Behavioral biases leading to imperfection in financial markets

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People say that financial market or stock market is risky. But what are the factors that make it so? Tentative market changes are no doubt one obvious reason, but there is one another reason that is hardly focused upon. This is the behavioral biases in the individuals. Behavior prejudices affects the questions of risk versus return that investors frame in their mind. Perceptive biases like overconfidence, overreaction, and information bias creates imperfection in financial markets.

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  • 1. Share 1 More Next BlogCreate Blog Sign InStock investmentMO N D AY, 1 APR IL 2013B LO G AR C HIVE 20 13 (8 )Behavioral biases leading to imperfection in financial April (1)marketsBehavio ral biases leading to imperfectio n in finan... March (5)People say that financial market or February (2)stock market is risky. But what arethe factors that make it so?AB O UT METentative market changes are noAarav Sharm adoubt one obvious reason, but View my co mplete pro filethere is one another reason that ishardly focused upon. This is thebehavioral biasesintheindividuals. Behavior prejudicesaffects the questions of risk versus return that investors framein their mind. Perceptive biases like overconfidence, overreaction, and information biascreates imperfection in financial markets.".. the market frequently mispriced stocks. This mispricing was most often caused byPDFmyURL.com

2. human emotions of fear and greed. At the height of optimism, greed moved stocksbeyond their intrinsic value, creating an overpriced market. At other times, fear movedprices below intrinsic value, creating an undervalued market." Robert G. Hagstrom, The Warren Buffett WaySome common biases that create a negative impact on the decision making capabilityduring investing in stocks includes: Overconfidence:Overconfidence can overrate ones own abilities. It is a pervasive tendency of humannature that they think they know more than others and this leads to disasters. Same is thecase with the overconfident investors as they make insensitive choices & even affectother market participants.For instance: Suppose the price of the stock in which they have recently madeinvestment goes up. The overconfident investors make an opinion of having goodjudgment skills. In case of further price rise, a pattern of price increases is detected thatresults into more buying of same shares. This sometime proves negative and callslosses instead of profit. Overreaction BiasOverreaction upon both good and bad news is disappointing. Suppose the quarterlyresults of the company are not upto the mark, then typical investor sells of the hoardingseven before understanding the reasons. The stock price gets majorly affected due tothis. Confirmation BiasMany investors consider the information or details that match up with their existingbeliefs. They tend to ignore any contrary information.PDFmyURL.com 3. Mental AccountingProspective losses sometimes bring morediscouragement for the investors oncompared to equivalent gains. Availability biasRecent, well-publicized, traumatic, & vividcircumstances or events are given moreweightage. Investors give more preferenceto blue chips stocks or the growth stockinstead of the stocks with less mediaattention.Theseare certain psychologicalcomponents, which majorly influence individual investors trading behavior in the stockmarket. Posted by Aarav Sharma at 06:13 +1 Recommend this on Google Labels: Best online stock broker , Discount stock broker , Investing stocks, Learn Stock Market, Multibagger stocks , Stock investment, Stocks and investments, Value investingNo comments:Post a CommentPDFmyURL.com 4. Enter your comment...Comment as: Pub lishPre vie w Ho me Older Po stSubscribe to : Po st Co mments (Ato m) Simple template. Po wered by Blo gger. PDFmyURL.com

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