A Conceptual Framework of Behavioral Biases in Finance

-- Khushbu Agrawal

The behavior of financial markets and decisions of individuals are many a time driven by various biases. This can be attributed to the tendency of humans to resort to shortcuts owing to the constraints on time and mental capacity to process unlimited information. Various researchers have made an attempt to classify these biases into various types. But these biases have been viewed in isolation, thereby ignoring the possibility of any interaction or relationship between them. This paper aims to provide a comprehensive view of the behavioral biases by taking into account such interactions and developing a conceptual framework that incorporates the antecedents or causes of the biases and their outcomes or consequences. It also explores the possibility of overcoming some of the biases. It is argued that certain biases reinforce each other. The strength of each bias is a function of several factors like the external environment and presence of other biases in the process. The paper concludes that behavioral biases have been and will continue to influence human judgement. Although it is possible to avoid some of the biases in specific situations, it is not possible to completely eliminate them.

© 2011 IUP. All Rights Reserved.

Prospect Theory and Tunisian Banks’ Risk-Taking

-- Nabila Zribi and Younes Boujelbène

The aim of this paper is to analyze bank’s risk-taking from a behavioral perspective. The paper addresses this issue through a special case: risk attitudes based on the prospect theory introduced by Kahneman and Tversky (1979) and Tversky and Kahneman (1992). According to this theory, agents usually underweigh the probable results compared to certain ones, which implies that agents are risk-averse when the gains are certain, and risk-seeking when losses are certain. In this respect, this paper analyzes the relationship between outcome variability and distance from target. Targets are defined as the median values of return variables. The results reveal that: in below target case, the results confirm the prospect theory; the distance from target is generally found to be negatively associated with the dispersion from the mean. In above target case also, the results do confirm the prospect theory; the distance from target is generally found to be positively associated with the dispersion from the mean.

© 2011 IUP. All Rights Reserved.

The Impact of Level of Purchase Decision Involvement on the Investment Behavior of Mutual Fund Investors

-- Sanjay Kr. Mishra and Manoj Kumar

This study investigates the impact of level of Purchase Decision Involvement (PDI) of Mutual Fund (MF) investors on their investment behavior through a survey of 268 MF investors. Overall the results suggest that the level of PDI significantly impacts the investment behavior of MF investors. Further, the results suggest significant difference in the width and depth of information search and information processing by low PDI MF investors and high PDI MF investors. Specifically, it is found that (a) during information search low PDI MF investors are likely to use fewer number of information sources to collect information, rely less on sources providing detailed information related to MFs (e.g., financial portal) and rely more on banks as a source of investment advice in comparison to high PDI MF investors; and (b) during information processing low PDI MF investors are likely to use information on a fewer number of attributes to compare MFs, and do not process MF-related attribute information in details in comparison to high PDI MF investors. The implications of the findings that are relevant to the marketing of MFs are also discussed.

© 2011 IUP. All Rights Reserved.

Investment Decision Making: A Gender-Based Study of Private Sector Bank Employees

-- Lalit Mohan Kathuria and Kanika Singhania

The fast growing Indian economy has led to higher income level and availability of new investment avenues. Government savings departments, banks, financial institutions and mutual fund houses are vying for a share in the savings of investors. Investors now have many options for making investments like debt instruments, stocks, mutual funds, gold, etc. With the role of women becoming increasingly important in the family as well as society, it becomes important to examine the investment behavior of women investors. The present study analyzes the level of knowledge regarding various investment avenues, select investment practices, and factors influencing investment decision making among male and female employees of private sector banks in a city of India. The study reveals that both male and female respondents were using magazines, Internet and TV channels as the three most important sources of awareness for collecting information about various investment alternatives. Also, male and female respondents were investing a larger portion of their savings into safe and risk-free investment avenues, like employee provident fund, public provident fund and life insurance policy.

© 2011 IUP. All Rights Reserved.

Evaluation of the Financial Ratio Capability to Predict the Financial Crisis of Companies

-- Fazlzadeh Alireza, Mohammadzadeh Parviz and Sheikhi Mina

This research evaluates the capability of financial ratios for predicting the financial crisis of companies. Predicting the financial crisis of institutions has been constantly the concern of different groups of users, because the final effectiveness of each decision has a direct relation to the accurate predicting of its consequences. One of the tools for predicting the financial crisis of companies is the use of financial ratios as independent variables and attaining some patterns for predicting financial crisis of companies. This research is aimed at presenting a model in a way suitable for Iran’s environmental conditions with a selection of 64 financial ratios for relatively predicting the financial conditions of companies in one, two and three years before bankruptcy. Analyzing the information of two groups, including that of 44 bankrupt and 56 non-bankrupt companies between 2003-2007, using the discriminant analysis, a final model was presented which was able to predict the financial situation of companies in the year of bankruptcy with an accuracy of 94% and in the years previous to the bankruptcy with an accuracy of more than 80%, showing the high potential of financial ratios for predicting.

© 2011 IUP. All Rights Reserved.

Price Discovery and Volatility Spillovers in Indian Spot-Futures Commodity Market

-- P Srinivasan

The present paper examines the price discovery process and volatility spillovers in Indian spot-futures commodity markets through Johansen cointegration, Vector Error Correction Model (VECM) and the bivariate EGARCH model. The study uses four futures and spot indices of the Multi Commodity Exchange of India (MCX), representing relevant sectors like agriculture (MCXAGRI), energy (MCXENERGY), metal (MCXMETAL), and the composite index of metals, energy and agrocommodities (MCXCOMDEX). Johansen cointegration test confirms the presence of long-term equilibrium relationships between the futures price and its underlying spot price of the commodity markets. The VECM shows that commodity spot markets of MCXCOMDEX, MCXAGRI, MCXENERGY and MCXMETAL play a dominant role and serve as effective price discovery vehicle, implying that there is a flow of information from spot to futures commodity markets. Besides, the bivariate EGARCH model indicates that although bidirectional volatility spillover persists, the volatility spillovers from spot to the futures market are dominant in case of all MCX commodity markets.

© 2011 IUP. All Rights Reserved.