An Understanding of the Landscape of Behavioural Finance Biases and the Adoption of Mathematical Models in Strategy Formulation
Keywords:
Behaviour, Finance, Biases, Mathematical Models, TheoriesAbstract
Persistent occurrences and phenomenon in the economic and financial systems about which there appears to be no sustainably effective solution are of concern to various stakeholders. Following the financial crisis of 2007-2008 there was a flurry of research activity geared towards explaining what the major causes of this and similar occurrences before were. Similar soul searching occurs after every such phenomenon, as evidenced when the South Sea Bubble burst centuries ago and other such crises that have occurred in the financial markets. This paper reviews some of the theories and what, in behavioural finance, are referred to as biases. An emerging strand of research is the field of neuroeconomics according to which medical imaging technology now allows us to look at brain activity as decisions are being made. The approach helps us to understand the nature and reasons for certain behavioural biases. Recent scientific studies have demonstrated that individuals with brain lesions that impaired emotional decision-making were more likely to behave as rational investors than individuals with normal brains. The paper reviews some of the quantitative or mathematical models used to explain behaviour underlying strategies used to make decisions in financial markets in particular and investment in general, namely, Prospect theory model, Quantitative Behavioural Model (QBM) and Igor’s portfolio rule and investment strategies model.
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