Finance and Psychology – A never-ending love story?!

Table of Contents

1 INTRODUCTION

1.1 Background

1.2 Research Question

1.3 Structure

2 LITERATURE REVIEW

2.1 Efficient Market Hypothesis

2.2 Behavioural Finance

2.3 From Expected Utility Theory to Prospect Theory

2.4 General Analysis Methods

2.4.1 Technical Analysis

2.4.2 Fundamental Analysis

2.5 Rational versus Irrational Investors

2.6 The Limits of Arbitrage

2.7 Principal-Agent Problems

3 METHODOLOGY

4 ANALYSIS OF BEHAVIOURAL PATTERNS

4.1 Confirmation Bias

4.2 Conservatism Bias

4.3 Overconfidence

4.4 Mental Accounting

4.5 Representativeness

4.6 Anchoring

4.7 Herding and Stock Market Recommendations

5 EMPIRICAL EVIDENCE OF BEHAVIOURAL PATTERNS

5.1 Evaluation of Experiment

5.2 General Discussion of Behavioral Patterns

6 CONCLUSION

Research Objectives and Themes

The primary objective of this dissertation is to investigate the extent to which behavioural finance influences the decision-making processes of traders and investors. Specifically, the study examines whether herding behaviour, characterized by following analysts' stock recommendations, persists during periods of financial crisis and subsequent recovery.

• The impact of psychological biases on investor decision-making.
• A comparative analysis of Efficient Market Hypothesis vs. Behavioural Finance.
• Experimental evaluation of herding behaviour across different market phases.
• The role of professional analysts' recommendations in market volatility.

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Summary of Chapters

1 INTRODUCTION: Outlines the background of market inefficiencies and presents the research questions regarding behavioural finance and herding behaviour.

2 LITERATURE REVIEW: Discusses the theoretical foundations, contrasting the Efficient Market Hypothesis with behavioural finance, and explores analysis tools and investor types.

3 METHODOLOGY: Details the qualitative and quantitative research strategies employed, including the rationale for an inductive and deductive approach.

4 ANALYSIS OF BEHAVIOURAL PATTERNS: Provides an in-depth identification and examination of seven key cognitive biases influencing trader and investor decisions.

5 EMPIRICAL EVIDENCE OF BEHAVIOURAL PATTERNS: Presents the results of the experiment regarding analyst recommendations and discusses findings from the interview with a professional trader.

6 CONCLUSION: Synthesizes the findings, confirming that psychological factors significantly influence financial decisions and that herding behaviour patterns fluctuate based on market trust.

Keywords

Behavioural Finance, Efficient Market Hypothesis, Herding, Confirmation Bias, Conservatism Bias, Overconfidence, Mental Accounting, Representativeness, Anchoring, Rational Investors, Noise Traders, Prospect Theory, Financial Crisis, Technical Analysis, Fundamental Analysis

Frequently Asked Questions

What is the core focus of this research?

The research investigates the influence of behavioural finance on the decision-making processes of traders and investors, specifically focusing on how cognitive biases and psychological patterns lead to irrational behaviour in financial markets.

What are the primary thematic fields covered?

The work covers market efficiency theories, the psychology of investing, specific behavioural patterns (such as herding and overconfidence), and practical analysis tools like technical and fundamental analysis.

What is the central research question?

The study primarily asks to what extent behavioural finance influences investor decisions, and secondarily whether herding behaviour based on analyst recommendations persists during a financial crisis.

Which research methods are employed?

The author uses a mixed-method approach: qualitative research through an informal interview with a professional trader and quantitative research by conducting an experiment evaluating stock performances against analyst recommendations.

What does the main body address?

The main body examines theoretical contrasts between the Efficient Market Hypothesis and behavioural finance, explains seven specific cognitive biases, and provides empirical evidence through an analysis of market responses to analyst advice.

What are the characterizing keywords of the work?

The work is characterized by terms such as Behavioural Finance, Herding, Noise Traders, Cognitive Bias, Market Efficiency, and Psychological factors.

How does the author define a "Noise Trader"?

A noise trader is described as an irrational investor who trades based on perceived information (noise) rather than actual, fundamental information, which contributes to market imperfections.

What was the outcome of the experiment regarding analyst recommendations during the crisis?

The experiment showed that during the financial crisis, the public's trust in banks diminished, leading to a lower recall ratio of correct analyst recommendations (50%) compared to stable times (100%).

What role does Thomas Vittner play in this dissertation?

Thomas Vittner, an experienced Austrian trader, serves as the primary subject for the qualitative interview, providing empirical insight into how these behavioural patterns manifest in real-world trading.