Financial Risk Management
The Impact of Herd Mentality and Pain of Regret Bias on Investment Decisions

Article Details
Pub. Date : December, 2020
Product Name : The IUP Journal of Financial Risk Management
Product Type : Article
Product Code : IJFRM41220
Author Name :Priya Angle and Sasmita Giri
Availability : YES
Subject/Domain : Finance Management
Download Format : PDF Format
No. of Pages : 16

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Abstract

This paper examines how the herd mentality and regret bias of investors impact their investment decisions. Primary data was collected from employees, stock brokers, students and others who are either active investors in the stock market or following it regularly. The questionnaire is divided into two parts, consisting of demographical questions and technical questions on herd mentality and regret bias. Regression analysis and descriptive analysis were done on the data. The approach of this study is different as it uses situation-based questions and demographics to find out how their affect the investor's biases.


Introduction

Classical and neoclassical finance theories assume that the market conditions are ideal, but in reality, the markets are more chaotic. The Dutch Tulip Bubble, the South Sea Bubble, Japan's Real Estate Bubble, the Dot-Com Bubble and the US Housing Bubble are some examples which the conventional finance theories have failed to explain. These deviations resulted in the emergence of the behavioral finance. Behavioral finance uses cognitive psychology along with conventional theories to analyze the irrational behavior in the investment patterns of individuals. Kahneman and Tversky (1982) are considered to be the fathers of behavioral finance (Choudhary, 2013). They did the first research in this field on how people underweight the outcomes that are obtained with certainty.

Economists argue that markets are not efficient all the time, especially in the short run, and people make irrational decisions at that time as they have a tendency to focus on profits. They tend to make decision based on advice, herd approach, emotions and sentiments, and not on the basis of logic. This results in making the investors buy more when the market is rising and sell when the market is falling. Investors buy more and more out of greed, and when something negative happens, they sell immediately without checking where the problem has occurred and which sector stocks are getting affected.

At times, investors display irrational and unpredictable behavior, which existing theories have failed to explain. Ultimately, investors incur losses by letting emotions affect their investment decisions. People get information from different sources and take that into consideration while making decisions. Behavioral economists have found some emotional


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