Traditional Financing Is Restrictive

Published Date: 02 Nov 2017

Introduction

Traditional financing is restrictive, explains how investors should act according to mathematical models and theories. Behavioral finance, on the other hand, is descriptive, attempting to explain the decision making process of investors observed, which clearly is not fully explained by traditional financing.

Traditional finance theory based on utility, which in turn makes individual decisions based on all available information, including the latest changes in price and volume, as well as business, market and investment specific information. For example, in the theory of capital markets, individuals that create an efficient frontier with expected returns, standard deviations and covariances investments.

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Behavioral finance assumes investors hold any provision of normal prejudices and traditional economy with the investment decision. Although it is recommended that investors should make a decision that tends to explain why they make the decisions they take.

Behavioral Finance recognizes that investors' decisions, individually and collectively, are affected by the lack of perfect information and the inability to interpret and evaluate information in an unbiased manner. In other words, investors have bounded rationality. Bounded rationality means that people who act as rationally as possible, while they are limited by lack of knowledge (not all available data), and lack of cognitive ability, does not have the processing power needed to interpret and put a price on information.

Rational investors

Completeness, transitivity, independence and continuity: To a utility rational investor to make decisions that maximize the benefits of the four axioms.

Completeness: Selection and preferences known. The individual is aware of all the options available and can assess and assign individual preferences, so that between two choices, everyone prefers one over the other, or is indifferent between them.

Transitivity: Rankings are applied consistently. If the investor prefers choice X to choice Y and prefers choice Y to choice Z, the investor will prefer choice X to choice Z.

3. Independence: Utilities are additive and divisible. Add choice of Z to X and Y will not affect the preference ranking of X and Y. If, for example, the investor takes X to Y and Z, we add these two options, the investor takes (X + Z) (Y + Z). Addition, under the assumption that the investor X preferably Y if part p, Z, x and y are not preferred by the investor ranking changes will be added. The investor takes (X + pZ) to (Y + pZ). The classification is based on the size of the part, the decisions are not independent.

Continuity: Indifference curve is smooth and complete. Suppose there are three choices, L, M and N, so that investors tend to be L, M & N must have a combination of L and N (parts a and b), so that investors no difference (AL + NL) and M This ensures that the indifference curve is complete (ie, continuous).

Behavioral finance can be divided into two categories:

Micro

Macro

Micro behavioral finance is concerned with describing the decision-making processes of individuals. It attempts to explain why individuals deviate from traditional finance theory.

Macro behavioral finance focuses on explaining how and why markets deviate from what we would term efficient in traditional finance.

Four behavioral finance models for investment decision making and portfolio construction are as follows:

(1) Consumption and savings,

(2) Behavioral asset pricing,

(3) Behavioral portfolio theory, and

(4) The adaptive markets hypothesis.

Consumption and savings model assumes investors framing, with self-control and mental accounting. Because of the lack of self-control, they can not maximize the balance between power consumption and long-term planning. Mental accounting is caused by a context and should be an optimal portfolio, but may also lead to the protection of certain assets in consumption. Asset pricing model gives a premium feel of the discount rate is the return on an asset is the risk-free rate plus a risk premium key, along with a premium feel.

Behavioral portfolio theory (BPT) shows how investors structure their portfolios in layers depending on their objectives. The composition of each layer depends on the importance of goals, performance requirements, the utility function of the investor, the investor access to information and the loss aversion of investors. Investors seeking a minimum position before assigning protected in riskier assets.

The adaptive markets hypothesis leads to five important conclusions:

1. Investors make decisions to help them survive rather than to maximize utility.

2. Investors must adapt to survive.

3. No investment strategy can continually outperform.

4. Risk premiums will vary depending on investors' perceptions of an aversion to risk.

5. Assets can be temporarily mispriced, allowing active management to capture excess returns.

Risk Aversion, Risk Neutrality, and Risk Seeking

Risk aversion (rational) investors always try to maximize the expected return for a given level of risk. Given two options with the same expected return but different risk levels (ie, different standard deviations), the risk-averse investors will choose the alternative with less risk. A risk neutral investor, on the other hand, would be indifferent between the two alternatives, and the risk-seeking investors prefer (to increase profitability) risky alternative.

Cognitive Biases

Cognitive psychologists have documented many patterns regarding how people behave.

Some of these patterns are as follows:

Heuristics

Heuristics, or rules of thumb to make decisions easier. But they can sometimes lead

to move, especially when things change. These decisions can lead to sub-optimal investment. When faced with the choice of N on how to invest for retirement, many people set off by the rule 1 / N. If there are three funds, one third goes to each. If both private equity funds, two-thirds goes into effect. If one of the three equity fund, the third goes into effect. Recently, Benartzi and Thaler (2001) have shown that many people follow the rule of 1 / N.

Overconfidence

People are overconfident in their abilities. Entrepreneurs are especially likely

Overconfidence. Overconfidence manifests itself in a number of ways. An example of too little scattering is due to a tendency to over invest in what we know. So people to invest in local businesses, even if it is not good in terms of diversification, is because their assets (the house they own) is connected to the company's fortunes. You think. To employees of the auto industry in Detroit, the employees of the construction industry in Hong Kong or Tokyo or hardware engineers in Silicon Valley Too many people invest in the stock of the company for which they work. Men tend to be more measured than in women. This manifests itself in several ways, including the commercial behavior. Barber and Odean (2001) recently, the business of

People with a discount brokerage account. They found that the more people trade, the worse they did on average. And men have more and worse than investors has changed, women.

Mental Accounting

People sometimes separate decisions should be combined in principle. for

For example, many people have a household budget for groceries and household expenses for entertaining. At home, where the food budget is now, they do not eat lobster or shrimp, as they are much more expensive than a fish stew. But in a restaurant, she ordered the lobster and shrimp, even if the cost is much higher than a simple fish dinner. If, instead, lobster and shrimp at home, and the simple fish dinner in a restaurant, they could save money. But because they think separately on eating out and eating at home, they choose to limit their food at home.

Framing

Framing is the idea that the way a concept introduced to people on issues. for

For example, restaurants can be known "early bird" or "after-theater specials" discount, but never peak "surcharges". You get more business when people pay they get a feeling peak discounts, rather than additional tip, even if the prices are the same. cognitive psychologists have shown that doctors make different recommendations if they "see, presents the likelihood of survival," the evidence, rather than the "mortality", even if the probability of survival and the mortality rate of up to 100%.

Representativeness

People underweight long-term average. People tend to put too much emphasis on the latest developments Experiment. This is sometimes called the "law of small numbers." For example, if equity returns are at a high level for many years (from 1982 to 2000 as the United States and Western Europe), many people start to believe that high stock returns are "normal."

Conservatism

When things change, people tend to be slow to make the changes. In other words, them on how things are anchored in the rule already. By conservatism is at war with the representativeness bias. When things change, people might react biased by conservatism. But if there is a pattern long enough, they will adapt to this situation and perhaps an overreaction, underweight long-term average.

Disposition effect

The disposition effect refers to the diagram to realize that people avoid paper waste and

seek to achieve gains in paper. For example, if someone buys a stock at $ 30, then fell to $ 22, before rebounding to $ 28, most people do not want to sell while stocks gets about $ 30. The disposition effect occurs in many small profits, and only a few losses. In fact, people act as they try to maximize their tax! The disposition effect is visible in its entirety stock trading volume. During a bull market trading volume tends to grow. If the market tends to fall southward volume of transactions. For example, the volume of transactions on the Japanese stock market fell by more than 80% compared to the end of the 1980s until the mid 1990s. That the volume in bear markets fall in net commission income resulting from major brokerage firms with a high degree of systematic risk2 One of the main criticisms of behavioral finance tends to be that the decision to focus on the bias , you can either provide underreaction or overreaction. This critique of the behavioral finance can be considered as "dredging model." In other words, can you explain a story to fit the facts posteriori a strange phenomenon. But how do you do on the ex ante forecasts prejudice dominate? There are two excellent products, to solve this problem: Barberis and Thaler (2002) and Hirshliefer (2001). Hirshliefer (p. 1547), in particular, addresses the question of when we expect behavioral bias dominate others. He emphasizes that there is a tendency for people to rely excessively on signal strength information and help with weight information signals. This is sometimes described as the salience effect.

Importance of study

This study is important for individual investor, companies listed in Karachi and Lahore stock exchanges and for government. For the individual investor most influencing factors on their investor are crucial as they have impact on their investment decision. For companies recognizing the most influencing factors of their investors would effects their future strategies and policies. For government identifying the most influencing factors behavior would effects the required legislation and the extra procedure needed to satisfy customers.

Chapter # 2

Literature Review

This literature review covers empirical studies. The past study shows that the researcher have given more attention on the behavior of the aggregate/institutional investors where they have given less attention to individual investor behavior.

Literature review anticipated that behavioral scientists named as Shefrin, Shiller and Weber is the well-known names that have made research in the vicinity of investor’s behavior. Shiller who stoutly believed that stock market is governed by the information floated in the market which directly influenced the behavior of the investors. Thorough studies have been made to create the link between the demographics like age, gender and risk tolerance level of investors. YDO elaborated that variation in the risky asset holding were not identical. He observed investors to increase their investment in risky assets all the way through their operational life time and lessen their risk experience once they stop working.

Lewellen et.al while classifying the rational models of investment behavior demonstrated by investors found age and articulated risk taking tendencies to be inversely linked with foremost shifts taking place at the age of 55 and ahead. As per the Indian studies on individual investors were frequently limited to studies on share ownership expect only some of them L.C Gupta’s equity and the survey of RBI of ownership of shares into the ownership pattern of industrial shares in India were a seldom in this direction. The NCAER’s studies fetch out the repeated form of savings of investors and the element of financial investment of pastoral family units.

Survey carried out by the Indian Shareowners relayed cascade of information on the share owners. The classification of investor’s basis was made on the demographics by The Rajarajan V. He has carried out the investor’s exceptionality as well on the basis of investment size made by them. He also found that the specified percentage of risky assets to the whole financial investments had turned down as the investor shift up through different phases in life cycle and the investor’s lifestyles based distinctiveness has been acknowledged. The above mentioned review presents a comprehensive image about the various features of perception of investor studies that have taken place in the past.

The behavioral finance literature falls into two primary areas: the identification of

anomalies in the efficient market hypothesis that behavioral models may explain

(DeBondt and Thaler, 1985) and the identification of individual investor behaviors or

biases inconsistent with classical economic theories of rational behavior (Odean, 1999).

Behavioral finance thus challenges the efficient markets perspective and focuses upon

how investors interpret and act upon information freely available to them. If helps us

better understand the investors’ behavior and real market practices. It thus can help

investors make better investment decisions in the very complex and complicated financial market places.

Sewell (2001) defined the behavioral finance as the study of the influence of psychology

on the behavior of financial practitioners and the subsequent effect on markets.

Behavioral finance is of interest because it helps explain why and how markets might be

Inefficient.

Behavioral researchers Barberis and Thaler (2003) have described the direction of

Behavioral research as follows: ―We have now begun the important job of trying to

document and understand how investors, both amateurs and professionals, make their

portfolios choices. Until recently such research was notably absent from the repertoire of

financial economists, perhaps because of the mistaken belief that asset pricing can be

modeled without knowing anything about the behavior of the agents in the economy.

Chapter # 3

Research Methodology

This study is focusing on the individual investor who are investing in the Lahore and Karachi stock exchanges or the individual or brokerage houses that assists individual in assisting in the stock markets. 50 individuals and brokerage houses in Lahore and Karachi stock exchange are taken as sample for this research. For this research I have develop a questionnaire which includes questions relating to accounting information, neutral information and advocate recommendations. The questionnaire does not include personal information except age and education. In the questionnaire questions are asked relating to how to make an investment decision in the Lahore and Karachi stock exchange.

Questionnaire

From this questionnaire the most important items and most important category of factors of accounting information will be identified. The questionnaire include 16 question of which 10 are related to the accounting nformation. 4 are related to neutral information, one question is related to advocate recommendation and one question states the extra religious factor.

The current study include one factors namely religious beliefs and values and it is assumed that this factor would have significant impact on the behavior of Pakistani investor as Pakistan has the Muslim and conservative society.

Questionnaire

Behavioral factors which are influencing investment decisions

Sr. #

Question

Remarks

1.

Either the investors considers the

source of income of the targeted

company from the Islamic point of

view in terms of Halal / Haram while

deciding for the investment in that

company?

As per research I have found that mostly investors here in Pakistan prefer Islamic shria in investing. In terms of halal and haram, they consider, halal investment and avoid the haram investment such as purchasing of bonds, debentures etc.

2.

Considering the size of a company,

where an investor wishes to invest::

a) In a large company

b) In small company

People do prefer that they make

investments in large companies because they are less risky as compare to small companies.

3.

Which type of sector is mostly

preferred by an investor i.e.

a) Government sector

b) Public sector

c) Multinational companies

Multinational have the highest

attraction for investment by the

investors because public sector are not performing up to the mark as compare to MNC whereas govt. sectors are more riskier in Pakistan due to political factors.

4.

Which is the most preferred industry

of an investor? Please rank the

following in order of priority.

a) Textile

b) Cement

c) Banking

d) Sugar

e) Rice husking

f) Sanitary works

g) Power

The following are ranks as per my

research:

1. Textile

2. Sugar

3. Cement

4. Rice

5. Sanitary

6. Power

7. Banking

5.

Is portfolio management theory is

considered while making the

investment decision. If so, please

explain the extent.

80% of my sample for research believes that portfolio management theory is not important for their decisions. They look each investment individually.

6.

Is portfolio management theory is

considered while making the

investment decision. If so, please

explain the extent.

80% of my sample for research believes that portfolio management theory is not important for their decisions. They look each investment individually.

7.

Is interest rates offered by a bank is

also considered while investing?

Yes as it’s a major in deciding the value of different securities or assets.

8.

Is impact of inflation is also

considered while investing?

Inflation also affects the value of

different securities such as stocks and bonds.

9.

With reference to risk and return, in

which securities you will prefer to

invest.

In what kind of securities you would

like to invest:

a) Those with higher return but

and higher risk over the years;

OR

b) Those with lower return but

lesser associated risk.

My survey shows that mostly investor invest for higher return. As far as return is higher they do not consider the risk so automatically they invest their money in higher return securities and that also has

higher risk.

10.

To what extent audited financial

statements are considered while

making decision.

Most of the time people used audited

file as they make their decision on the basis of audited financial statements.

11.

Is qualified report impacts investor’s

Decision. If so, please explain extent.

Qualified reports negatively impact the investors. Mostly investor starts selling shares when qualified report is published.

12.

While deciding how you will rank the

following factors in terms of their

value.

a) Earnings per share

b) Sales of the company

c) Dividend yield

11.d) Type of business of the

company

e) Management of the company

f) Any other factor (if any,

please specify)

g) Information provided by

dealers

Earnings per share

Dividend yield

Share of the company

Company performance as

compare to competitors

interest rate

information provided by the

dealers

management of the company

types of the business

Data collection

The data for this study has been collected through questionnaire, as earlier I have noted that the 100 individuals are taken a sample, so I have distributed the questionnaire in the Lahore stock exchange to the individual investor and to the brokerage houses. Out of 100 75 responses were received. In the Karachi stock exchange there are 654 listings. So the investors are large in number.

Hypothesis

Factors influencing individual investor behavior in Karachi stock exchange.

Factors influencing individual investor behavior in Lahore stock exchange.

Regression technique was used to find out the effect of independent variables on the dependent variables.

Y=(X1,X2,X3,X4,X5,X6)+(X7)+∑i

In the regression model ‘Y’ is the dependent variables and ‘X1......X4’ are independent variables indicating dividend paid, earning per share, stock marketability and past performances of the firm, X5…. X6, indicating recent price moment in the firm stock and firm status in the industry and finally X7 indicating family member opinion and broker recommendations. The ∑I is the error term.

X1…………X7 independent variables

X1= Dividend paid

X2= Earning per share

X3= Stock marketability

X4= Past performance of stock

Y- Independent variables-Investor behavior.

Chapter# 4

The Behavioral Finance Perspective

Although one can argue with the assumptions of the utility theory but in fact one cant argue with its perception that for how all investors should act essentially. It's another matter in general i.e. developing a single behavioral finance model that explains investor decision making. One will discuss 4 behavioral finance models that are endeavored to explain the behavior of markets as well as individuals and their implications for portfolio creation:

(1). Consumption and savings,

(2). Behavioral asset pricing,

(3). Behavioral portfolio theory and

(4). The adaptive markets hypothesis

1. Consumption and savings: Traditional finance assumes investors make conscious decisions to save and consume in a pattern that meets both their short- and longterm goals. In order to explain the consumption/savings patterns actually observed, Shefrin and Thaler (1988)6 propose an alternative theory incorporating behavioral finance assumptions. According to their behavioral life-cycle model, individuals are subject to framing, self-control bias, and mental accounting, so they will not necessarily achieve the optimal balance of short-term consumption and long-term investing.

• Framing refers to the way a question is asked or the way information is presented and can affect the way individuals perceive a choice and view its alternatives. We know, for example, that individuals exhibit loss aversion. Given a choice, their selection will be affected by whether the outcome is stated in terms of the possible loss or in terms of the possible gain (e.g., stating a 50% probability of losing instead of a 50% probability of winning).

• Self-control refers to an individual's ability to think rationally when making

Consumption/savings decisions. For example, rather than consume all wealth and maximize current utility, the rational individual will exhibit self-control and save a portion of his current income to meet future goals. Self-control bias refers to an individual's tendency to place a much greater value on current consumption than on future goals. Self-control bias produces suboptimal lifetime consumption/savings patterns.

• Mental accounting refers to individuals' tendencies to mentally place goals into different "files." They then assign different portions of their wealth to meet the different goals. This ignores the fact that wealth is fungible, which means that it is interchangeable.

Classifying Wealth

The behavioral life-cycle model assumes individuals classify their wealth as current income, currently owned assets, or present value of future income. Classifying wealth this way has implications for how or when it is consumed. An individual's marginal propensity to consume, for example, is greatest with current income. How an individual classifies wealth affects the individual's consumption/savings decisions. For example, if wealth is classified as current income, the individual is more likely to use it to meet current spending needs and desires. Any excess current income over current spending is saved and becomes currently owned assets (e.g., a savings account). Once classified as currently owned assets, the individual is somewhat less likely to spend it. Finally, individuals are least likely to spend out of wealth classified as future income.

This is where foaming affects the individuals' consumption patterns. For example, a one-time cash: How, such as a bonus or tax refund, can be mentally classified (framed) as current income, current assets, or possibly even future income. If classified as current income, the individual will be much more likely to consume it than if it is classified as currently owned assets or future income. Finally, money automatically deducted from a paycheck and deposited into a 40l(k) retirement plan is likely framed as future retirement income and will be used to meet current consumption only under unusual

circumstances.

2. Behavioral asset pricing: Traditional asset pricing models (e.g., CAPM) assume Market prices are determined through an unbiased analysis of risk and return. The intrinsic value of an asset is its expected cash flows discounted at a required return, based on the risk-free rate and a fundamental risk premium. The behavioral asset pricing model adds a sentiment premium7 to the discount rate; the required return on an asset is the risk-free rate, plus a fundamental risk premium, plus a sentiment

premium.

The sentiment premium can be estimated by considering analysts' forecasts. The greater the dispersion of analysts' forecasts, the greater the sentiment premium, the higher the discount rate, and the lower the perceived value of the asset.

3. Behavioral portfolio theory (BPT): Based on empirical evidence and observation, rather than hold well-diversified portfolios as prescribed by traditional finance, individuals tend to hold a combination of nearly riskless assets and considerably riskier assets. In order to explain this phenomenon, BPT shows how investors structure their portfolios in layers according to their goals. 8 The composition of each layer of the portfolio is determined by the interaction of five: factors:

• The importance of the goals: To assure meeting the most important goals, the investor constructs a layer using assets with little downside potential. Investors tend to focus on this layer first, thus, the portfolio typically contains a layer of nearly riskless assets.

• Required return: The risk of assets in any layer depends on the return required to meet the goals in the Layer.

• The investor's utility function: Remember that investors experience (subjective; varied) decreasing marginal utility. The utility provided by an individual stock, for example, increases at a decreasing rate as more and more of the stock is purchased. Rather than using a single or just a few securities to fill a layer, therefore, the individual will tend to use several different securities. The number of different securities held in a layer will vary directly with the concavity of the investor's utility function-the greater the concavity, the greater the number of different securities.

• Access to information: If the investor perceives that he has an information advantage, the layer could be concentrated in one or a few securities.

• Loss aversion: The investor might hold a suboptimal amount of cash (too much) to provide liquidity rather than face the potential of having to liquidate a position at a loss. Alternatively, the investor might hold a position that has already experienced a loss to avoid selling it and having to publicly recognize the loss.

An important implication of the portfolio layering process is that investors seek a minimum position, a safety net. Having achieved that, they begin to allocate to riskier assets.

4. The adaptive markets hypothesis (AMH): The AMH assumes successful market participants apply heuristics until they no longer work and then adjust them accordingly. In other words, success in the market is an evolutionary process. Those who do not or cannot adapt do not survive. Because AMH is based on behavioral finance theory, it assumes investors satisfies rather than maximize utility. Based on an amount of information they feel is sufficient, they make decisions to reach subgoals, steps that advance them toward their desired goal. In this fashion, they do not necessarily make optimal decisions as prescribed by utility theory.

How Practical Is Behavioral Finance?

We can ask ourselves if these studies will help investors beat the market. After all, rational shortcomings ought to provide plenty of profitable opportunities for wise investors. In practice, however, few if any value investors are deploying behavioral principles to sort out which cheap stocks actually offer returns that can be taken to the bank. The impact of behavioral finance research still remains greater in academia than in practical money management.

While it points to numerous rational shortcomings, the field offers little in the way of solutions that make money from market manias. Robert Shiller, author of "Irrational Exuberance" (2000), showed that in the late 1990s, the market was in the thick of a bubble. But he couldn't say when it would pop. Similarly, today's behaviorists can't tell us when the market has hit bottom. They can, however, describe what it might look like.

Chapter: 5

Heuristic-Driven Biases

Heuristic-Driven Biases:

From an investment standpoint, a heuristic learning process is one in which people develop investment decision-making rules through trial and error, experiment, or personal experience. Rather than research financial statements and other relevant data, individuals form investment rules and make investments using information that is well-known in the media or otherwise most readily available. Shefrin****** provides four steps in the process of developing heuristic- driven bias in the investment process:

Step 1: People used to develop general principles when they find things out for themselves.

Step 2: People rely on heuristics (i.e., rules of thumb) to draw conclusions from information at their clearance.

Step 3: People are susceptible to particular errors because the heuristics they use are imperfect.

Step 4: Individuals in fact commit errors in particular circumstances.

Representativeness:

Representativeness is a heuristic process through which investors make base expectations upon precedent experience, applying the stereotypes e.g. investors might feel that all firms with management supporting environmental wakefulness are "good" firms (i.e., good investments). Another example can be taken as interpreting all good earnings announcements as predictors of good future performance, without determining whether the performance will continue for the individual firm making the announcement.

It can be observed that the representative ness can capture many forms. At any moment an investor or anyone else for the identical matter bases expectations for the future on some past or current features or measure, the individual is applying an "if-then" heuristic. That is, if this has happened, then that will happen.

Overconfidence:

People tend to place too much confidence in their ability to predict is known as overconfidence. It can be illustrated as asking investors to predict a confidence interval around the expected return on a stock. The investors will consistently make the interval too narrow (i.e., they will set the range of possible returns too

narrow) i.e. they tend to methodically under estimate the risk of the returns on the stock.

It is observed that overconfidence can lead to surprises. Because investors continually underestimate the range of possible returns, there is a higher than normal probability of a return outside the confidence interval (i.e., a surprise).

Anchoring-and-Adjustment:

Anchoring refers to the inability to fully incorporate (adjust) the impact of new information on projections (i.e., conservatism). For example, an analyst may have already made a forecast for the performance of a stock, when the firm releases new information that can have a material effect on the price of stock. Being psychologically the analyst anchored by his previous projection, will be likely to not fully reflect the full value of the new information in his altered projection. Similar to overconfidence anchoring can lead to surprises. In this case the surprises tend to be biased in the way of the announcement. For example, assume an analyst receives negative information about a stock that indicates its price should fall 25%. Being anchored by a previous forecast, the analyst may fail to fully incorporate the value of the negative information and predict a fall of 15%. The next surprise, therefore, will tend to be negative as the stock falls to fully incorporate the impact of the negative information. Likewise, if the analyst fails to fully incorporate positive information, the next surprise will tend to be positive.

Aversion to Ambiguity:

Aversion to ambiguity can be freely described as fear of the unknown although aversion to ambiguity can be applied to investing; it is best described by using probabilities linked with options. For example, we know the odds of heads or tails coming up in a coin toss are 50/50. The individuals will often be eager to take the bet and if the odds are unidentified, however, individuals are uncertain. For example let us assume we have several decks of cards. let us assume we have several decks of cards. In any one of those decks we know the odds of randomly selecting a diamond card are one in four. That is, there are four suits in the deck, so the chance of selecting a particular suit is one in four. Now let us mingle and shuffle together all the decks. Randomly draw 52 cards. Now we don’t have idea the odds of selecting a card from one of the four suits as we don’t know the number of each suit in the sample.

The application of this behavioral trait to investing is quite interesting, and you may have actually witnessed it without naming it. For example, you have probably heard of momentum investing. Following a momentum strategy, investors buy in an up-trending market and sell in a down-trending market. Using aversion to ambiguity as a starting point, could it be that in trending markets investors visualize odds? Perhaps in an up-trending market, for example, investors see the odds as greater than 50% that prices will continue moving up.

In a down-trending market they might see the odds as greater than 50% that the market will keep on down. However a non-trending market presents individuals with ambiguity. They might not be capable to base their expected odds on anything. So they might shy away or in any case leave the stock picking to the professionals.

Chapter: 6

Frame Dependence

Frame Dependence:

Frame dependence implies that individuals make decisions and take actions according to the framework within which information is received that’s individual’s environment at the time that is emotional state or the media. If investors respond with frame independence then they would make merely economic decisions and the form within which information is received, the individual’s current circumstances would have no effect on their decision making. They would base each decision purely on its expected merits. Behavioral characteristics that can be accredited to frame dependence containing the money illusion, regret minimization, self control and loss aversion.

Loss Aversion:

Loss aversion, one of the basic tenets of behavioral finance theory, refers to the individual’s reluctance to accept a loss. The investor holds on the stock by hoping that it will recover soon while in market a stock may be down considerably from its purchase price. One can narrate this to the gambler who keeps throwing the dice until and unless hope meets to break even and loss aversion can also lead to the risk-seeking behavior. A portfolio manager, for example, may have experienced recent losses. Knowing that he must report at the end of the quarter and being reluctant to report losses, he might start taking progressively riskier positions in hopes of at least breaking even.

Self Control:

Self control is associated with frame dependence. Framework dependence occupies the investor’s response to information. It’s influenced by the framework wherein the information is acknowledged. The framework is media, carrying the information and individual’s situation, when its get acknowledged e.g. consider stage of dividends and life. A younger, affluent investor may totally avoid high dividend paying stocks because of the related tax consequences and the effect on the overall portfolio return. A retired investor might use dividends as a self- imposed control mechanism to stay away from spending the capital in his retirement account. These investors are able to psychologically separate the dividends they receive from the portfolio (i.e., their capital). They view the dividends as cash flows, and receiving and spending the cash flows does not affect the portfolio. By allocating to bonds and high dividend paying stocks and

living off the cash flows only, they protect against spending down the principal too quickly (i.e., outliving the portfolio).

Regret Minimization:

In an investments framework, regret is the feeling (in hindsight) associated with making a bad decision. The investor starts thinking, If only he had…, an example is selling a winning stock and then watching it soars even privileged. The investor starts thinking then, if only he had held on a little longer. On the other hand the same investor after holding onto the stock and watching it fall back might say that if only he had sold the stock prior week.

Regret minimization can lead to 2 common circumstances. First, to avoid the possibility of feeling regret, investors can tend to stay in comfortable investments, such as stocks and bonds (i.e. regret minimization can lead to lack of variety in investments). Next, rather than sell profitable investments, investors may tend to use their cash flows, such as interest payments and dividends, for living expenses.

Money Illusion:

Money illusion refers to the way individuals react to inflation and its impact on investment performance. People tend to think logically in terms of supposed amounts i.e. they look at the overall investment return without looking upon for the level of inflation and the resulting actual return. This may lead to the positive reactions to high returns no matter what the level of inflation and resulting actual return ultimately the opposite is also true. Investors tend to react negatively to low the returns even if inflation is greater or less unreal.

Chapter no.7

Facts and findings

I have conduct the research by preparing the reliable material contained questionnaire for the purpose of key findings regarding financial behavior; the perception of investor. It was performed to find out the behavior of the investor in a specific environment that how he does think, behave and perceive the changes around him.

So far, I have been considering whether behavioral finance is a worthy endeavor on a priori grounds. My conclusion, unsurprising given the source, is that we can enrich our understanding of financial markets by adding a human element. Some researchers have been at this task for quite a while, however, so it is reasonable to ask whether any real progress has been made.

Perhaps the most important contribution of behavioral finance on the theory side is the careful investigation of the role of markets in aggregating a variety of behaviors.

In our part of the world that people think the financial flows of the study as a simple game number. In my opinion, Finance & Investment is a really interesting area of ​​research, where you could do anything to make a difference. We can take into account any discipline of management science and social science in the study of investment and finance.

Analysis

2010

2011

Dividend

KBIT

EPS

Dividend

KBIT

EPS

Bonus

Million

Bonus

Million

Right

%

Right

%

Nestle

250

4215.25

68.28

Good luck industries

Stock refinery

Fauji fert bin qasim

Stock petroleum

National refinery

Unilever Pak

Shell Pakistan

P.S.O

MCB

Fauji fertilizer

Engro chemical

Rafhan maiz

Koh e noor textile

Bank alfalah

Bata pak

NBP

This table shows the performance of the entities whose trading volume are huge and offer high dividend based on their large earning and these are listed in Karachi and Lahore stock exchange.

The data of the questionnaire and of above tables has been tested through SPSS software and it gives the result regarding regression, covariance and correlation.

Chapter no.8

Results and conclusion

Factors influencing individual investor behavior at Karachi and Lahore stock exchange are studied in this paper. This study includes the factors that research previously. I have collected the data through questionnaire. In questionnaire the questions are asked regarding Lahore stock exchange and Karachi stock exchange.