Progress Report on Behavioral Finance and the Psychology of Financial Decisions

The core objective of the assignment was to explore a case issue on the aspects of behavioral finance and the psychology of financial decision. The case scenario was based on Shefrain Consulting where I was to explore the issue using the gained knowledge from the course as an associate consultant. The first step was a discussion on the difference between prospect theories and expected utility theory. Exploring this question helped me in attaining varied knowledge on the behavioral finance theories. Understanding the aspects of prospect theory from the case scenario illustrates the use of perceived gains among investors, as losses are likely to cause greater emotional influence. 

Through this, an investor will emphasize more on the gains of the investment rather than the loss where the decisions will lay on the gains from the investment. My plan for this section was to analyze the key differences between prospect theories and expected utility theory. Explained in simple terms, in the prospect theory an individual makes the decision whether to invest or not based on the reference point before ranking it as a loss or gain while in expected utility theory, an investor makes a decision based on the outcome.

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The second phase of my progress is bias identification from the provided case study. I have identified three behavioral concepts – confirmation bias, hindsight bias, and illusion control bias. I was able to explore every bias and its impact on Jojo’s case and the impact that each bias had on their decisions on investment. Maxwell et al. (2011) was a great source that helped me to analyze the issues of confirmation bias, which helped me understand the impact of the failure of anticipating the impact of losses in the future. 

There is the aspect of hindsight bias where I understand that the future is not predictable. Predicting the future is likely to cause tremendous financial decisions. For example, in the case scenario, the investor was overconfident of his large position in Omega Corporation without discerning the unrealized loss following the reduced stock price. I learned several concepts from Roese and Vohs (2012) a reference that was of significance in understanding the elements of hindsight bias. The third behavioral finance concept learned from this study was the illusion control bias. The source by Yarritu, Matute, and Vadillo (2014) was a great source in exploring the aspects and impact of over-optimism and overconfidence to financial decisions. This is what causes an illusion bias in an investor’s mind where they get the notion that they are controlling the incidents. 

My core goal for the assignment was to understand the aspects of behavioral finance and the psychology of financial decision. Over the past week, I can attest that I have gained knowledge on the different aspects of behavioral finance and the psychology of the financial decision, which I can apply both in my financial and investment decisions, as well as in assisting other investors. The case scenario has helped to understand that investor is not always rational, have limited self-control, and biases influence their financial decisions. Although I have positivity with what I have learned from the two parts of the assignment, there have been challenges and pitfalls. For example, although it was easy to explore the aspects of biases in behavioral finance, it was challenging to select the biases that suit the case scenario. However, with deep researching, I was able to choose and I believe with more studying it will be easy.

References

Baker, M., & Wurgler, J. (2013). Behavioral corporate finance: An updated survey. In Handbook of the Economics of Finance (Vol. 2, pp. 357-424). Elsevier.

Kahneman, D., & Tversky, A. (2013). Prospect theory: An analysis of decision under risk. In Handbook of the fundamentals of financial decision making: Part I (pp. 99-127).

Maxwell, A. L., Jeffrey, S. A., & Lévesque, M. (2011). Business angel early-stage decision making. Journal of Business Venturing, 26(2), 212-225

Roese, N. J., & Vohs, K. D. (2012). Hindsight bias. Perspectives on psychological science, 7(5), 411-426.

Yarritu, I., Matute, H., & Vadillo, M. A. (2014). The illusion of control. Experimental psychology.

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