Introduction

This research studies the relation between Traditional Finance & Behavioral Finance. Extensive literature investigates the reactions of the investors in different situations & personality traits. Traditional Finance focuses on the Efficient Market Hypothesis (EMH). The EMH proposes that competition between investors seeking abnormal profits drives prices to their correct value. In contract, Behavioral finance assumes that, in some situations, financial markets are informationally inefficient.

Behavioral Finance in getting momentum & becoming an important alternative to market efficiency in explaining many of the empirical anomalies observed over the past few decades. The study is conducted to understand the factors which force investors to behave differently are & how these factors influence their post investment behavior. Based on the traditional finance perspective, investors are rational & act on the information available in the market which is a main pillar in their investment decisions. While behavioral finance looks at irrationality of the investors where they make their own analysis mainly based on personality traits or past behavior.

This study is an attempt to understand whether investors always follow traditional finance perspective or catch by their own beliefs or trial & error behavior. Behavioral finance proposes that investors follow Goals based investing where they try to meet important or basic needs first then move on towards aspirations.

Traditional Finance tends to think in terms of investment results in terms of percentage returns, statistical risk & many investors define their investing objectives quite differently (Behavioral Finance). Most of the time, they define them in terms of personal lifestyle objectives or Goals based investing. Reframing the investment process in terms of investor’s Goals can provide clearer picture of how investment decisions are related to different variables not captured by traditional finance.

Literature Review

In the literature of finance, Behavioral finance is a relatively new development. There are number of studies conducted by researchers where behavioral finance has been added with traditional analysis to assess the differences in the investment decision. The impacts, estimations & application of behavioral finance in investment decision making have been originated by academicians, but now it is fast growing in the practical field when analyst or portfolio managers construct the investor’s portfolio.

Kausar, Taffler (2005) focused on to explain market over & underreaction in both bad & good news & concluded that investors suffer from such behavioral biases as overconfidence, self attribution biases & representativeness, tested the impact of going concern announcement which reveals that investors take these things positive & start basing their decision on this good news in future as well even market is depicting or giving other information which may change their return expectations. By looking at Heuristic (Rule of Thumb) that good news will always bring positive returns clearly shows investor’s decision based on past behavior for which he is using as representative.

Shiller R. (2004) worked on underlying behavioral principles, which come primarily from Psychology & sociology, depicting that these personality traits do have important & profound effect on efficiency of the financial system but on the other hand concluded that traditional finance has shown over a period of time efficiency in the financial system. These behavioral traits impact the financial system & lead towards inefficiency because every investor has heterogeneous expectations & act on the investment based on the way the information received & in which condition that information is received (Frame Dependence).

Shefrin & Thaler (1988) have identified a process of Heuristic-driven bias in the investment process where people develop general principles as they find things out for themselves, they rely on heuristic (rule of thumb) to conclude or draw inference from information at their disposal, people are susceptible to particular errors because the heuristics they use are imperfect & people actually commit errors in particular situation. Representativeness is the heuristic process identified by which investors base expectations upon past experience, applying stereotypes. It can take many forms where any time investor bases expectations for the future on some past or current characteristic or measure, the individual is applying an “if-then” heuristic. That is “if this has happened, then that will happen.

Shefrin & Thaler (1988) have also concluded that investors when trapped by Heuristic-driven bias tend to become overconfident in their abilities to predict & start believing that they are better able to interpret the information & place greater confidence in their forecasting abilities. This overconfidence tends to systematically underestimate the risk inherent in the investment decision. Overconfidence leads investors to witness surprises sometimes positive & sometimes negative making the financial market inefficient based on their wrong forecasts because of their trap with overconfidence.

Biais et al. (2000) also revealed some interesting results suggesting that there is indeed a correlation between some of personality traits & judgment biases measured by psychology questionnaire & the behavior & performance of the subjects in the experimental trading game. This shows that investors when taking decisions sometimes ignore the traditional finance perspectives & start behaving as per their traits which make them involve in trading game to transact more in the hope to realize more profit. They tend to place more orders but they do not tend to place unprofitable orders more frequently. This trading game affects behavior which investors make as a base for future forecasting leading to sometimes misjudgment in properly forecasting the investment return.

Ricciardi & Simon (2000) have concluded that Standard finance is the centerpiece of the behavioral finance as behavioral finance involves different fields of study in consideration & there is an integration of fields in behavioral finance which makes it totally unique in the finance field. Ricardi & Simon (2000) have proposed that behavioral finance attempts to explain & increase the understanding of the reasoning pattern of investors including the emotional processes involved & the degree to which they influence the decision making process & explaining Why, What & how of finance & investing, from a human perspective. Ricardi & Simon (2000) have also proposed that psychological & social factors impact the decision making process of the investors & their reactions in different timings & different personality traits.

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