Psychoanalysis of Investor Irrationality and Dynamism in Stock Market

Abstract

This article provides an alternative theoretical framework to explain investors’ irrational behaviours in finance theories (mainly asset pricing) based on psychoanalysis approach. This is an approach used by psychoanalysts and psychiatrists to investigate human minds. The investigation is facilitated by interdisciplinary theories, namely (a) bounded rationality theory which differentiates intuition and reasoning, (b) prospect theory which explains framing and valuation and (c) theory of mind which divides behavioural risks into cognitive heuristics and affective biases. These theories collectively explain the origin of irrational behaviours. Additionally, (d) the ABC (Activating–Beliefs–Consequences) model is also used to interpret the causes and effects of irrational behaviours on investors and market behaviour. Last theory, (e) the dual system model of preference is used to conceptualize the bounded human mind that contains both rational and irrational elements. The proposed theoretical framework provides the theoretical foundation of investors’ irrational origin, forces, causes as well as their systematic effects on investors, asset prices and stock market behaviours dynamism. The validity of the theoretical framework is supported by empirical test using a representative of emerging stock market data and behavioural risk proxies.

Heterogeneity of Sentiment Risk in Malaysian Stock Market

“…This research extends the works of Tuyon and Ahmad (2014) that provides discussion on the theoretical relations between sentiment and stock market activity and Tuyon et al (2015) that proposed CSI, BSI and FKLI as possible sentiment proxies. The objectives of this paper are to theoretically and empirically examine the heterogeneity roles of these sentiment proxies on aggregate stock market indice returns in the Malaysian setting.…”

“…In the Malaysian stock market environment, CSI, BCS, and FKLI are publicly available, commented on by economists, analysts, journalists and investment bloggers, and believed to be attended by both professional and retail investors as a potential valuable information in forecasting the future direction of the stock market. In this regard, in Tuyon and Ahmad (2014) we proposed the cognitive neuroscience based theory of mind (TOM) and cognitive psychology based theory of causation called the ABC model to theorize the association between sentiment and returns. Both these theories can justify the origin, cause and consequence of sentiment on investor thinking and behavior as well as explain their possible influence on the formation of share prices as illustrated in Figure 1 below.…”

The Roles of Investor Sentiment in Malaysian Stock Market

“…Idealised from interdisciplinary theories, this framework provides an understanding of the origin, cause, and effects of sentiment on market activity which has been earlier suggested in Tuyon and Ahmad (2014). The first theory is the neuroscience-based cognitive-affective theory of mind (Premack & Woodruff, 1978).…”

Anatomy Of Behavioural Risk Seasonality In Equity

“…To recap, in behavioral perspective, investors' decision will be influenced by rational (fundamental) and irrational (behavioral) as represented in equation 1. In reference to Tuyon and Ahmad (2018), the stock return model with fundamental and behavioral risks are presented in equation 2. Where, represents the sensitivity of stock j to the respective risk factor k. The risk measures incorporate both fundamental factor and behavioral factors.…”