Describe the behavioral challenges in achieving efficiency in capital marketing?
BEHAVIORAL CHALLENGES IN ACHIEVING EFFICIENCY IN CAPITAL MARKETING:
People are not always rational, however, and markets are not always efficient. Behavioral finance is the study of why individuals do not always make the decisions they are expected to make and why markets do not reliably behave as they are expected to behave. As market participants, individuals are affected by others’ behavior, which collectively affects market behavior, which in turn affects all the participants in the market.
As an individual, you participate in the capital markets and are vulnerable to the individual and market behaviors that influence the outcomes of your decisions. The more you understand and anticipate those behaviors, the better your financial decision making may be.
Ø BIAS: One kind of investor behavior that leads to unexpected decisions is bias, a predisposition to a view that inhibits objective thinking. Biases that can affect investment decisions are the following:
Availability bias occurs because investors rely on information to make informed decisions, but not all information is readily available. Investors tend to give more weight to more available information and to discount information that is brought to their attention less often.
Representativeness is decision making based on stereotypes, characterizations that are treated as “representative” of all members of a group. In investing, representativeness is a tendency to be more optimistic about investments that have performed well lately and more pessimistic about investments that have performed poorly.
Overconfidence is a bias in which you have too much faith in the precision of your estimates, causing you to underestimate the range of possibilities that actually exist. You may underestimate the extent of possible losses, for example, and therefore underestimate investment risks.
Anchoring happens when you cannot integrate new information into your thinking because you are too “anchored” to your existing views. You do not give new information its due, especially if it contradicts your previous views.
Ambiguity aversion is the tendency to prefer the familiar to the unfamiliar or the known to the unknown. Avoiding ambiguity can lead to discounting opportunities with greater uncertainty in favor of “sure things.” In that case, your bias against uncertainty may create an opportunity cost for your portfolio.
Ø FRAMING: Framing refers to the way you see alternatives and define the context in which you are making a decision. A concept related to framing is mental accounting: the way individuals encode, describe, and assess economic outcomes when they make financial decisions.
Every rational economic decision maker would prefer to avoid a loss, to have benefits be greater than costs, to reduce risk, and to have investments gain value. Loss aversion refers to the tendency to loathe realizing a loss to the extent that you avoid it even when it is the better choice.
Ø INVESTOR PROFILE: An investor profile expresses a combination of characteristics based on personality traits, life stage, sources of wealth, and other factors. It influenced by investor’s
o Life Stage
o Personality
o Source of Wealth
Describe the behavioral challenges in achieving efficiency in capital marketing?
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