Cognitive Biases as an Integral Part of Behavioral Finance

Abstract

The complex world of finance is characterised by numerous irrationalities that representatives of behavioral finance seek to explain by cognitive biases (flaws, inclinations or anomalies). Cognitive biases represent imperfect perception of reality and are caused by limited cognitive capacities of decision-makers. By analysing cognitive biases, the paper aims to answer the following questions that standard finance fails: Why active portfolio strategy is still the most influential strategy in portfolio management despite the mounting evidence of unsuitability of its application? Why investors prefer dividend payout over increase in capital value (dividend puzzle)? Why investors ignore benefits of investment diversification and choose to invest in a small number of shares of well-known local businesses (diversification puzzle)? Why investors avoid to sell “loser” shares and thus reduce the tax burden? Why shares of small companies usually bring higher returns compared to shares of large companies? The answers to these questions are obtained by using qualitative research methodology, which also represents the main result of the research.

Psychological Indicator(s) in Stock Activities considering SDGs: The Wealth Maximization Criteria of Investors and Growth of Economy

“…Behavioral finance responds to the query of why investors constrain methodical errors and how the psychosomatic phenomenon disturbs investor capabilities to make a decision (Leković, 2020). This research finds the causes of biases that affect the investment decisions and finds the relationship between endowments bias that allows the irrational and suboptimal decision making.…”

Cognitive Bias and Emotional Bias in Investment Decision Making With Risk Perception Mediation

“…On the other hand, prospect theory relates to the idea that individuals do not always behave rationally. This theory states that there are persistent biases motivated by psychological factors influencing individual choices under conditions of uncertainty (Leković, 2020). Purchase decisions made by investors are not only based on rational considerations.…”

“…The state of mind that can affect the investment decisionmaking process often occurs when behavioral bias occurs due to the tendency to choose wrong investment alternatives (Civek, 2019). Investors who experience bias will ignore existing information and facts and with all their abilities, they are able to conclude something on their own and believe that their choice is the most correct (Leković, 2020). Behavioral bias consists of cognitive bias (cognitive factors) and emotional bias (emotional factors) from within each individual which can influence it in making investment decisions (Pradhana, 2018).…”

Can Artificial Intelligence (AI) Manage Behavioural Biases Among Financial Planners?

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