Impact of Behavioral Finance on Financial Strategies and Market Efficiency

[Music] supposing you and your friends were plan for a short traits of vacation at out of

town location by tomorrow everyone is talking about should we all bring along a raincoat in case of raining and

obviously there's no straightforward answer for it people who believe it might be raining tomorrow will bring

along the rain cold and those who are not believing in it may not bring along the wrinkle so there is no one answer

for it different decisions hence is made due to different kinds of behavior and mindset guys don't you realize such

phenomena also apply and appear in the context of financial management in making all financial decisions and all

these behaviors are collectively term behavioral Finance hello my name is zik Chan the

expert tutor for Advanced Financial Management this topic explainer is about impact of Behavioral Finance on

financial strategies in these sessions of the topic explainer the discussions will be

made mainly on Acca resources primarily from the study hub for learning purpose you are advis to refer to the relevant

chapters for this topic explainer it is found in Chapter 2 particularly section 2.1 and to be more precise

2.1.5 about behavioral Finance for practice purpose you are advised to visit ranges of

quizzes relating to the chapter ranges of practice questions which either appearing in the form of exam format

revision questions other revision questions and study question questions for

practice finally upon wrapping up the knowledge recapping the knowledge will be Essential by visiting flash cards

providing you ranges of terminology on all the technical terms and last but not least technical article particularly

titled patterns of behavior will be worth reading and that followed by the ranges of past Year's questions found on

practice performance and feedbacks suggestions given in examiner report were highly recommended

to be used as learning purpose at the first part of this video I'll take you through what is behavioral

financed what give rise to ranges of all such Behavior Follow by what exactly are the ranges and the types of Behavioral

finance that were mentioned implications of Behavioral Finance on financial strategies of

investors and businesses finally how can behavioral Finance contribute to market efficiency towards the end of this video

the demonstrations will be made referring to an extract of a p Year's questions pertaining to behavioral

Finance so guys what exactly is behavior of Finance according to the order it describ an influence of psychology on

Behavior or financial practitioner but before we pluck in all these technical term to understand how

Financial practitioner behave in different psychological state of condition let's revisit the example of

the short vacations that mentioned at the beginning of this video people or team member in The

Holiday Tour may prefer not to bring along a rain perhaps the reason of making such a

decision could be due to they refer to the weather at the same point in the past so based upon the track record in

the history at the same point in the past it was not raining so with this assumption that it may repeat the same

weather conditions on tomorrow that just happened in the past at one point of time people will therefore decided not

to bring the rainold that would be why one of explanations on the behavior secondly people may believed

that in the past couple of days or weeks the location has not been raining so therefore there could be a

possibility that tomorrow may be raining and this day for explain the other group of people may say I may want to bring

along the rain Cod because it has not been raining for the last consecutive days I may want to assume that tomorrow

may be raining so that would trigger a different decision made alternatively another team member may say well I would

believe that based upon the track records of not raining instead of

believing it may be raining tomorrow the other group member will say I believe the trend May persist in other words a

sunny weather condition will be assumed by another team member as such this explain why another team member may not

want to bring along the rain cold well obviously another team member also do not prefer to bring along the rain Cod

for another reason and say but because of these sunning weather that found in the past of this location they believe

this momentum may continue in the future guys do you notice all these explanations would tends to tell why is

the decisions being made due to different state of mind and belief and all these things in simple were

described by these explanations on the definitions of Behavioral Finance the influence of psychology on behavior of

an individual let's apply it into financial management the behavior of Finance

explain in reality financial decisions makes are not necessarily at all times

rational instead many financial decisions made were irrational it is same goes to the

example of the vacation with the rain cods to bring along or the otherwise guys it is worth for you to

take note what it meant by rational decisions making as what you may have learned in other part of the syllabus

decisions should be made based upon relevant informations that is been available so what do we mean by relevant

information informations that arise in the future and ideally it is specific and cash flow related these are term as

relevant information that will be considered in making financial decision and all these decisions were made with

considerations on objectives that to be met in running a business or account company it is always common to hear that

the fundamental the primary objectives of running a business is always aim to maximize the wealth of the shareholder

which exactly what it meant by maximizing the utility of the business operation and running the business

activity it's always expected to encounter risk so that is equally important to bring up the considerations

on the risk appetite in the IR rational decision making mindsets without any further additional evidence or

information indicating the riskiness of the outcome one should behave in the form of risk neutral so these are the

three main condition that describe what it meant by a rational decision maker however behavioral Finance is

proven that it may not be the case in many of the occasion so from there it they T

behavioral Finance therefore discover or unveil the justifications for many types of financial decision among the common

one investment decisions that found in many businesses as well as strategy adopted by individual investors B

members or managers of the company all these decision tends to be affected not only by rational mentality but it is

heavily affected by ranges of irrational Behavior this bring up the need to understand what exactly are the ranges

and the types of Behavioral Finance to understand the types of Behavioral Finance referring to the

study Hub you will notice it is an overwhelming answers for it they are a total of 17 types of Behavioral finances

discovered so how exactly to make your life easier to understand better on what exactly these behavioral finances are

all about my suggestion is try to imagine each and every types of this behavioral Finance is prompt to

challenge the validity of the three condition that claim people make make decision in the rational manner in other

word the challenges is first to prove not necessary everyone is making decision based on relevant

information secondly another group of Behavioral Finance would then prove not everyone tends to behave in a risk

neutral attitude it may be occasions where people tends to behave in the risk seeking attitude or risk averse

attitude both of these disturbance will ultimately lead to a disturbance on achieving rational objective that was

meant to be maximizing utilities or the wealth of the shareholders which behavior of Finance proven it may not be

necessarily true people tends to achieve in the suboptimal objective at most of the time so what exactly are those

behavior of finance that cause the disturbance and the challenges in meeting all the three

criterias guys let's take a look at the first category the there are five main types of behavior which found under

behavioral finance that are to disturb the usage of relevant information in decision making

anchoring Gambler fallacy positive feedback noise trading and tratment you should spend time looking

at and reading up study Hub as well as the technical article for full detail of explanation with example I would like to

call you a two simple example by making use of these two of out of the five behavioral finances that disturb the

usage of relevant information do you still remember the example I quote for the holiday when team member believe at

one point of the time in the past the weather of that particular day it's sunny so that make the person believe

that same weather condition May repeat again these day for indicate a person is making the decision based on a point of

the historical result as a decision-making criteria that Anchor Point is describing such Behavior

anchoring same thing appli in financial management decision maker example investor May believe the performance of

the share price will move up or down at this point of time based upon the performance at one point of the time in

the past secondly Gambler fallacy based upon the prediction on

tomorrow's weather whether it is going to rain at the Holiday vacations location the person may look at the

trend of the weather conditions at the past of that location should the locations in the

past as mentioned at the beginning of the video was proven sunny weather this person may therefore believe maybe the

sunny weather will come to the end so tomorrow they will put a back and speculating there may be raining

tomorrow so with this kind of speculation the person in the team may want to bring along the rinkle same

thing apply for the prediction on the movement of share price for the investor based upon the past trends of the

movement that believe the trend may come to the end and the reverse may happen this mentality will call Gambler

fallacy guys there are many illustration and example that were found in the study Hub and article explaining the rest of

the behavior of finances apart from the first five let's visit the other group of Behavioral

finances that were disturbing the risk neutral and attitudes of an investor

guys they were one of these category of behavior that tends to encourage investor or decision maker

tends to be reeking and this Behavior it's term overconfidence whereas they may have

some other behavior that may seduce the person or the investor t to be RIS Avers and

these source of the solution is coming from three different type of behavior namely

conservatism ambiguity aversion regret aversion so these could be the explanations why someone tends to be re

reservers or tends to be behave conservatively which otherwise not necessary last but not least the other

group of behavior of finance that discover that this time it may lead the investor or decision maker to be

undecisive as to whether they should be reeking or they should be reservers so these undecisive directions of the risk

appetite may be let by ranges of behavior such as representativeness momentum effect

narrow framing confirmation biased availability biased and last but not least miscalculation of

probabilities guys do you still remember the illustrations I gave at the beginning on the vacation when someone

believed that if the weather in the past has been a signing weather on the locations for the

holiday same may have happened in the future that following the trend that seems to be the opposite mindset of

Gambler fallacy and this kind of assumption on a representation from the past that is to

be continue to the Future this were termed as representativeness Behavior it could be the same kind of

mindset and answer in the mind however explaining by different reasoning and mindset and these will be called

momentum effect where people may believe tomorrow may not be raining just because that in the past it has not been raining

so they believe this kind of momentum tends to continue so with this kind of momentum belief people will therefore

make the decisions accordingly so this will call Momentum effects so guys spend some time go through the study Hub find

out the reason and the meaning of all of other Behavior discovered in behavior of Finance finally with the distortion on

the rational Behavior by looking at relevant information and a distortion of the risk neutral attitude there will be

a high possibility that these Behavior May L to a deviation from achieving rationale

objectives so when it come to The Challenge on making decision that lead to rational objectives these are two

other possible types of behavior that discover by behavior of Finance connective dissonance and loss aversion

bias so how does this apply to the example of the vacation you may simply refuse to bring a rainco for the shop

trip tomorrow just because that you want to prove to people that your decision make is Right despite the fact all the

evidences including the weather forecast from the media have say there will be a high chance that tomorrow there will be

a raining weather on the locations for where your locations for the vacations is located just that you refuse to admit

the wrong decisions you make you insist on holding back your origal decision this is called connective dissonance

don't you think so guys it is equally common found in a lot of financial decision made and financial strategy

formulated by businesses that tends to suboptimal yet people just refuse to admit the mistake they would insist to

carry on such decision and strategy so guys after hearing some of the explanations and demonstrations on

some of these type of behavior that found in behavioral Finance how would these be affecting Financial strategy of

investors and businesses here is the answer financial decision made that influenced by

behavior of finances May reflect mispricing of asset an investor a decision maker may have ended up

overpaying the price in acquiring the asset or maybe disposing the price at undervalue so all these are term

mispricing of asset at the same time misalignment and mismatch of one desire risk appetite could be an influence as a

result of Behavioral finances and ultimately all this Distortion may lead to deviation from the desired Financial

objectives these state for explain how different types of behavior discover in behavioral finances distort the

achievement or reflecting ranges of rational Behavior guys with all these findings

how exactly behavioral finances then explain and affect market efficiency well there are two way of

thoughts one behavioral Finance is possibly to proved that is a contradictions with what the findings

that is covered by efficient market hypothesis meaning the EMH believes share prices in the market should

reflect the informations that make available at one point of time which depending on level of stock market

efficiency however behavior of Finance explain not necessarily true people make decision at an irrational conditions at

many point of the occasion but because of these irrational decisions to be made behavioral Finance however contribute to

the market efficiency on the other way given that different Financial decision were actually made by different

individual or practitioner that behave differently in other word at any point of the price level of an asset example

share or Bond there will be people that promp to invest they will also prompt to be people that prompt to sell the asset

even there's a supply there's a demand in the market for the asset that create liquidity that create the trading

activities of all asset and Creations of activities in trading and liquidity in the market that will therefore

contribute to improve the market efficiency and this market efficiency is providing an opportunity for every

individual to learn and realize the mistake they make from the irrational behavior in long term hopefully one will

behave towards more rational manner so guys time for us to take a look at how ranges of behaviors that

discussed a moment ago that apply into the following extracts of a past year questions well as mentioned this is an

extract of a past exam questions please pause the video read through the requirement think through your answer

plan the requirement is asking discussed behavioral factors that may have led to businesses such as metr verse tag being

overly valued so this is clearly explaining why is that the the price the share price of this company is overly

stated well guys pausing the video go through the informations carefully based on this extract what do

you have to realize to answer questions on behavioral Finance here are some advises for you number

one when you go through the informations given by the story and the scenario identify is there any decisions is there

any descriptions regarding prices regarding values of an asset that seems to be out of the norm

or is there any kind of decision made or any strategies that formul related not explained by rational

behavior when you discover any of those evidences try to ask yourself what could be out of the 17 types of the irrational

Behavior which of it would be possibly be explaining such phenomena once you identify a potential

irrational Behavior the last things that you need to figure out it's that how how do you connect them how do you try to

look for evidences from the scenario to join up the phenomena as described in the scenario and explained by this

particular this irrational behavior that you may want to articulate ensuring that the articulation is systematic well in

manner this is how you form your answer for answering questions pertaining to behavioral Finance so guys our therefore

suggest by going through the extract of this information you will notice W or West py Company it's the first company

that describe in this questions based upon background information such as listed company as a background retailer

businesses as the nature of business operation selling ranges of foods and household good this company has been

performing relatively well due to the following critical success factor as mentioned followed by the share price

performance of this company in the recent year has performed better than many of the competitor or player in the

retail sector the questions went on tells you about the disappointing share price performance on the retail sector

so on one hand it is trying to show how outstanding the performance of West Pary comparing to other player but at

the same time guys do you see the word exception the questions is going on and telling us while share prices of many

retail sectors company are done poorly there is one exception where the share price in the retail sector specializing

in computers and high technology Goods however are doing pretty well the share price seems to show a

boom obviously however based upon findings and comments from some analyst they believe this share price in the

high-tech sectors has been significantly higher than what it sounds to be should

rational mindset is applied on valuing such share guys don't you think so that's provide a crucial hint something

that is not rational so pick this up and start creating the idea of what could be the type of irrational behavior that

could help to explain such an abnormally High share prices in this industry followed by here comes another

Target meterse company well they are another listed company and why is that a center of attention that's simply

because that meterse company is now becoming a target of acquisitions by West

Pary keep it short a meterse company the target company it has two type of store home and teac keeping an eye about metr

verse Tech as what relating to part A of the questions these segment of the businesses involved in selling computers

and phones guys if you connect the nature of this businesses with the outstanding share

price performance in computer and Hightech sector don't you think these is trying to tells you that the share price

performance or the value of these businesses are also tends to be overly valued if you manage to connect this

together this day for explain why the following statements happen to be so West Pary would therefore plan to take

the advantage on the current values relating to the business such as the technology company like metroverse Tech

so therefore they would like to C the price of metroverse TCH based upon PE ratio instead of following the value

that deriv by it believes to be a more rational approach valuation looking at Future free cash flow however that is

not the value that vest party may be looking at instead they prefer to refer to another valuation model PE ratio that

tends to refer to the historical performance in the past at one point of time so guys that seems to provide hint

and clue for another irrational Behavior such as anchoring

finally part of the plan for Metro company it's the the moment the Acquisitions of all the share capitals

of M company has been completed W West py Company would like to sell metroverse Tech because of the reason it doesn't

fit well in the strategy but at the same time they will also like to take advantage on the overvaluations of the

businesses in metr T So guys spend some time organize your creativity what are the irrational behavior that could ties

back to the clue that Mark with the questions mark over here so here is a bit of the

demonstrations of my answer planning I may want to start telling the marking team that the behavioral factors that

were asked to explain this phenomena may be pertaining to the three of the main criteria or condition as mentioned a

moment ago that form rational decision making so I would need to pick up those irrational behavior that serve to be a

challenge to any of the three condition you may want to think about identifying at least one of the irrational behavior

that go under the challenge of each of these three characteristics then connect back to the scenario and form a solid

and well articulated justification so here is the demonstrations on one of the irrational Behavior I may picked it

up noise trading and let's take a look at how I articulate with the justifications of

the proofed why do I make myself believe that noise trading seems to be found in the abur phenomena on the valuations of

the share prices in metroverse tech industry that tends to be overly valued I say the boom in the share prices of

this Hightech company may have indicated a high demand for shares in these sector what make this happen and I say this

pattern and Trend May therefore have created noises for other investors to just follow by applying the similar

investment strategy and these noises will therefore help to escalate the rising trend in the share price so

that's how I explain the phenomena that explained by noise trading and guys pause the video spend

some time take a look at how the model answer has produced with segregation based upon hings and describing each

type of irrational behavior that based upon the evidences that provided in the scenario once you have gone through

these explanations from the model answer you will notice there are six different types of Behavioral finances discovered

with all the supporting explanation so guys with this video I hope you will understand that behavioral finances is

appearing not only in the context of financial management but it is something that explain every movement and decision

we make in life with that thank you for watching [Music]