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11
Aug
2010
I take investment and finance as a behavior

Since I have been associated with Investment & Financial research the most stunning horizon of study for me is behavioral finance. Even behavioral finance and its research is rare to find in countries like Pakistan but somewhere market participants follow a standardize set of psychology while making investment decision in a given time and premise. If you are capable to pick the said psychology so it is highly probable that you can lead the market as analyst and investor.

What I can say about behavioral finance? In our part of the world people think financial stream of study as a mere number game. In my view Finance & Investment is really an interesting area of research where you have everything that can make a difference. We can take all discipline of Management Sciences and Social Sciences in account while studying Investment and Finance.

It was right from 1896 [when Gustave le Bon wrote The Crowd; A Study of the Popular Mind] to 2009 [when Harrison and Rutstrom proposed a reconciliation of expected utility theory and prospect theory by using a mixture model] that behavioral studies in finance and investment have been gaining their reputation as core studies that govern markets, business units and their participants.

Indeed I can not go ahead without acknowledging the contribution of Gilovich Grin & Kaheman [2003] that edited Heuristics & Biases: The Psychology of initiated Judgments. It was a benchmark book that consists of the most influential research on Heuristics & Biases by Kahneman, Slovic & Tversky in 1982. Then in 2003 Barberis & Thaler published a survey on behavioral finance. There are many more that I can quote to show how dynamic and worthy behavioral finance is!

After spending a short but professionally diversified career in finance & investment for last five years I think finance and investments are now more a behavior for me. I always like our generation and generations to come to research it in the aspect of psychology or behavior rather than thinking it a mere number game. You can not make it management by putting management as a space distant suffix. Management shall come from proper planning of events and to plan events we need to jot down probable behaviors of markets, participants and finance.

Sometimes people just see the results that stock markets posts. They just talk about numbers on indices screens, stock prices or other market data. I know all those are important but they only address market and instruments. The tag that very few post is SEE WHO IS INVESTING! Even many says that it is the behavior of market but I emphases more on participant’s behavior distinct from behavior of market in totality.

It is really interesting that Karachi Stock Exchange is one of the best exchanges of the decade [1999 – 2009]. If someone invested $100 in KSE on Dec 31 1999 had $900 plus in his tally on Dec 31 2009 [Average Market Return]. Even in this scenario if you conduct a survey so you will find a very interesting fact that majority of the investors in KSE have been losers. There have been few that earns and made this average of $900 plus.

In stock markets everything is offsetting. The rupee an investor loose is a gain of some other market participant. So why some people loose in an attractive market while few makes money. If market is same means available variables have same volatility & opportunities for everyone so why one investor end up crying and one jumps with joy. These behaviors in consequences have some behaviors that cause it.

The point is simple that some investors are risk takers and some are risk averse, some investors are information-wise efficient while others consider it a jackpot or lottery ticket. The one who exposes his weakness become an opportunity for the sharper participants of the market.

In my view the environment of market and total challenge is equal for everyone on unitary investment. It is basically people’s instincts, behaviors, traits and knowledge that is different. If I would be able to understand people’s psychology and behavioral instincts so I can forecast their decisions in specific investment environment. Once I would be able to know that what they are going to do so I can easily explore opportunity for me in this because I shall become information efficient.

To understand it in a lay man’s language I want to quote an understandable example i.e. I have two boys of equal age, color & weight but one is fearless [boy A] and the other one is always surrounded by fears and apprehensions [boy B]. Now if I have house in my lane that is known as haunted and I offer Rs 10,000 for the one who jumped and stay in that house for 10 minutes. The most probable is that Boy A shall jump in it and win the money.

Now if I raise prize money to jump in an haunted house to Rs 100,000 so even it is highly probable that Boy A shall jump but here I can say that it can make Boy B thinks even how fearful he is. And if I raise the prize to Rs 100 billion so I am sure that both boys shall not jump in it because they can better understand that I can not arrange that money and I am merely fooling them.

The above instance merely suggests that my analysis of both boys are not based on the haunted house neither what money I am offering them as a prize. My analysis is purely based on the learning of behaviors & psychology of both boys. The same way we can analyze investors and participants of financial & investment system in connection to financial instruments, opportunities and markets. Then we can also analyze the behavior of other elements in the market like costs & rates etc. i.e. also responsive of participant’s actions or constraints.

I am actually conducting a formal research on this discipline so I can not explore technical stuff until I shall conclude my research. Surely that research is highly sophisticated and a lot of application of sophisticated research tools is involved. But my basic objective of writing this post is to induce new entrants in financial and investment research/profession towards behavioral finance. It is indeed a need of time. Even I suggest Business Schools in the country to offer it as a subject and specialization. In addition business schools in Pakistan have to rephrase their curriculum of Finance. They need to integrate finance with research, strategy & logic science. They have to come out of the perception that finance is merely calculation. It is a science that is far beyond in its scope.

Even industry is a bit premature to understand that Accountants are not finance & investment managers. The way finance & investment posts are handing over to CA, CMA or ACCA is nothing but merely a show of corporate irrationality. The corporate sector has to make their house in order and they need to understand the role of behavioral finance and core financial decisions distinct from accountancy. It is the call of time and we need more understanding on core fields of business in their true totality.


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Soul Skinner Says:

I totally agree that investment decisions are correlated with behavioral sciences and I must thank you for exposing finance in such a unique way that has not been thought by me or by many corporate leaders. As you correctly mentioned that CA’s and other accountants handling corporate finance show irrationality and I will like to add to this point of yours that this has actually created some misleading sentiment among many finance students (mba and bs) who perceive that their way to the top level of hierarchy in an organization is blocked by CA’s as they are the heads of Finance department. Do you agree to this view? And have you witnessed this situation in Pakistan? Second thing is that most of our investors are looking for a good return in relatively short time span and this shows their irrationality or lack of financial knowledge. I presume the giants of stock market in Pakistan take advantage of this lack of information of investors and trigger fake crisis and make investors penniless. As a result I am jumping to a premature conclusion that the Boys of your hypothetical example might actually jump into the haunted house for a lucrative return that they think they will earn (which is in real not possible).what is your opinion? Nevertheless I feel that the behavioral finance will obviously answer the sentiments of Pakistani investors and I am looking forward towards your findings in this field.


12 - September - 2010 04:09:27 PM

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Mr. Omer

Mr. Omer [1982 born] started  his professional career as a commercial / investment banker after achieving Gold Medal in Finance at master level from University of Karachi in 2006.

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