Investment Funds in Canada (IFIC) -
Chapter 5 with verified solutions
Behavioral Finance
A field of study that combines psychology and economics to explain why and how investors act and how
that behaviour affects financial markets.
It is commonly defined as the application of psychology to understand human behavior in finance or
investing.
Standard Finance
Is characterized by how individuals make investment decisions
January Effect
Where stocks in general, and small stocks in particular, move abnormally higher during the month of
January, that demonstrate that human behaviour influences securities prices and markets.
Behavioural Finance vs. Standard Finance
- Theories from behavioural finance suggest that investors:
> Can be risk averse or risk seeking, depending on the situation
> Can act irrationally, thus creating market opportunities.
- Standard theories of finance and investing assume that investors are:
, > Risk averse
> Rational in their decision making abilities
The difference between Behavioural Finance and Standard Finance
Standard finance is characterized by rules about how investors should behave rather than by principles
describing how they actually behave. Behavioural finance, in contrast, identifies with and learns from
human behaviour that individual investors demonstrate in financial markets.
Behavioral Biases
are defined as systematic errors in financial judgment or imperfections in the perception of economic
reality.
What are the 2 categories of behavioral biases?
Behavioural biases fall into 2 broad categories, cognitive and emotional, with both yielding irrational
judgments.
> Cognitive biases - result from subconscious mental procedures for processing information.
> Emotional biases - originate from impulse or intuition.
Chapter 5 with verified solutions
Behavioral Finance
A field of study that combines psychology and economics to explain why and how investors act and how
that behaviour affects financial markets.
It is commonly defined as the application of psychology to understand human behavior in finance or
investing.
Standard Finance
Is characterized by how individuals make investment decisions
January Effect
Where stocks in general, and small stocks in particular, move abnormally higher during the month of
January, that demonstrate that human behaviour influences securities prices and markets.
Behavioural Finance vs. Standard Finance
- Theories from behavioural finance suggest that investors:
> Can be risk averse or risk seeking, depending on the situation
> Can act irrationally, thus creating market opportunities.
- Standard theories of finance and investing assume that investors are:
, > Risk averse
> Rational in their decision making abilities
The difference between Behavioural Finance and Standard Finance
Standard finance is characterized by rules about how investors should behave rather than by principles
describing how they actually behave. Behavioural finance, in contrast, identifies with and learns from
human behaviour that individual investors demonstrate in financial markets.
Behavioral Biases
are defined as systematic errors in financial judgment or imperfections in the perception of economic
reality.
What are the 2 categories of behavioral biases?
Behavioural biases fall into 2 broad categories, cognitive and emotional, with both yielding irrational
judgments.
> Cognitive biases - result from subconscious mental procedures for processing information.
> Emotional biases - originate from impulse or intuition.
