Influences of Behavioural Finance
What contribution can behavioural finance make to the explanation of stock market bubbles and crashes?
Introduction
Efficient markets hypothesis markets can adjust by themselves, because there are rational and irrational investors. But stock bubbles and crashes just like evils followed the world global economy in last decades.
Readhead (2008) suggested that behavioural finance applies the psychology of decision-making to investment behaviour, and it can be useful to show the irrational behaviour of the investors causes the stock bubbles and crashes.
Readhead (2008) listed some systematic distortions that can be used to explain stock bubbles and crashes by behavioural finance method. They are representativeness, narrow framing, overconfidence, familiarity and celebrity status. In this essay, I will try to understand that how these factors influence the stock markets.
Representativeness and narrow framing
In this part, I will focus on representativeness, and then study the knowledge about narrow framing.
Redhead (2008) believed that representativeness can be helpful to explain the investors to follow the market, and those behaviours of the investors can lead to stock market prices anomalies. Redhead (2008) also pointed out that there are two interpretations of the representativeness. First interpretation is that recent prices movements are the representativeness. Secondly, representativeness also can be seen as that people will think about the patterns and tends. One mental shortcut, the representativeness bias, involves overreliance on stereotypes (Shefrin, 2005) . Grether (1980) and Kahneman and Tversky(1973, 1974) said that representativeness would cause the investors to play against the Bayes’s rules.
In stock markets, recent market prices become the representatives that help to explain the phenomenon for investors to chase the market. In fact, the representativeness heuristic showed us that people trust the movement of the market prices
Introduction
Efficient markets hypothesis markets can adjust by themselves, because there are rational and irrational investors. But stock bubbles and crashes just like evils followed the world global economy in last decades.
Readhead (2008) suggested that behavioural finance applies the psychology of decision-making to investment behaviour, and it can be useful to show the irrational behaviour of the investors causes the stock bubbles and crashes.
Readhead (2008) listed some systematic distortions that can be used to explain stock bubbles and crashes by behavioural finance method. They are representativeness, narrow framing, overconfidence, familiarity and celebrity status. In this essay, I will try to understand that how these factors influence the stock markets.
Representativeness and narrow framing
In this part, I will focus on representativeness, and then study the knowledge about narrow framing.
Redhead (2008) believed that representativeness can be helpful to explain the investors to follow the market, and those behaviours of the investors can lead to stock market prices anomalies. Redhead (2008) also pointed out that there are two interpretations of the representativeness. First interpretation is that recent prices movements are the representativeness. Secondly, representativeness also can be seen as that people will think about the patterns and tends. One mental shortcut, the representativeness bias, involves overreliance on stereotypes (Shefrin, 2005) . Grether (1980) and Kahneman and Tversky(1973, 1974) said that representativeness would cause the investors to play against the Bayes’s rules.
In stock markets, recent market prices become the representatives that help to explain the phenomenon for investors to chase the market. In fact, the representativeness heuristic showed us that people trust the movement of the market prices