Unit IV  research on the effectiveness of self-instruction has

Emotional Foundation shown mixed results

Emotions  prompt the use of the self-instructional strategy
 can be defined as a complex pattern of changes,  cognitive antecedents are acquired
including physiological arousal, feelings, cognitive  For instance, you become angry when a pedestrian runs
processes, and behavioral reactions, made in in a red light, and you almost hit them because you
response to a situation perceived to be personally believe that the pedestrian is careless and has
significant endangered you and his life.
 Observe how the emotion of anger differs from hunger,
What are emotions? another bodily state that arises because of the desire to
 They are Intense feelings that are directed at eat since your stomach is empty. Though hunger may be
someone or something triggered by a belief or a norm such as it is already
 Emotions are private experiences 11:30AM, so I must be hungry for lunch, it is generally
 We infer observable behavior associated with triggered by a sensory signal such as your stock is
emotion growling, rather than a thought. This distinction is not
perfect, but it is generally understood that beliefs are
Lesson 1: The Substance of Emotion important to trigger emotions.
Six Features of Emotions 2. Intentional Objects
 Cognitive Antecedents  Emotions are towards a person or the situation.
 Intentional Objects  For example, you are angry with the pedestrian who ran
 Physiological Arousal the red light. The object of the emotion is closely related
 Physiological Expressions to the belief that stimulates the emotion. You are angry
 Valence with the pedestrian because he is reckless. Take note
that the distinction between an emotion and a mood.
 Action tendencies.
Emotion is towards something, whereas a mood is more
of a general feeling that does not focus on anything in
DIFFERENCE OF MOODS AND EMOTIONS
particular. You are angry with the reckless pedestrian,
MOODS EMOTIONS
but you may also have been in a gloomy mood.
 DURATION  DURATION
3. Physiological Arousal
minutes to hours seconds to minutes
 Hormonal and nervous system changes can affect
 PROVOCATION  PROVOCATION
emotional responses. Our body goes through hormonal
lowers threshold more easily
changes when we experience an emotion. During the
needed to trigger experienced within
near-death experience, you might feel your blood
emotions moods belonging
pressure and heartbeat rising.
 MODULATION to same "family"
4. Physiological Expressions
regulation mostly  MODULATION
 Emotions can be classified by observable expressions
unaffected more difficult to
that are related with how a person functions.
 EXPRESSION no regulate if
 You may express your anger at the pedestrian by
unique nonverbal experienced within
raising your voice or pointing your finger in his
expressions mood
direction. Anyhow some physiological responses are
 AWARENESS  EXPRESSION
functional, others are simply the result from the
difficult to identify universal facial
situation.
exact trigger(s) expressions
 For instance, an angry person may exhibit red face that
causing mood  AWARENESS
results from increased blood flow but does not
triggers more
necessarily assist the person in resolving the problem.
easily identifiable
Many physical expressions related with emotions are
1. Cognitive Antecedents
observed characteristics.
 beliefs trigger an emotional response.
 For example, if you saw a person with a red face and
 cognitive antecedents are typically covert self-
closed fists, you might judge that he was angry. Also,
statements that include:
expressions are not necessarily unique and can result
 self-instructions from different emotions. A red face is also related with
 rules –strategies embarrassment or fluttery. In addition to an angry
 logical thinking self response, a person might also close his fists in a time
 statements develop into more complex covert of celebration.
statements with age
 5. Physiological Expressions 3. Purposive component
 Emotions can be measured on a scale with a neutral  Give emotion its goal-directed force.
point in the center and positive and negative feelings on  Motivation to take action
the endpoints.  Cope with emotion-causing circumstances.
 Valence is a psychological term used to rate feelings of  Why people benefit from emotions.
pleasure and pain, happiness and unhappiness, and joy  Social and evolutionary advantage.
or grief. 4. Social-Expressive component
 You are feeling very negative toward the pedestrian.  Emotion's communicative aspect.
Emotions that are highly stimulating are also at the  Postures, gestures, vocalizations, facial expressions
positive or negative endpoints for feelings. Take note, make our emotions public.
that we can’t always assume that strong emotions are at  Verbal and nonverbal communication.
the endpoints or vice versa.  Helps us interpret the situation.
 For example, a teenager sometimes reports very strong  How person reacts to event.
feelings of boredom, an emotion low on valence.
6. Action Tendencies Facial Expressions convey Emotions
 Emotions are connected to action tendencies. Categories of Emotions
 When you experience an emotion, you often feel and Emotions are Divided Into Two Categories Primary emotions
react in a certain way. Commonly, you might even feel 1. Primary Emotions
obliged to take action. You may have an impulse to open 2. Secondary emotions
your window at the direction of the pedestrian and give
him a piece of your mind. Or you might change the PRIMARY HUMAN EMOTION
initial desire to action and simply drive away, while A primary human emotion types are the one triggered in
carefully watching other pedestrians on your way home. response to an event
 This control of your action tendency can happen with or
 Sadness  Love
without conscious choice.
 Surprise  Joy
 Your body might automatically stop your initial reaction.
 Fear  Anger
SECONDARY EMOTIONS
Types of Emotions If we experience fear, the secondary emotions would be feel
1. Happiness threatened or feel anger, depending on the
2. Sadness
• Shame • Passion • Irritation
3. Fear • Nervousness • Optimism • Disgust
4. Disgust Variety of Emotions
5. Anger Positive human emotions
6. Surprise Negative human emotions
Four Components of Emotion
1. Feeling Positive Emotions
2. Bodily Arousal • Positive emotions that lead one to feel good about
3. Sense of Purpose one's self will lead to an emotionally happy and
4. Social Expressive satisfied result.
Some of the positive emotions are:
1. Feeling component • Hopeful • Desire • Happiness
 Emotions are subjective feelings • Confident • Gratitude • Empathy
 Make us feel in a particular way. • Peaceful • Euphoria • Hope
 Anger or joy • Joy • Pride
 Meaning and personal significance. Negative Emotions • Desire
 Vary in intensity and quality. Negative emotions sap your energy and undermine your
 Rooted in mental processes (labeling). effectiveness. In the negative emotional state, you find the
2. Bodily Arousal lack of desire to do anything.
 Biological activation. Some of the negative emotions are:
 Autonomic and hormonal systems. • Exhausted
• Panic • Shame • Depression
 Prepare and activate adaptive coping behavior • Fame
• Obnoxious (unpleasant) • Despair
during emotion. • Grief
• Frustration • Envy
 Body prepared for action. • Desire • Guilt • Doubt
 Alert posture, clenched fists. • Sadness • Jealousy
Lesson 2 - Interpretation of the experience based on the
A Short History of Emotion Theory environmental cues.
• Bodily state of emotional arousal is much same for most
EMOTION of the emotions we feel. But people have different
 It is derived from a Latin word “emovere” meaning ‘to emotions because of the differences in the way they
stir up’ or ‘to agitate’ interpret.
 It is an affective experience that accompanies • In other words, our emotional arousal depends on both
generalized inner adjustment and mental and physiological changes and cognitive or mental
physiological stirred up states in the individual and that interpretation of those changes. Since this interpretation
shows itself in his overt behavior. is purely by cognitive functioning, cognitive factors are
COGNITIVE PSYCHOLOGY said to be the potent determiners of emotional states.
 focuses on particular mental processes, including Step 1: Stimulus: a threatening grizzly bear approaching
conscious mental processes like thinking, speaking, Step 2: Arousal: heart pounding, trembling, sweating, running
problem-solving, and learning. It explained emotions in away
consideration of cognitive processes so that emotion is Step 3: Cognitive label: "That is one scary bear! I'm afraid of
what we think about a situation. it!"
Theories of Emotions Step 4: Emotion: FEAR
In 1870, Charles Darwin said Dog (Stimulus) – I freeze (auto response) – My brain appraises
 Emotions evolved because they were adaptive. the situation – I feel fear (emotion)
 allowed humans and animals to survive and reproduce. For instance I see a bear "I am trembling, therefore I am
 Feelings of love and affection lead people to seek mates afraid."
and reproduce. • Perception of emotion-arousing stimulus
 Feelings of fear compel people to either fight or flee the • Specific physiological changes
source of danger. • Interpretation of specific physiological changes as the
 Emotions motivate people to respond quickly to stimuli, emotion
which improve the chances of success and survival. Lesson 3
 Understanding the emotions of other people and Evolutionary Theory
animals also plays a crucial role in safety and survival. If It was naturalist Charles Darwin who proposed that
you encounter a hissing animal you quickly realize and emotions evolved because they were adaptive and allowed
run away. humans and animals to survive and reproduce. Feelings of
CANNON BARD THEORY OF EMOTION love and affection lead people to seek mates and reproduce.
• Proposed by Walter Cannon and Philip Bard in 1927 Feelings of fear compel people to either fight or flee the
• It states that we react to a stimulus and experience the source of danger.
associated emotion at the same time. According to the evolutionary theory of emotion, our
• we feel emotions and experience physiological reactions emotions exist because they serve an adaptive role. Emotions
such as sweating, trembling and muscle tension motivate people to respond quickly to stimuli in the
simultaneously. environment, which helps improve the chances of success
• For Example: I see a snake – I’m afraid – I begin to and survival.
tremble Understanding the emotions of other people and animals
Other Example: also plays a crucial role in safety and survival. If you
Dog (stimulus) – My Brain becomes active – I freeze encounter a hissing, spitting, and clawing animal, chances are
(automatic response) and I feel fear (emotion) you will quickly realize that the animal is frightened or
JAMES-LANGE THEORY OF EMOTION defensive and leave it alone. By being able to interpret
• It states that emotions occur as a result of physiological correctly the emotional displays of other people and animals,
reactions to events. you can respond correctly and avoid danger.
• proposes that you will interpret your physical reactions Evolutionary theories of emotion assume that emotions
and conclude that you are frightened. are innate reactions that require little cognitive
Dog (stimulus) – I freeze (auto response) – I feel fear interpretation. They are arousal states that help organisms
(emotion) cope with important recurring situations. For example:
SCHACHTER-SINGER THEORY -Fear – helped individuals in your family tree react to
(Cognitive labeling theory/Two factor theory of emotions) situations that could have killed them.
• Proposed by Stanley Schachter and Jerome Singer -Love – commit to a family, which helps us continue the
• Two factors jointly determine the emotional experience. genetic line.
- Physiological arousal
-Jealousy – dealing with the biologically important problem of combines this information and sends it on to other parts
mate infidelity, which threatens the individual's chances of the brain.
of producing offspring.  The amygdala assesses sensory information and is
-Humor – social bonding, also important to survival. important in the evaluation of primary emotions such as
anger and fear. These responses can be classified as
Lesson 4 automatic, rather than resulting from controlled
The Brain, Emotion, and Reasoning evaluation.
 The hippocampus is relevant for the storage of long term
Anatomy of the Brain memory and allows us to access facts and events to assess
new experiences.
 The cingulate gyrus is important in evaluating emotional
experiences.

FACTORS AFFECTING EMOTIONS

 PERSONALITY
 CULTURE
 WEATHER
 STRESS
 AGE
 GENDER
 ENVIRONMENTAL
 MARITAL RELATION
 ORGANIZATIONAL
 SOCIAL
It represents the brainstem structures and major lobes of the EMOTIONAL INTELLIGENCE
brain. The brain stem structures comprises the medulla, pons,  Emotional intelligence (EI) refers to the ability to
and cerebellum. The medulla binds the rest of the brain to perceive, control and evaluate emotions.
the spinal cord and governs many of our unconscious  Emotional intelligence is a person's ability to understand
functions, including breathing, blood pressure, and their own emotions, the emotions of others, and to act
circulation. The pons, which connects the brainstem and appropriately using these emotions.
medulla, regulates eye movements, sleep, and dreaming. The  Emotional intelligence never stops growing. Because we
cerebellum synchronizes our movements and is important for are always evolving as people, EQ is something that
physical balance. must be nurtured.
The Limbic System FOUR BRANCHES
Salovey and Mayer proposed a model that identified four
different factors of emotional intelligence
1. Reasoning With Emotions: The next step involves using
emotions to promote thinking and cognitive activity.
Emotions help prioritize what we pay attention and
react to; we respond emotionally to things that garner
our attention.
2. Perceiving Emotions: The first step in understanding
emotions is to accurately perceive them. In many cases,
this might involve understanding nonverbal signals such
as body language and facial expressions.
3. Understanding Emotions: The emotions that we
perceive can carry a wide variety of meanings. If
 Limbic system borders the upper and lower parts of the someone is expressing angry emotions, the observer
brain. It is particularly important to us because it regulates must interpret the cause of their anger and what it
instinct and some experts claimed it to be the center of might mean.
emotional activity. 4. Managing Emotions: The ability to manage emotions
 The thalamus is in the middle of the limbic system and effectively is a key part of emotional intelligence.
most sensory information passes through it. The thalamus Regulating emotions, responding appropriately and
 responding to the emotions of others are all important Components of Emotional Quotient
aspect of emotional management. 1. Intrapersonal - Self-regard, emotional self-awareness,
independence, self-actualization
1. Self-awareness: Recognizing Internal Feelings 2. Interpersonal - Empathy, social responsibility,
 Recognizing how someone is feeling, without them interpersonal relationships.
having to say anything. 3. Adaptability – Reality-testing, flexibility, problem-
 Using your gut feeling to guide decisions. solving.
 WHAT MATTERS MOST IS HOW YOU SEE YOURSELF 4. Stress management - Stress tolerance, impulse control
2. Managing Emotions: Finding Ways To Handle Emotions 5. General Mood – Optimism, happiness
That Are Appropriate To the Situation
3. Motivation: using self-control to channel emotions How to Increase Your EQ?
toward a goal  Conduct a "personal inventory."
4. Empathy: Understanding The Emotional Perspective of  Analyze the setting & identify skills needed
Other people  Enlist trusted friends
5. Handling relationships: using personal information and  Focus on a few competencies
information about others to handle social relationships  Practice, practice, practice
and to develop interpersonal skills  Be observant and reflective.
Studies show that those individuals with a high sense of  Don't expect immediate results.
emotional intelligence tend to succeed and excel in different  Learn from your mistakes.
areas of life:  Acknowledge your successes.

How to develop a higher sense of emotional intelligence? UNIT 5: The Implications of Heuristics for Financial Decision
 Become emotionally literate; Label your feelings, rather Making
than labeling people or situations. (Say "I feel" instead of  Affect heuristics
"I know")  Anchoring and adjustment heuristic
 Distinguish between thoughts and feelings.  Availability heuristic
 Take more responsibility for your feelings  Common sense heuristic
 Use your feelings to help make decisions  Familiarity heuristic
 Use feelings to set and achieve goals  Representativeness heuristic
 Feel energized, not angry. A heuristic, is any approach to problem solving or self-
 Validate other people's feelings. discovery that employs a practical method that is not
 Use feelings to help show respect for others. guaranteed to be optimal, perfect, or rational, but is
 Don't advise, command, control, criticize, judge or nevertheless sufficient for reaching an immediate, short-term
lecture to others. goal .
 Avoid people who invalidate you. Heuristics are rules-of-thumb that can be applied to guide
decision-making based on a more limited subset of the
How IQ Differs? available information. Because they rely on less information,
 Measure of an individual's personal information bank heuristics are assumed to facilitate faster decision-making
 Memory, vocabulary and visual motor skills than strategies that require more information
 IQ is set and peaks at age 17
 Remains constant through adulthood What is heuristic?
A heuristic is a mental shortcut that allows people to solve
IQ vs. EQ problems and make judgments quickly and efficiently.
EQ The implications of Heuristic in Decision Making?
 Not fixed While heuristics are usually excellent time- and effort saving
 Can be improved throughout life mechanisms, they sometimes appear to lead decision-making
IQ investors in unfortunate directions.
 Established by mid-teens Common Uses for Heuristics
 Can't increase  Reduce mental effort needed to make decisions
 Predicts only 10%-20% of life success  Simplify complex and difficult questions
 90% of the success of outstanding leaders is attributable  They're a fast and accurate way to arrive at a conclusion
to emotional intelligence (EQ), which is twice as  Help with problem-solving
important than intellectual intelligence (IQ).
What is Cognitive Bias?
Cognitive bias - also known as psychological bias – is the  Fund managers, consistent with familiarity bias,
tendency to make decisions on to take action in an tendency to favor local investments, that is, they tend to
unknowingly irrational way. For example, you might buy firms headquartered near their head office.
subconsciously make selective use of data, or you might feel
pressured to make a decision by powerful colleagues. Lesson 2: financial Behaviors Stemming from
Representativeness
LESSON 1: Financial Behaviors Stemming from Familiarity  This form of representativeness is often called
HOME BIAS – Is the tendency for investors to invest the recency
majority of their portfolio in what they know such as  To those with this view, investment performance in
domestic companies or locally owned investment. the recent past is representative of future
 such as domestic companies or locally owned investment performance.
investments.
 Other investors may simply exhibit home bias due to a Community – wealth informational
preference for investing in what they are already Advantage – is unique knowledge that gives a firm or
familiar with rather than moving into the unknown. individual a strategic or tactical advantage in a particular
 As a result, investors are not diversified across multiple context-
sectors and types of investments, which can reduce risk. Simplicable – the average manager invests in companies that
Reasons for Home Bias are located closer to her than
1. Excessive optimism towards home country - the average firm she could have held.
2. Comfort – seeking and familiarity - one rational motivations for investing locally is limiting
3. Rational reasons (tax and trading restrictions) demand.
Reasons for Intra-national Home Bias
➢Feeling of informational advantage & better monitoring There is evidence that representativeness and related biases
➢Hedging demand for local goods & services, especially induce inappropriate investment decisions.
those not traded
➢Local investments tend to outperform remote investments Assumption of good companies as good companies as good
investments
Distance, Culture and Language  To casual observers it seems obvious that if a company has
 Diversification theory says you should look for income high-quality management, a strong image, and consistent
streams that are weakly correlated. For this reason, it growth in earnings, it must be a good investment.
would have been better for investors to buy stock  Good company is not equal to good investment
outside their region.
Local Investing and Informational Advantages INVESTING IN YOUR EMPLOYER OR BRANDS THAT YOU
 Gains from being geographically close to a company may KNOW
appear in improved monitoring capability and access to There is evidence that representativeness and related biases
private information. induce inappropriate investment decisions.
Investing In Your Employer Or Brands That You Know •In valuation, future cash flows are forecasted and
 Also known as familiarity bias discounted back to the present using an appropriate risk-
 The familiarity bias prevents the investors from adjusted discount rate
analyzing the actual potential of the lesser-known •it is a mistake to think that a good company is
companies and stocks. representative of a good investment, and yet, that is exactly
 The argument that institutional considerations cause what people often seem to believe. Further, according to
investors to shy away from foreign investment became market efficiency, excess returns should be unpredictable.
weak it can be demonstrated that people prefer to Nevertheless, as we have noted, there is a tendency to
invest locally, even within their own country. overestimate predictability.
•In this context then, there may be a tendency to associate
 For example, when presented with an option to choose
past success (which led to high past returns) with likely future
between the stock of Apple and Synaptics, the investors
returns.
are more likely to choose Apple.
 When investors are presented with an option to choose
FAMILIARITY BIAS prevents the investors from analyzing the
between the stock of apple or Synaptics, the investors
actual potential of the lesser-known companies and stocks,
are more likely to choose Apple. They are familiar with
that may turn out to be more profitable than the familiar
company and use its product more often.
options.
 Investor favor local markets because they may possess,
informational advantages
  Investors choose to oversee the opportunity in order 1. news reports on stocks
to avoid risk 2. unusually high trading volume
 Investor are afraid to diversification 3. extreme returns
Effects:
 Investors may end up losing several opportunities Lesson 4: anchoring to available economic cues
due to their resistance to try out something new. We are influenced by available cues instead of our own
expertise. This occurs with real estate agents when appraising
REMEMBER that a familiar does not mean safe. Remaining houses, as well as financial analysts.
confined to it, investors may end up in a loss-bearing
company. What is Anchoring in decision Making
If it seems like X, then it must be X. The anchoring effect is a cognitive bias that describes the
However, we ignore how X actually occurs (base rate). There common human tendency to rely too heavily on the first
is evidence that representativeness and related biases induce piece of information offered
inappropriate investment decisions. During decision making, anchoring occurs when individuals
 Quite simply, it is a mistake to think that a good company use an initial piece of information to make subsequent
is representative of a good investment and yet, that is judgments
exactly what people often seem to believe. Further,
according to market efficiency, excess returns should be Anchoring to Available Economic Cues
unpredictable. We are influenced by available cues instead of our own
 Assumption of good companies as good investment expertise. This occurs with real estate agents when appraising
 Good companies will sell at high prices, and bad houses, as well as financial analysts. There is also herding,
companies will sell at low prices. But, once the market has which is going with the crowd, and analysts all tend to give
adjusted, there is no reason to favor a good company over the same advice for the market (unless one is attempting to
a bad company. stand out by anti-herding).
Myth vs Reality
It is a mistake to think that a good company is representative Anchoring vs Herding and Analysts
of a good investment, and yet, that is exactly what people ANCHORING BIAS the tendency for the brain to rely too much
often seem to believe. on the first information it received when making decisions.
ANCHORING the use of irrelevant information, such as
Lesson 3: chasing winners purchase price of a security, as reference for evaluating or
Trend following estimating an unknown value of financial instrument.
Buy an asset when its price tend goes up, and sell when its HERD INSTINCT the phenomenon where investors follow
trend goes down what they perceive other investors are doing, rather than
their own analysis
Momentum chasing HERD MENTALITY refers to an investor habit where the
Traders buy and sell according to the strength of recent price decision to buy or sell is clouded by the behavior of others
trends around him. Thus, if everybody is investing in a particular
Momentum trading seeks to take advantage of market stock or sectors, there is strong tendency for a bunch of
volatility and price ... idea of momentum investing is built investors to do the same. This is without taking merits of
around chasing performance. investment into consideration
Research has also shown that investors choose Do’s and don’ts of investing to avoid herd mentality
securities and investment funds based on past performance.  Do invest in what you understand
•It's all too human to chase winners because we are driven by  Do not invest on the basis of a “hot” tip
a powerful human tendency called the recency effect. Stated  Do read up before investing
simply, it means that we overweight our most recent  Do not try to time the market
experience  Do invest according to your financial goals
•Such trend-following, or momentum chasing, has long been Human beings are prone to a herd mentality, conforming to
a popular strategy, and, coupled with detecting turning the activities and direction of others in multiple ways, from
points, is at the heart of technical analysis. the way we shop to the way we invest. The fear of missing
out on profitable investment idea is often the driving force
Availability and Attention Grabbing behind herd instinct which can be a mistake in many ways.
Investors tend to invest in stocks about which info is readily
available. This information comes in 3 forms:
This information comes in 3 forms:
  News reports on stock (negative tends to be ignored; short, it’s egotistical belief that we’re better than we actually
positive news induces purchases) are. It can be a dangerous bias and is very prolific in
 Unusually high trading volume behavioral finance and capital markets.
 Extreme returns
- Reduce the mental effort needed to make decision- Overconfidence Bias
making processes  Placing too much faith in your knowledge
- Heuristic can lead to deviation from optimal decision  Believing that your contribution to a decision is more
- They often rely on readily available internal valuable than it actually is
information and “gut feeling” “Overconfidence pertains to how well people understand
their own abilities and the limits of their knowledge.” (Hersh
At some decision points, the gathering of information by Shefrin, 2007)
decision model could result in long time delays and high When people are overconfident
costs, and, if decision errors are “cheap”, it is acceptable to Overconfidence can cause a person to experience problems
sacrifice decision quality and choose a simpler, fast, and less because he may not prepare properly for a situation or may
expensive evaluation method. get into a dangerous situation that he is not equipped to
handle.
How does heuristics impact the financial decision making of Examples:
investors? A person who thinks his sense of direction is much better
- When individual investors use heuristics, they reduce than it actually is. The person could show his overconfidence
the mental effort in the decision-making process, but by going on a long trip without a map and refusing to ask for
that leads to errors in judgement and, as a result, directions if he gets lost along the way.
investors make incorrect investment decisions, Effects of overconfidence
which could lead to the market becoming inefficient.  Overconfidence effects decision-making, both in the
But even though heuristics can lead to deviations from corporate world and individual investments.
optimal decisions, there is some accuracy close to more  In a 2000 study, researchers found that
complex decision rules which can be useful in difficult entrepreneurs are more likely to display the
decision-making contexts overconfidence bias than the general population.
Some succeed in their ventures, but many do not.

UNIT 6. THE IMPLICATIONS OF OVERCONFIDENCE BIAS IN

According to traditional finance theory the market is always
DECISION MAKING
rational and so are the investors but the changes in the
market were not properly explained practically by the
WHAT IS OVERCONFIDENCE BIAS? traditional market theory, so after the introduction of
Overconfidence bias is a tendency to hold a false and behavioral finance theory by “kahnemann and tversky”
misleading assessment of our skills, intellect, or talent. In (1974) it was clear that the human emotions involved in the
market are influencing it as well. So, a clear distinction was
made by the behavioral finance theory and the biases was
categorized in two main parts namely Cognitive biases and
emotional biases. Cognitive biases can be corrected by giving
additional knowledge to the investors, but emotional biases
may or may not be corrected as it is completely based on
human emotions.

 US Dollars
 Continuously increasing in US dollar price
 People become overconfident that price of US dollar
will always increase in the future
 They start buying US dollar blindly
 But suddenly prices are fall in 2014

 Stock market crash of 1929

 Most significant crash in US history
 Since 1922, the stock market had gone up, not down
– Nearly 20% a year.
  Over the four days of the stock market crash, the may not be the best example to inform your decision (Tversky
Dow jones losing $30 billion in market value and Kahneman, 1973)
 When the stock market crashed, brokers called in In other words, information that is more easily brought to
loans. Many people were wiped out, selling mind (i.e., more available) is assumed to reflect more
businesses and losing their life savings. frequent and/or more probable events.
While information that is more difficult to bring to mind (i.e.,
 Gold prices less available) is assumed to reflect less frequent and/or less
 Continuously increasing in gold price probable.
 People start investing in gold It is often the case that more frequent events are indeed
 But after oct-2012 prices start falling still now more easily recalled than less frequent events, and so this
mental manipulation regularly leads to rapid and accurate
 Motorola (1980) judgments in a range of real-world scenarios (Markman &
 Mobile phone coverage was weak Medin, 2002)
 Idea development was technically strong
 Technology changed in 1990
 Product (Mobile) launched in 1998
 Per phone cost $3000
 Moving cars and inside the building
 Bankrupt in 1999
 Sell for $25million
 Cost $5billion

Overconfidence Bias
Overconfidence = expected performance > actual
performance
Overconfidence (-ve) decision making
 Overconfidence is considered the most robust
finding in the psychological finding of judgment.
(Bondt and Thaler, 1995)

How does it affect investors’ decision

 Overconfidence causes investors to misinterpret the
accuracy of our information and overestimate our
skill in analyzing them.
 This can lead to poor investment decision, excessive
trading (Odean 1999), risk taking, and ultimately
losses.

Confirmation Bias
 Confirmation bias is also a cognitive bias. Its
tendency to affect decision making is greater in
males as compared to females (Zipporah, 2014)

Common Biases and Errors in Decision Making

Gambling Bias: Forming Portfolios
Overconfidence Bias – make us think we know more than we
 Gambler’s Fallacy is the tendency to think that future
actually do
probabilities are altered by past events, when in
The anchoring bias is a tendency to fixate on initial
reality they are unchanged. The expectation of
information and fail to adequately adjust for subsequent
growth in the future is related to another bias called
information. Usually, people emphasize the first receiving
gamblers’ fallacy
information.
Confirmation Bias – represents a specific case of selective
Availability Bias
perception; we seek out information that reaffirms our past
The availability heuristic is a cognitive bias in which you make
choices, and we discount information that contradicts them.
a decision based on an example, information, or recent
experience that is that readily available to you, even though it
Availability Bias – is our tendency to base judgments on  the overconfidence upshot is a well-established bias.
information readily available. (events that evoke emotions,  According to Shefrin, overconfidence “pertains to
are particularly vivid, or are more recent tend to be more how well people understand their own abilities and
available in our memory, leading us to overestimate the the limits of their knowledge” (Shefrin, 2007)
chances of unlikely events such as an airplane crash)  The tendency for explanations of other individuals’
behaviours to overemphasize the influence of their
How does overconfidence impact the financial decision- personality and underemphasize the influence of
making of investors? their situation
- Overconfidence causes investors to misinterpret the  Overconfidence is an unrealistic positive view of
accuracy of information and overestimate his/her skill in oneself and one’s performance.
analyzing them. This can lead to poor investment decision,
excessive trading, risk taking, and ultimately losses.
- Overconfidence may also have an impact at the level of
markets. It can afflict managers and entrepreneurs. They may
be too ready to enter markets, allow cash flows to dictate
investment, invest excessively, acquire other companies too
readily, and take on too much debt because of excessive
optimism or overconfidence.

Overconfidence
Ha: overconfidence affects investor’s decision making while
investing in stock market.
H0: overconfidence doesn’t affect investor’s decision making
while investing in stock market.

Overconfidence Bias
According to many psychologists’ people are usually
confident but whether they are overconfident or not depends
on their knowledge and their perception of the knowledge.
Basically, overconfident people tend to overestimate own
skills and accuracy of their judgement regarding investments.
People usually put their own personal information in priority,
and they put too much emphasis on that information
especially if they have gathered that information personally.
Overconfidence is a decision-making bias which influences
and overestimates the tendency to solve easy to difficult
questions. (Bazerman, 1994)
To paraphrase Lichtenstein and Fischoff (1977), the degree to
which people do not know what they do not know. Many
studies consider overconfidence bias as a cognitive bias, but it
is considered as an emotional bias widely because it is mostly
based on human emotions, and it may or may not be
corrected by giving additional information.
However, research has shown that some individuals exhibit
higher levels of overconfidence than others do (e.g., Karen
1987; Simon and Houghton, 2003; Yates et al., 1998). Building
on this insight, Busenitz and Barney (1997) found that
entrepreneurs were more overconfident than ordinary
managers and this is also impacting their financial decision
making.
 Researchers have proved that investors make
unreasonable investment decision.
 Overconfidence bias is an affection component of
the decision-making process.