Today’s world is accompanied with several set of activities performed by so many business organizations. Financial crisis is the term which is used to divulge the mass loss in the nominal value of assets. Ideally it is consisted with banking crisis, currency crisis, speculative bubbles and international financial crisis. In this report we would be discussing how behavioral finance could be used to measure why people around the globe make irrational financial decision which results into emergence of financial crisis (Varoufakis, 2014, p24). There are other factors which have also been discussed such as role of behavioral finance in identifying the impact of financial crisis, bubbles of finance, behavioral explanation for anomalies and other key foundation and main principle in financial decision making. In the end of this report gracious advice has been divulged for the investors regarding how could they rationalize their investment in significant approach (Poe, 2016, p28). The Bertton woods system of monetary management provides rules for commercial and financial relations among several countries.
This financial crisis was the results of continue changes and uncertainty in economical factors such as volatility in price of commodity, currency and other stock market of international economy. In 1980 there was seen most of the bank and financial institutions failure due to increment in their Non-performing assets in their banking system (Bouchaud, and Challet, 2014, p, 133). It was urged due to high increment in loan to borrowers. The financial crisis was peaked in 2008 which has been still roiling all the persons in big recession. There are many economists offered several theories regarding how financial crisis develop and how it could be controlled in timely manner. There is no exact result, however, financial crisis consistently occur for the time being in force. Garcia, 2013 suggested that financial innovation could result into euphoria for a whole before destabilizing the economy and hurling into crises which results into great depression (Hockett, 2015, p55). However, the main depression in financial market around the globe emerges was due to high level of failure of banking system. Financial crisis was observed due to main failure of Basel II in determine standard market risk and capital reserve amount for banks. These crises were surged due to increment in the bubble of stock price NASDAQ stocks. There are several cases which resulted into loss of stocks and assets around the globe. The latest finical crisis was noticed since 2008 due to the major failure of banking and financial system around the globe (Fernandes, et al. 2014, p 77).
It is an investment theory whose purpose is to make maximum return out of given level of investment Modern finance represents the best possible ways regarding how capital market actually operate. On the other hand behavioral finance depicts how investors actually act at the time of investing their money. It could be said that modern finance is theoretical concept that attempts to divulge how capital market operate (Hirshleifer, 2015, p 22). In addition to this, it is also further observed that when the financial advisors make their decision based on certain factors may changed at the time when they deliver their report to investors for their decision making. However, modern finance could be helpful to forecast the trend of capital market in determined approach. It also observed that investor face loss in their investment if volatility in factors is happened. In addition to this, the major problem in modern finance is that investors making their investing decision based on modern finance make it on the basis of assumption which may result into falsified facts and can be changed due to uncertain economical factors. In many cases there are several swings which result into invalidation of assumption made in modern finance. Modern finance has several major drawbacks but due to its availability to all investors it does not help investors to make effective return out of their investment (Hirshleifer, 2015, p59).
It is the details or database which is to be gathered by each and every investors or it could be said that it is a price or rate of return distortion on financial market that seem to be against the efficient market hypothesis (Statman, 2014, p44). There is no way easy way for the investors to beat the market. Market anomalies can appear, disappear and re- appear without any prior warning to investors. Nonetheless, by knowing these market anomalies investors could easily make shield against negative factors through by investors. There are several market anomalies which are given as below (Fernandes et al., 2014, p122). It is analyzed by evaluating market anomalies that small firm outperform as compare to big multinational firm. It is assumed that small companies tend to perform better as compare to other big firms. As per the perception of Miller, et al. 2010, p45 it could be bifurcated with clear example that Microsoft has to earn $ 6 billion amount for 10% growth rate on yearly basis. On the other hand small company in same field need only $ 70 million amount for the same growth rate After than stock market anomalies could be measured with January effects it is the most common effects which are known to almost all the investors that if a company underperforms in the fourth quarter of prior year then it would eventually outperform in next year (Poe, 2016 p29). According to Maio, and Santa-Clara, 2016, p27 it is reflected that turnover of multinational companies such as Wesfarmers, Tesla and ITC are tend to follow same effects of earning what they had in the last quarter of year end.
Stock market anomalies could also be analyzed by evaluating Low book value of companies in market throughout the time. As per the perception of Collins, and 2000, p26 it is the market anomalies that stock with below average price to book ratio tend to outperform the market without any problems. It is further observed that company depicting less return but at the same time increasing its market value of shares tends to reveal high amount of return to investors (Fernandes et al. 2014, p37).
Other factor of market anomalies is reversal. As per the data collected by Rodriguez et al. 2014, p78 it is reflected that company showcasing negative results in one year will generate profit in next year. It is observed that reversal is completely true for the underperformer stocks. In addition to this, days of weeks in market anomalies provides that stocks and their prices tend to be gone upward on Friday than Monday. It is evaluated that there is bias tend toward the changes in stock price on Friday (Hockett, 2014, p65). The same tend could be seen with the help of image given as below. Then dogs of dow provides an instance of danger of trading. It is observed that investors could beat tend of market by electing stocks in Dow Jones industrial average which have certain value intents (Coleman, 2014, p77).
(Simon, 2016, p1)
It stands for those stocks with low PE ratio based on large risk and providing less return. It is evaluated that companies with low price to earnings are undervalued and vice versa. Stock market anomalies throughout the time could be changed on the basis of price to earnings ratio anomalies dividend yield anomalies, overreaction anomalies and ex dividend date anomalies.
It integrates and sum up with psychology and economy in finance theory. Throughout the time investors are using behavioral finance in their corporate finance decisions. Behavioral finance has taken two distinct paths. First part is connected with investors are less than rational investors and investment decision is made based on responses of investors in the market. Sometime investors and mangers in the organizations make their investment decision based on the sentiments, issues in market and set standard. It is further observed by the investors in their behavioral finance that if one company is making profit since last two years then it would be believed that in next year there will be same trend in the return earning capacity of organization. Rational managers and investors believe that capital structure of organization is completely based on the past earning capacity of organization (Endres, and Rogers, 2014, p78). The key foundation of behavioral finance is that technical analysis assumes that investors act rationally in their investment decision making. In addition, it is further evaluated that investors are more tend to make their investment decision based on most recent news which results into drastic changes on a security prices (Preis, et al., 2013, p89).
A stock market bubble could be describe as a type of bubble which take place in stock market when market participants stock price above their value in relation to some system of stock valuation. Behavioral finance is accompanied with stock market bubbles to cognitive bias which results into collective thinking and herd behavior of investors bubbles are the viability of certain factors which not only occurs in real market but also put impact on highly predictable market. In order to identify stock bubble needs to evaluate from non-sustainable ups and downs of market. These could be defined as speculative bubbles when the price of factors does not equal to its market fundamental for a determined period of time. These bubbles help corporate to raise capital from the market in easy and determined approach (Huang, et al., 2016, p122). Market bubbles frequently produce hot markets in initial public offers issued by corporation around the globe. Throughout the time, there are several ways of bubbles which could be explained by its separate financial crisis in particular time period. These are the biggest reasons in the fluctuation of share prices of companies around the globe.
|
First wave bubble |
Happened after 1971 in Latin America results into dollarization crises in all 13 Latin America countries |
|
Second wave bubble |
It is related with equity bubble in Japan and Scandinavia happened due to financial de- regulation. |
|
Third wave bubble |
It is developed due to Asian crisis arised from strong reduction in the value of currency |
|
Four wave bubble |
It is aroused in US because of downfall in real estate business. |
|
Biggest bubble |
It is recent one Bubble which is aroused due to global financial crisis in 2008 |
This is related with random effect which is aroused due to random changes in stock prices. On the other hand herd behavior in financial decision making describes how individual collectively can act without centralized direction. Herding depicts that if in the market some of the investors are making investment in certain particular areas then other investors would do the same thing. Herding could be described as complete process which results into overvaluation of stock price due to high level of investment in particular stock price of stocks. On the other hand momentum could be evaluated as a strength and weakness in the issue’s price. It provides a critical measure to evaluate the changes and other velocity in the price of stocks. It could be computed by measuring changes in price during the certain period of time. However, momentum could be taken as far more useful in case of when market is rising but in case of market is falling it is kept unusual. In order to construct a 10 days momentum line, a simple way of subtracting 10 days momentum line in closing price could be used by investors (Ricciardi, 2017, p34).
These changes are also called Minsky Moments. In this it is analyzed that when over indebted investors are forced to sell of their investment to make good loss from their assets. It is observed in behavioral finance that good news related with the company if disclosed then it would result into increment or surge in the price of stocks and if bad news related with particular company performance then it would results into decrease in price of shares of company. Oftentimes, participants in the stock market overact to new information which results into changes in the stock prices (Cebula et al., 2016, p133). However, these price changes are not certain or permanent in nature and erodes over the time. These changes arouse due t o fundamental uncertainty which cannot be quantified. Overreaction of clients results into changes in price and it would be predictable that price of stock will changes accordingly. However, to measure the exact amount of change in share price are hard to measure in behavioral finance. This reaction could be described with the help of real example if we see the accident on road it will result into changes in our car driving skills but this will happen for the certain time period and over the time we will make be back to our normal habit of driving car. In order to evaluate the over and under reaction in behavioral finance capital assets pricing model could be used (Preis et al., 2013, p89).
These are the persons who increase the price of selected shares by creating market of selling and purchasing of determined shares with a view to increase the demand and price of scriptures in market. However, market makers do this kind of activities with a view to create a fictitious market in case when market is illiquid and spread widen. These strategies are agent based plans aim to replicate several strategies to create fictitious market plan such as mean reverting traders, noise traders, buy and hold traders.
If market is considered then it would be deemed that there will be less trading of stocks. As per the market index it is found that only 5% of stocks in market are traded monthly overtrading.
It is evaluated that market volatility is much higher than prediction made for cash inflows of business. These trading are done by fictitious persons to increase the market price of stocks in market. Trading histories of 60000 US investors are taken into consideration to divulge that investors had annual average turnover of 11.4% from the market in spite of several market anomalies and stock bubbles.
Role of credit
By considering market factors and consistent changes in stock bubbles it is analyzed that increment of credit in market result into high inflation and increase in stock prices of corporations. In addition to this, in case of trade deficit, collapse Bretton Woods there is seen high decrement in share prices.
Securitization process system
In addition to this in order to fight with these market bubbles some company use securitization process. It is ideally a process system which is used to sell securities on the basis of underlying assets in company. Ideally all the mania in stocks are accompanied with rapid growth in supply of credit. However, all the changes in market could be linked in positive manner if growth in credit of organization is related with genuine economic growth. It helps banks to move off its underlying assets to sell of scriptures in market. These are similar to syndicated loans used by banks and financial institutions for providing credit to corporations.
A lender of last resort is ideally used by banks to lend money to borrowers on the basis of any sort of securities. This policy is last resort used by banks to make effective use of resources in high stock bubble situations.
There are several anomalies which could be used to describe behavioral explanations in financial decision making such as January Effects, the winner curse, equity premium puzzle and further more (Hirshleifer, 2015, p119).
This provides that if a company has outperformed in the fourth quarter of previous year then in January their income will be higher than its previous month. It is predicted on the basis of investor’s decision making strategies (Pandey et al., 2014, p122).
It is rationally evaluated that all the investors and other economics are aware about true value of assets of company in which they invest accordingly. It could be understood with the example that if there is sale of one house in the market then it would be presumed that all the bidders are aware of true value of house and if bidder is in aggressive mood and having curse of winning the he would end up with paying overvalue (Bouchaud and Challet, 2014, p176).
It is presumed at investors who are ready to take high risk will be compensated with the high return on their investment amount (Drezner and McNamara, 201, p122). Ideally it is evaluated that joint ventures or highly net worth investors are more likely to take risk for their investment amount. On the other hand retail investors would indulge in safe investment plan which results into low return on their investment (Baucells et al., 2016, p16).
Behavioral corporate finance is related with the financing decision making in the corporate world by the managers or investors in determined approach (Shefrin, 2011, p24). Behavioral corporate finance is accompanied with psychological and economic into human decision making under the conditions of uncertainty. Behavioral corporate finance provides that corporations are the natural arbitrageurs (Preis et al., 201, p33). It is assumed that if market is providing positive indication then CEO or mangers of the company would result into issuance of new shares in the market. It will help corporation to raise money from the market. On the other part if the market prediction is divulging negative sign then it would result into no strategically decision in financial areas (Coricelli and Bicaba, 2015, p44). (Behavioral finance research indicates that traditional idea of corporate governance would result into simplest way (Cooper, 2014, p44). It is presumed that CEO of the company has to look beyond the normal available information so that company could make changes in its business function for achieving determined tasks. Theories of Behavioral corporate finance are used to divulge the difference between capital structure and corporate financial policies. Mangers and investors should develop their business plan by making good return out of their investment in mispricing in capital (Altman, 2015, p33).
In this report various facts has been taken into consideration which provides the true value of Behavioral finance and its various core intent in investment decision making. It is evaluated that all the investors are tend to follow each and everyone’s investment decision. It is highly understood that capital market is not only based on the performance of company but there are several other factors such as sudden changes in investor’s sentiments, government policies, disclosure of insider’s information (Statman, 2014, p59). It is further observed that investment decision of investors should not only base on the available information but also they should indulge in using critical evaluation of all the required factors. (Huang, et al., 2016, p 22). Investors should evaluate all the possible opportunity for their investment purpose and at the end most appropriate investment decision should be based on the mixture of Behavioral corporate finance and modern finance. Both theories depict the trend of corporate and help investors to make investment in determined securities. However, investor should make mixture of both theories by using financial tools such as ratio, financial analysis, CAPM model and Behavioral finance for evaluating market sentiments (Dung, 2016, p56).
Conclusion:
Now in the end it would be said that investors should be rational in their investment plan and in order to earn profit they should not indulge in following one theory but a system analysis of both theories should be implement for their investment plan. It would be inferred that changes in the stock price or trend in market is not based on the information divulged in the market but it is occurred due to the behavioral changes of investors after considering sudden disclosed information (Shafir, 2013)
References:
Altman, M., 2015. Handbook of contemporary behavioral economics: foundations and developments. Routledge.
Baucells, M., Osadchiy, N. and Ovchinnikov, A., 2016.Behavioral anomalies in consumer wait-or-buy decisions and their implications for markdown management. Operations Research.
Bouchaud, J. and Challet, D., 2014. Behavioral finance and financial markets: Arbitrage techniques, exuberant behaviors and volatility. Opinion etdébats, 7, pp.20-35.
Cebula, R.J., Cebula, R.J., Rossi, F., Rossi, F., Dajci, F., Dajci, F., Foley, M. and Foley, M., 2016. Financial market determinants of the real cost of funds to public corporations in the US: 2SLS and GMM findings. Journal of Financial Economic Policy, 8(1), pp.2-12.
Coeurdacier, N. and Rey, H., 2013. Home bias in open economy financial macroeconomics. Journal of Economic Literature, 51(1), pp.63-115.
Coleman, L., 2014. Why finance theory fails to survive contact with the real world: a fund manager perspective. Critical Perspectives on Accounting, 25(3), pp.226-236.
Cooper, R.N., 2014. The Bretton Woods Transcripts. Journal of Economic Literature, 52(1), pp.234-236.
Coricelli, F., and Bicaba, Z. 2015. Learning to open up: Capital account liberalizations in the post-Bretton Woods era (No. halshs-01267264).HAL.
Drezner, D.W. and McNamara, K.R., 2013. International political economy, global financial orders and the 2008 financial crisis. Perspectives on Politics, 11(01), pp.155-166.
Dung, N.V., 2016. Value-relevance of financial statement information: A flexible application of modern theories to the Vietnamese stock market. Quarterly Journal of Economics, 84, pp.488-500.
Endres, A.M. and Rogers, A.J., 2014. Trade policy and international finance in the Bretton Woods era: a doctrinal perspective with reference to Australia and New Zealand. History of Economics Review, 59(1), pp.62-81.
Fernandes, D., Lynch Jr, J.G. and Netemeyer, R.G., 2014. Financial literacy, financial education, and downstream financial behaviors. Management Science, 60(8), pp.1861-1883.
Garcia, M. J. R. 2013. Financial education and behavioral finance: new insights into the role of information in financial decisions. Journal of Economic Surveys, 27(2), 297-315.
Hirshleifer, D. 2015. Behavioral finance. Annual Review of Financial Economics, 7, 133-159.
Hockett, R.C., 2014. Materializing Citizenship: Finance in a Producers’ Republic.
Hockett, R.C., 2015. Pre-Liberal Autonomy and Post-Liberal Finance.
Huang, J.Y., Shieh, J.C. and Kao, Y.C., 2016. Starting points for a new researcher in behavioral finance. International Journal of Managerial Finance, 12(1), pp.92-103..
Pandey, D.K., Bhatt, S., Jindal, A. and Gautam, B., 2014. Effect of combination of ketanserin and escitalopram on behavioral anomalies after olfactory bulbectomy: Prediction of quick onset of antidepressant action. Indian journal of pharmacology, 46(6), p.639.
Poe, G.L., 2016. Behavioral Anomalies in Contingent Values and Actual Choices. Agricultural and Resource Economics Review, 45(02), pp.246-269.
Preis, T., Moat, H.S. and Stanley, H.E., 2013. Quantifying trading behavior in financial markets using Google Trends. Lerner, J.S., Li, Y., Valdesolo, P. and Kassam, K.S., 2015. Emotion and decision making. Annual Review of Psychology, 66, pp.799-823.
Ricciardi, V., 2017. The Role of Group Psychology in Behavioural Finance: A Research Starting Point for Banking, Economic, and Financial Historians. In Decision Taking, Confidence and Risk Management in Banks from Early Modernity to the 20th Century (pp. 269-292).Springer International Publishing.
Rodriguez, E., Aguilar-Cornejo, M., Femat, R. and Alvarez-Ramirez, J., 2014. US stock market efficiency over weekly, monthly, quarterly and yearly time scales. Physica A: Statistical Mechanics and its Applications, 413, pp.554-564.
Shafir, E. ed., 2013. The behavioral foundations of public policy.Princeton University Press.
Shefrin, H. 2011. Behavioral corporate finance
Simon, M. 2016, 5 unprecedented stock-market anomalies teach investors a lesson, TRADING DECK, online available at < https://www.marketwatch.com/story/5-unprecedented-stock-market-anomalies-teach-investors-a-lesson-2016-06-17> accessed on 23/07/2017
Statman, M., 2014. Behavioral finance: Finance with normal people. Borsa Istanbul Review, 14(2), pp.65-73.
Varoufakis, Y. 2014. UNITED STATES MONETARY POLICY IN THE POST-BRETTON WOODS ERA Did it cause the Crash of 2008? (No. wpaper50).
Collins, D.W. and Hribar, P., 2000. Earnings-based and accrual-based market anomalies: one effect or two?. Journal of Accounting and Economics, 29(1), pp.101-123.
Maio, P.F. and Santa-Clara, P., 2016. Short-term interest rates and stock market anomalies.
Essay Writing Service Features
Our Experience
No matter how complex your assignment is, we can find the right professional for your specific task. Contact Essay is an essay writing company that hires only the smartest minds to help you with your projects. Our expertise allows us to provide students with high-quality academic writing, editing & proofreading services.
Free Features
Free revision policy
$10Free bibliography & reference
$8Free title page
$8Free formatting
$8How Our Essay Writing Service Works
First, you will need to complete an order form. It's not difficult but, in case there is anything you find not to be clear, you may always call us so that we can guide you through it. On the order form, you will need to include some basic information concerning your order: subject, topic, number of pages, etc. We also encourage our clients to upload any relevant information or sources that will help.
Complete the order form
Once we have all the information and instructions that we need, we select the most suitable writer for your assignment. While everything seems to be clear, the writer, who has complete knowledge of the subject, may need clarification from you. It is at that point that you would receive a call or email from us.
Writer’s assignment
As soon as the writer has finished, it will be delivered both to the website and to your email address so that you will not miss it. If your deadline is close at hand, we will place a call to you to make sure that you receive the paper on time.
Completing the order and download