Behavioural Finance

Behavioural Finance

What is behavioural finance?

In investment choices, it is not only rationality that counts. Psychology and emotions play a key role in determining economic and financial decisions. This assumption is the basis of behavioural finance, which studies precisely the effects of non-rational factors on investment choices and markets. The aim is to understand the behaviour of financial markets in relation to the behavioural patterns of society and the individual. In particular, people are influenced by several variables, including past experiences, context, beliefs and the format in which information is presented. All these factors drive, for better or for worse, the performance of the economy.

Cognitive biases

The mind tends to reason rationally, but can still run into certain cognitive biases. Among the most common are: overconfidence or over-optimism, the illusion of having control over phenomena that are in reality uncontrollable, the conviction of wanting to maintain the status quo because in reality one is unable to cope with strategic change.

Market failures

It is not only the individual that moves irrationally. Markets can move irrationally and, above all, inefficiently. From erroneous price valuations to anomalies in investment returns, the entire economic-financial community can behave erratically.

Losses vs. Gains

Loss aversion is a central factor and one of the most widespread biases. This aversion is so strong that a loss, according to some theories, weighs 2.5 times more than a gain of the same magnitude in an investor’s history and choices.
Moreover, a loss can also push the investor in two opposite directions. In some cases it may lead him to take a risk in order to quickly return to profit in a kind of gamble. The problem is that one often ends up making losses worse, because one invests irrationally, driven only by the desire to catch up. In other cases, it may push one who is in a loss-making situation to keep the situation unchanged for fear of running into bigger losses.