined by Shefrin (1999) as "a rapidly growing area that deals with the influence of psychology on the behaviour of financial practitioners".
Behavioural finance research is developing rapidly and now beginning to answer such questions as ( Taffler 2002): Why, when all the evidence shows investors cannot beat the market on any systematic basis, they still resolutely do; how can we explain the stock market "bubbles"; why is the volume of trading in financial markets so excessive and why is the stock market so volatile; why do investment analysts have so much difficulty in identifying under- and over-valued stocks; why do stock prices appear to under-react to bad news; Economic evidence indicates that private investment has a stronger, more favourable effect on growth rather than government investment, probably because private investment is more efficient and less closely associated with corruption.
2.1.1. Share market investors
In general findings of Phillip Kottler (2001), 'A customer is the most important person ever in this office... in person or by mail'. 'A customer is a person who brings us his wants. It is our job to handle them profitability to him and to ourselves.' If a person deals with a bank, he is referred to as 'customer'. Likewise, if a person deals with the share market activities, he is referred to as 'investor'. Investors are the persons and institutions who buy and sell the shares in the share market. In the share market, investors cannot participate directly. It means that they cannot buy or sell the shares directly. They can buy or sell the shares through the share brokers. Once the shares are allocated to the investors who subscribed, they become shareholders of that company respect of a share issue. They wishing to buy or sell shares in the stock market must register with one or more stock broker companies.
Investors belong to two broad categories; Private and institutional. The term private investor usually refers to an individual or small group of individuals, such as those represented by a family trust. Private investors have many ways to invest globally. They can also buy through a broker, foreign shares not listed domestically. They can buy mutual funds that invest only in specific markets. Finally, they can have their money managed by investment professionals; high-net-worth individuals (HNWI) are a clientele actively sought by many investment management firms. (M.Y.M. Siddeek, 1997). Institutional investors are represented by variety of institutions in the banking, life assurance, merchant banking, general insurance, stock brokering, and finance industries, etc. They invest their funds in the share market. Institutional investors can be divided into foreign and domestic institutions.
It cannot be expected for a holistic theory aimed at explaining how the financial markets function, to neglect how the investors, as one of the fundamental actors of the markets, make their decisions as to purchase or sell a stock. It can be said that the question about how people in general and investors in particular make their decisions is a subject matter of behavioural psychology (Peter, 1996). However, this approach does not justify the thought of the traditional finance that psychology does not contribute to financial explanations. The aversion of the traditional approach to understand and explain the decision processes of investors was the main reason to trigger the emergence of behavioural finance as an approach which tries to identify and understand the meaning of psychological decision processes for financial markets (Ricclardi and Simon, 2000).
2.1.2. Investor behaviour
The main approach of behavioural finance is that investors are not rational and they are under influence, as opposed to traditional finance. (Matthew R., 1998). The main concepts of behavioural finance can be classified into four groups; Expectations theory, Regret Aversion, Over-Confidence, Cognitive Dissonance. The investment behaviour of individual investors is somewhat different from that of international investors. Individuals tend to invest relatively more in non-tradable assets such as real estate, hedge funds, or structured products. The term institutional investor is generally used to describe an organisation that invests on behalf of others, such as a mutual fund, pension fund, or charitable organisation. According to Gerald Appel (2006) Customer behaviour is one that customer displays in searching for purchasing, using, evaluating, and disposing of goods, services, ideas, or experience to satisfy their needs and desires. Understanding customer behaviour and 'knowing customers' are never simple. The customer behaviour is mainly influenced by environmental factors. These factors are uncontrollable by the markets, but very important.
Marketing and environmental stimuli enter the buyer's consciousness. The buyer's characteristics and decision process lead to certain purchase decisions. The marketer's task is to understand what happens in the buyer's black box between the arrival of outside stimuli and buyer's decision. Likewise, the investor behaviour in share market is influenced by a multitude of factors at any time. They are political, economical, social, and technological factors. These can be called 'PEST' factors. (Bernard Burned, 2004, P: 456) Some can be of long term nature or cyclical in character whilst others can be temporary or short term. Investor behaviour means that investors change their attitudes by buying and selling the shares under different environment.
2.1.3. Economic factors
In general findings of Beenstock and Chan [BC] (1988), Economic factors affect the purchasing power of potential investor and the firm's cost of capital. The fluctuations of local, national and world economics are related in many ways for changing investor behaviour in share market. The following key factors that affect the investor behaviour in share market:
Interest rates
It represents the price paid for the use of money or credit and reflects the interactions between the supply of credit and demand for it. Interest rates are thought to affect the stock market in several ways. When interest rates rise, the cost of money borrowed by companies also increases. This dampens the company expansion plans, profit margins, and it is regarded by economist as deflationary. It has a negative effect on stock market prices. While certain studies (Green and Villanueva 1991, Solimano 1992) have confirmed the negative relationship between interest rates and investment, studies by others (Serven and Solimano 1993, van Wijinbergen 1985) have shown that in repressed financial markets, credit policy affects investment in a distorted manner. The interest channel transmission mechanism, therefore, depends upon the institutional set up of financial markets.
Inflation rates
The inflation is the most important factors to affect the investor behaviour. If the share market growth rate is lower than the inflation rate, investors invest their money in other assets. Such as fixed assets, fixed deposits, saving A/C, and debentures etc. When inflation rate is less, share market investment is profitability and most of the investors move toward the share market. So, buyers of the shares are higher than the sellers of the shares in the share market. (McGraw- Hill, 2009, P: 557). Consequently, a low rate of inflation and appropriate pricing of capital, labour and land to maintain international competitiveness are two main macroeconomic challenges for decision makers to make the country invest friendly (World Bank 1995). A high rate of inflation will tend to discourage private savings and investment. This calls for prudent fiscal policies, which will avoid unsustainable fiscal deficits, as well as disciplined monetary policies including self-denial in resorting to domestic borrowing from monetary authorities (Fairbairn 1992).
Exchange rates
Siwatibau (1993) analysed that fluctuations in the exchange rate affect the share market investor behaviour. Movements in the value of country's currency can directly affect the value of its listed securities in a number of ways.
The fluctuations in exchange rates between the currencies of trading nations have become increasingly important factors affecting the performance of stock market. Export competitiveness requires proactive real exchange rate policies (Fischer & Khan 1998; Herandez 2000). This will prevent domestic resources from being overvalued and ensure that domestic investors are encouraged to make new commitments.
Balance of payments (BOP), Commodity Prices and Terms of Trade
For exporters of primary commodities, the price level of such items in both domestic currency and other trading denominations are of major concern to the share market. More over the overall quantity and value of such exports has a major bearing on the countries BOP. A deficit in the current account means that industry as a whole is paying more money to overseas companies than those companies are paying to their domestic counterparts. Hence, capital is leaking out of the country, capital that could be channelled into productive areas via the share market.
2.1.4. Individual rationality
According to Sargent (1993), the traditional finance paradigm, which underlies many of the other articles in this research, seeks to understand financial markets using models in which agents are "rational". Rationality means two things. First, when they receive new information, agents update their beliefs correctly, in the manner described by Bayes' law. Second, given their beliefs, agents make choices that are normatively acceptable, in the sense that they are consistent with Savage's notion of Subjective Expected Utility (SEU). In broad terms, behavioural finance argues that some financial phenomena can be better understood using models in which some agents are not fully rational.
One of the biggest successes of behavioural finance is a series of theoretical papers showing that in an economy where rational and irrational traders interact, irrationality can have a substantial and long-lived impact on prices. These papers, known as the literature on "limits to arbitrage", form one of the two buildings blocks of behavioural finance. To make sharp predictions, behavioural models often need to specify the form of agents' irrationality. How exactly do people misapply Bayes law or deviate from SEU? For guidance on this, behavioural economists typically turn to the extensive experimental evidence complied by cognitive psychologists on the biases that arise when people form beliefs, and on people's preferences, or on how they make decisions, given their beliefs. Psychology is therefore the second building block of behavioural finance.
It is important to note that most models of asset pricing use the Rational Expectations Equilibrium framework (REE), which assumes not only individual rationality but also consistent beliefs (Sargent 1993). Consistent beliefs mean that agents' beliefs are correct. The subjective distribution they use to forecast future realizations of unknown variables is indeed the distribution that those realizations are drawn from. This requires not only that agent's process new information correctly, but that they have enough information about the structure of the economy to be able to figure out the correct distribution for the variables of interest. Behavioural finance departs from REE by relaxing the assumption of individual rationality. While investors apply Bayes' law correctly, they lack the information required to know the actual distribution variables are drawn from. This line of research is sometimes referred to as the literature on bounded rationality, or on structural uncertainty.
2.1.5. Psychology
Researcher summarizes the psychology that may be of particular interest to financial economists. The theory of limited arbitrage shows that if irrational traders cause deviations from fundamental value, rational traders will often be powerless to do anything about it. In order to say more about the structure of these deviations, behavioural models often assume a specific form of irrationality. For guidance on this, economists turn to the extensive experimental evidence complied by cognitive psychologists on the systematic biases that arise when people form beliefs, and on people's preferences. (Kahneman and Tversky, 2000)
Beliefs: A crucial component of any model of financial markets is a specification of how agents form expectations. Researcher summarizes what psychologists have learned about how people appear to form beliefs in practice.
0verconfidence: Extensive evidence shows that people are overconfident in their judgments. This appears in two guises. First, the confidence intervals people assign to their estimates of quantities - the level of the Dow in a year, say - are far too narrow. Their 98% confidence intervals, for example, include the true quantity only about 60% of the time (Alpert and Raiffa, 1982). Second, people are poorly calibrated when estimating probabilities: events they think are certain to occur actually occur only around 80% of the time, and events they deem impossible occur approximately 20% of the time (Fischhoff, Slovic and Lichtenstein, 1977).
Optimism and wishful thinking: Most people display unrealistically rosy views of their abilities and prospects (Weinstein, 1980).
Representativeness
Kahneman and Tversky (1974) show that when people try to determine the probability that a data set A was generated by a model B, or that an object A belongs to a class B, they often use the representativeness heuristic. This means that they evaluate the probability by the degree to which A reflect the essential characteristics of B. Much of the time, representativeness is a helpful heuristic, but it can generate some severe biases. The first is base rate neglect. To illustrate, Kahneman and Tversky present this description of a person named Linda:
'Linda is 31 years old, single, outspoken, and very bright. She majored in philosophy. As a student, she was deeply concerned with issues of discrimination and social justice, and also participated in anti-nuclear demonstrations'.
When asked which of "Linda is a bank teller" (statement A) and "Linda is a bank teller and is active in the feminist movement" (statement B) is more likely, subjects typically assign greater probability to B. This is, of course, impossible. Representativeness provides a simple explanation. The description of Linda sounds like the description of a feminist - it is representative of feminist - leading subjects to pick B. Put differently, while Bayes law says that
P (statement B/ description) = [p (description/ statement B) p (statement B)]/p (description)
People apply the law incorrectly, putting too much weight on p (description/statement B), which captures representativeness, and too little weight on the base rate, p (statement B). Representativeness also leads to another bias, sample size neglect. Sample size neglect means that in cases where people do not initially know the data-generating process, they will tend to infer it too quickly on the basis of too few data points. (Gilovich, Vallone and Tversky, 1985).
Belief perseverance
There is much evidence that once people have formed an opinion, they cling to it too tightly and for too long (Lord, Ross and Lepper, 1979). At least two effects appear to be at work. First, people are reluctant to search for evidence that contradicts their beliefs. Second, even if they find such evidence, they treat with excessive scepticism. Some studies have found an even stronger effect, known as confirmation bias, whereby people misinterpret evidence that goes against their hypothesis as actually being in their favour. In the context of academic finance, belief perseverance predicts that if people start out believing in the Efficient Markets Hypothesis, they may continue to believe in it long after compelling evidence to the contrary has emerged.
Anchoring
Kahneman and Tversky (1974) argue that when forming estimates, people often start with some initial, possibly arbitrary value, and then adjust away from it. Experimental evidence shows that the adjustment is often insufficient. Put differently, people "anchor" too much on the initial value. In one experiment, subjects were asked to estimate the percentage of United Nations' countries that are African. More specifically, before giving a percentage, they were asked whether their guess was higher or lower than a randomly generated number between 0 and 100. Their subsequent estimates were significantly affected by the initial random number. Those who were asked to compare their estimate to 10, subsequently estimated 25%, while those who compared to 60, estimated 45%.
Ambiguity aversion
This discussion so far has cantered on understanding how people act when the outcomes of gambles have known objective probabilities. In reality, probabilities are rarely objectively known. To handle this situation, Savage (1964) develops a counterpart to expected utility known as subjective expected utility, subjective Expected Utility (SEU) henceforth. Under certain axioms, preferences can be represented by the expectation of a utility function, this time weighted by the individual's subjective probability assessment. Experimental work in the last few decades has been as unkind to SEU as it was to EU. The violations this time are of a different nature, but they may be just as relevant for financial economists.
The experiment suggests that people do not like situations where they are uncertain about the probability distribution of a gamble. Such situations are known as situations of ambiguity, and the general dislike for them, as ambiguity aversion. Ambiguity aversion appears in a wide variety of contexts. In general, people prefer to bet on the machine, illustrating aversion to ambiguity. Heath and Tversky (1991) argue that in the real world, ambiguity aversion has much to do with how competent an individual feels he is at assessing the relevant distribution.
Regret Aversion
Regret is a strong emotional situation related to information about the past regarding a decision in the past leading to a worse result than an alternative decision or than a decision of someone else. The opposite of regret in positive sense is gratification. The Joy of gratification and the pain of regret is important. Kahneman and Tversky define regret as the frustration which occurs as a consequence of a bad choice (Statman, 1999). The desire for gratification and aversion of regret result in realization of profits and retardation of losses.
Another approach related to regret aversion is the Cognitive Dissonance Theory which is a theory of consistency founded by Festinger. According to Festinger if any belief, information or attitude of a person requires the opposite of another belief, information or attitude of that person, there is a cognitive dissonance between them (Kagitcibasi, 1993). In this manner, cognitive dissonance can be regarded as the pain of regret stemming from wrong beliefs. It is possible to observe this approach in investor behaviour in financial markets.
Preferences
An essential ingredient of any model trying to understand asset prices or trading behaviour is an assumption about investor preferences, or about how investors evaluate risky gambles. The vast majority of models assume that investors evaluate gambles according to the expected utility framework, EU henceforth. The theoretical motivation for this goes back to Von Neumann and Morgenstern (1944), VNM henceforth, who show that if preferences satisfy a number of plausible axioms - completeness, transitivity, continuity, and independence - then they can be represented by the expectation of a utility function.
2.1.6. Feelings and Decision-Making Involving Risk and Uncertainty
The traditional perspective of how people make decisions involving conditions of risk and uncertainty assumes what Loewenstein et al.(2000) describes as a 'consequentiality perspective'. In this traditional model, the decision-maker is assumed to quantitatively weigh the costs and benefits of all possible outcomes and choose the outcome with the best risk-benefit trade-off. This perspective can be seen in the traditional finance theories of Markowitz portfolio theory (Markowitz, 1952) and the Capital Asset Pricing Model (e.g. Sharpe, 1964). The traditional consequentiality perspective is argued to be unrealistic, as it takes no account of the influence of feelings on decision-making, especially when the decision involves conditions of risk and/or uncertainty (e.g. Schwarz 1990 and Loewenstein et al., 2000).
An advance on the traditional perspective has been to include the impact of anticipated emotions on decision-making. Anticipated emotions are emotions that are expected to be experienced by the decision-maker given a certain outcome. For example, it might be assumed that the decision maker is influenced by the effect of emotions such as regret and disappointment if they experience a negative outcome (Loomes and Sugden, 1982). This perspective has been applied in finance; for example, the myopic loss aversion theory of Benartzi and Thaler (1995) utilizes the implication of the emotional reaction of investors to losses on their investments to explain the equity risk premium puzzle identified by Mehra and Prescott (1985).
While the inclusion of anticipated emotions is an advance over the traditional consequentiality perspective, the perspective does not incorporate the significant influence of emotions experienced at the time of making a decision on the decision-maker. Thus, for example, it does not incorporate the finding that people in good moods at the time of making a decision make different decisions to people in negative moods (e.g. Schwarz, 1990). This has been found to be true even if the cause of the mood state is unrelated to the decision being made (Schwarz and Clore, 1983). The risk-as-feelings model was developed by Loewenstein et al. (2000) primarily to incorporate the fact that the emotions people experience at the time of making a decision influence their eventual decision.
The model is based on a number of premises, each of which is well supported. The combined effect of the premises of the risk-as-feelings model is to show that every aspect of the decision-making process is influenced by the feelings of the decision-maker. Figure 1 provides an illustration of the decision-making process argued for by the risk-as-feelings model and the contrasting decision-making process argued for by the risk-as-feelings model and the contrasting decision-making processes assumed by the traditional consequentiality model and the consequentiality model incorporating anticipated emotions.
Three premises which Loewenstein et al. (2000) use to support the argument that decision-making involving risk and uncertainty is influenced by feelings are of particular relevance to understanding how investor decision-making might be influenced by the feelings of investor. These are:
1. Cognitive evaluations induce emotional reactions. This argument is well established by psychologists. In a review of psychologist's research on emotions and feelings, Zajonc (1980) summarizes that emotions are considered by most contemporary theories to be post cognitive, that is, to occur only after considerable cognitive operations have been accomplished (p.151).
2. Emotions inform cognitive evaluations. The idea that emotions inform cognitive evaluations is also well established by researchers in psychology and decision-making. That emotions inform cognitive evaluations can be seen from the body of research which shows that people in positive moods tend to make optimistic judgements, while people in negative moods tend to make pessimistic judgements.
3. Feelings can affect behaviour. Damasio (1994) showed that emotions play a vital role in decision-making by studying people who had an impaired ability to experience emotion. People with impaired ability to experience emotions had difficulty making decisions and tended to make suboptimal decisions. In a study of the influence of emotions on decision making, under conditions of risk and uncertainty, set up a card-playing game. They found that subjects who could not experience emotions, indicating an influence of emotions on decision-making. This experiment is discussed in greater detail in the next section.
2.1.7. The behaviour of investors in the framework of the Prospect Theory
The approach named as the prospect theory is an approach which emerged from the studies of Kahneman and Tversky's which explained how individuals make decisions under risky conditions (Kahneman, Daniel, &Amos Tversky, 1979; Barberies &Huang, 2001). The importance and the influence of the "Prospect Theory" which had an important place in the literature of psychology comes from the fact that it enables us to see the deficiencies and mistakes of the way traditional finance explains the attitude of individuals towards risk based on the "rational human being". However, the experimental studies in the framework of Prospect Theory have shown that the decision making process is not a completely rational process and individuals are more inclined to take risky to avoid losses rather than to attain higher returns (Laver, 1997).
For internal consistency, the rehabilitation of the Keynesian marginal efficiency of investments schedule requires either a changing rate of interest, as suggested by Haavelmo, or a changing price of capital goods, as suggested by Lerner. For if the rate of interest and the price of investment goods are fixed overtime and the marginal productivity of capital is equal to the implicit price of capital services, the firm's demand for investment is determinate; this demand is precisely equal to replacement demand so that net investment is zero. Under these circumstances, the rate of investment demand by users of capital equipment is independent of the rate of interest so that the price of investment goods must be that at which this rate of investment will be supplied by investment goods products.
To complete the rehabilitation of the Keynesian marginal efficiency of investment schedule, interpreted as the level of investment resulting from market equilibrium in investment goods corresponding to a given rate of interest, market equilibrium must be studied in a fully dynamic setting. The demand for investment goods must be derived from a comparison among alternative paths of optimal capital accumulation. It remains to be seen whether such rehabilitation can be carried out in an internally consistent way. (Hirshleifer, 2001)
2.2 .1. Results of various empirical research
Economic theory on investment decisions treats the investment decision of the individual as a macroeconomic aggregate and the microeconomic foundations of it are drawn from intertemporal utility theory. Individuals maximize their utility based on classic wealth criteria making a choice between consumption and investment through time. However, some empirical studies that first appeared in the 1970s focused on the individual rather than aggregate investor profiles. At about the same time, the sub-discipline of behavioural finance evolved investigating investment choices under conditions of uncertainty. Research in behavioural finance produced three major theoretical streams, namely: Prospect Theory, Regret Aversion and Self Control. Each of these research streams captured and analyzed behavioural attributes of individual investors.
A Wharton survey contributed empirical data for the study of these research streams by examining how demographic variables influence the investment selection and portfolio composition process, and Blume and Friend (1978) provided a comprehensive study and overview of the Wharton survey results and its implications for behavioural finance. Furthermore, Cohn et al. (1975) provided tentative evidence that risk aversion decreases as the investor's wealth increases, while Riley and Chow showed that risk aversion decreases not only as wealth increases, but also as age, income and education increase. LeBaron, Farrelly and Gula (1989) added to the debate, by advocating that individuals' risk aversion is largely a function of visceral rather than rational considerations.
On the other hand, Baker and Haslem (1974) contended that dividends, expected returns and the firm's financial stability are critical investment considerations for individual investors, and Baker, Haargrove and Haslem (1977) went a step further by proposing that investors behave rationally, taking into account the investment's risk/return tradeoff. (The Journal of Economic factors and individual investor behaviour in the case of Greek Stock Exchange, 20(4)). This study focused exclusively on the variables that were identified by the Greek investors to significantly affect their individual investor behaviour, namely the "Act on" variables.
Kadiyala and Rau (2004) investigated investor reaction to corporate event announcements. They concluded that investors appear to under-react to prior information as well as to information conveyed by the event, leading to different patterns: return continuations and return reveals, both documented in long-horizon return. They found no support for the overreaction hypothesis. Merikas et al., (2003) adopted a modified questionnaire to analyze factors influencing Greek investor behaviour on the Athens Stock Exchange. The results indicated that individuals base their stock purchase decisions on economic criteria combined with other diverse variables. The authors did not rely on a single integrated approach, but rather on many categories of factors. The result also revealed that there is a certain degree of correlation between the factors that behavioural finance theory and previous empirical evidence identify as the influencing factors for the average equity investor, and the individual behaviour of active investors in the Athens Stock Exchange (ASE) influencing by the overall trends prevailing at the time of the survey in the ASE.
Malmendier and Shanthikumar (2003) tried to answer the question: Are small investors' naïve? They found that large investors generate abnormal volumes of buyer-initiated trades after a positive recommendation only if the analyst is unaffiliated. Small traders exert abnormal buy pressure after all positive recommendations, including those of affiliated analysts. Hodge (2000) analyzed investors' perceptions of earnings quality, auditor independence, and the usefulness of audited financial information. He concluded that lowered financial statements and fundamental analysis of those statements when making investment desperceptions of earnings quality are associated with greater reliance on a firm's auditisions. Krishnan and Booker (2002) analyzed the factors influencing the decisions of investor who use analysts' recommendations to arrive at a short-term decision to hold or sell a stock. The results indicate that a strong form of the analyst summary recommendation report, i.e., one with additional information supporting the analysts' position further, reduces the disposition error for gains and also reduces the disposition error for losses.
Nagy and Obenberger (1994) examined factors influencing investor behaviour. They developed a questionnaire that included (34) questions. Their findings suggested that classical wealth - maximimization criteria are important to investors, even though investors employ diverse criteria when choosing stocks concerns such as local or international operations, environmental track record and the firm's ethical posture appear to be given only cursory consideration. Epstein (1994) examined the demand for social information by individual investors. The results indicate the usefulness of annual reports to corporate shareholders. The results also indicate a strong demand for information about product safety and quality, and about the company's environmental activities. Furthermore, a majority of the shareholders surveyed also want the company to report on corporate ethics, employee relations and community involvement.
De Bondt et al., (1985) published a paper about behavioural finance in which they asked the following question: "Does the stock market overreact?" the article gave evidence to support the hypothesis that cognitive bias (investor over-reaction to a long series of bad news) could produce predictable mispricing of stocks traded on the NYSE. The main findings of the above studies can be summarized as follows:
UNISA that a first SA University to offer course in investor psychology. Focus on its' 'A matter of psychology' Research has established people are willing to take more risks to avoid losses than to realise gains. Faced with sure gain, most investors are risk-averse. Faced with sure loss, investors become risk-takers. "A different set of rules takes over when an investor panics," says Pieter van der Merwe (2009), co-ordinator of investor psychology at the Department of Industrial and Organisational Psychology of Unisa's College of Economic and Management Sciences (CEMS). "It's all about emotional weaknesses, triggered by a condition of investor anxiety."
Van der Merwe says the collaboration between finance and other social sciences which has become known as behavioural finance or investor psychology has led to a profound deepening of our knowledge of financial markets and the often unexpected investment decisions of individuals? People aren't accustomed to thinking hard and are often content to trust a plausible judgment that comes quickly to mind- intuition- rather than to reason out a complex decision. Led by an irrational decision process, wrong decisions are therefore taken." That's why the markets always overreact upwards or downwards, Van der Merwe says. "Modern finance theory portrays financial decision-making as rational choice. However, pure rationality fails to describe how many decisions are truly made. Important research into behavioural finance has been conducted over the past decade or so but until the market turmoil struck, investors preferred to think and talk about global prosperity.
Van der Merwe, who also lectures on investor psychology as part of Liberty Life's annual actuarial induction programme and who is working towards a doctorate on a related subject, says investor psychology research is still limited in SA. "However, there's a new awareness that there are more factors involved in an investment strategy than meets the eye and that will probably add new impetus to research, Investors are becoming more aware of the fact that the market and the associated decisions made by investors involves much more than a rational predictable playing field." In SA, the Institute of Behavioural Finance (IBF) was recently formed to focus on the study and research of behavioural biases and their effects on SA's markets. The various behavioural strategies amateur and expert investors rely upon to make financial decisions, The structure and dynamics of asset prices in global financial markets (from a psychological perspective), The practice implications of behavioural finance for investment professionals.
"The course includes a discussion of common psychological errors, such as unrealistic optimism, extrapolation bias, tunnel vision, overconfidence, procrastination, lack of self-control, myopia and emotional distortion, " says Van der Merwe. "Investor psychology occupies itself with an individual's propensity and preference for certain financial behaviour, the process of acquiring investment and other risk-related instruments and the adviser's marketing behaviour in meeting those customer needs." (UNISA education, 2009)
2.2.2. Irrational investors key cause of inefficiencies
According to Liam Egan, irrational investor behaviour plays a key role in forming market inefficiencies, according to Tyndall Investment Management head of retail Craig Hobart, writing in the newly released Tyndall white paper on Australian equities, entitled "Greed and fear: investor behaviour and its influence on market cycles", Hobart said the two main causes of inefficient markets are 'heuristic biases' and 'frame dependence' by investors, "Heuristic biases are essentially 'rules of thumb' gained by investors from previous experiences, thereby creating a natural bias based on a previous experience rather than logic. An investor who has lost a lot of money in a single mining stock may never invest in mining stocks again in the belief that their previous experience will be repeated. Hobart said the concept of frame dependence centres on people having "frames of reference" when making investment decisions particularly when it involves risk or uncertainty. Investors often focus on die initial capital outlay as die amount 'at risk', rather than the accumulated value over time. (www.moneymanagement.com)
Several recent studies have found that women invest their pensions more conservatively than men (Bajtelsmit and VanDerhei, 1996; Hinz, McCarthy, and Turner, 1996) and that woman are more risk adverse (Jianakoplos and Bernasek, 1996). Although these findings have serious implications for the well-being of women in retirement, the reasons for observed gender differences are less well-defined. The holdings of risky assets as a percentage of total assets are regressed on the natural log of wealth and other explanatory variables. The coefficient on the wealth variables thus provides a measure of relative risk aversion. Although previous studies had attempted to measure risk aversion in this way, this study is the first to examine the significance of gender differences. Examination of the equation for different categories of the sample shows that single women are relatively more risk averse in their asset holdings than single men or married couples. In this study, participants self-reported investment risk tolerance provides evidence that women also perceive themselves to be less inclined to risk taking.
2.3. Chapter Summary
In this chapter, the researcher reviews the literature to examine the investor behavior of share market. The investor behavior is changed by the economical and psychological factors. The researcher identified the economical and psychological factors variables that influence the investor behavior. Changing investor behavior can be evaluated by survey questionnaire. The following chapter explains the research methodology.
