New Heritage Doll Essay Example for Free

New Heritage Doll Essay This paper summarizes recent studies in behavioral finance—particularly regarding market anomalies and investor behavior—that are not reconciled with the traditional finance paradigms. This paper differs from previous survey literature in several aspects. We introduce more recent papers in the field, more literature on behavioral corporate finance, and provide statistics on the recent trends that are explored in behavioral finance papers. We expand the research scope to studies on Korean financial markets, introduce specific funds using behavioral finance techniques, and discuss the challenges facing behavioral finance. Keywords: Behavioral finance, Market anomalies, Market efficiency, Survey of literature *  Hyoyoun Park: Credit Analyst, Euler Hermes Hong Kong Services Limited, Suites 403-11, 4/F Cityplaza 4, 12 Taikoo Wan Road, Taikoo Shing, Hong Kong; phone: +852-3665-8934; e-mail: [emailprotected] **  Wook Sohn (Corresponding author): Professor, KDI School of Public Policy and Management, 87 Hoegiro, Seoul 130-868, Korea; phone: +82-2-3299-1062; e-mail: [emailprotected] kdischool.ac.kr. 4 Seoul Journal of Business INTRODUCTION Although Modern Portfolio Theory (MPT) and the Efficient Market Hypothesis (EMH), which represent standard finance, are successful, the alternative approach of behavioral finance includes psychological and sociological issues when investigating market anomalies and individual investor behavior. In the financial markets, we often observe some phenomena which cannot be explained rationally. For example, we do not have any logical evidences on random walk in the stock price movement while many fund managers use several behavioral concepts in their investment strategy. In corporate perspectives, company owners and managers do not rely only on logical elements to make critical decisions on mergers and acquisitions and new investment. Two of the key topics discussed in behavioral finance are the behavioral finance macro, which recognizes â€Å"anomalies† in the EMH that behavioral models can explain, and the behavioral finance micro, which recognizes individual investor behavior, or biases that are not explained by the traditional models incorporating rational behavior. In particular, we employ the behavioral finance micro because it explains a number of important financing and investment patterns by using a behavioral approach, which expands on the research in the behavioral corporate finance field. This paper summarizes these two major topics in behavioral finance, which include behavioral corporate finance, and introduces evidence that adopts behavioral concepts in the actual financial market. It also describes challenges to behavioral finance by reviewing recent studies and surveys. Recently acknowledged theories in academic finance are called standard or traditional finance theories. Based on the standard finance paradigm, scholars have sought to understand financial markets using models that presume that investors are rational. MPT and the EMH form the basis of traditional finance models1). How1) Harry Markowitz introduced MPT in 1952,  and he illustrated relationships between portfolio choices and beliefs in terms of the â€Å"expected returns–variance of returns† rule. Ricciardi and Simon (2000) defined MPT as an expected return, while standard deviations of particular securities or portfolios are correlated with the other securities or mutual funds held within one portfolio. Another major concept is known as the EMH, which states that investors cannot consistently  ever, if researchers only use the MPT and EMH, individual investor behavior is not easily understood. In contrast, behavioral finance is a relatively new concept in the financial markets, and is not employed within standard finance models; it replaces traditional finance models, and it offers a better model for human behavior. Although MPT and the EMH are considered as successful in financial market analysis, the behavioral finance model has been developed as one of the alternative theories for standard finance. Behavioral finance examines the impact of psychology on market participants’ behavior and the resulting outcomes in markets, focusing on how individual investors make decisions: in particular, how they interpret and act on specific information. Investors do not always have rational and predictable reactions when examined through the lens of quantitative models, which means that investors’ decision-making processes also include cognitive biases and affective (emotional) aspects. The behavioral finance model emphasizes investor behavior, leading to various market anomalies and inefficiencies. This new concept for finance explains individual behavior and group behavior by integrating the fields of sociology, psychology, and other behavioral sciences. It also predicts financial markets. Research in behavioral corporate finance studies highlights investors’ and managers’ irrationality, and shows nonstandard preferences, and judgmental biases in managerial decisions. Currently, many companies apply behavioral approaches to determine important finance and investment patterns. Several theories under the banner of traditional finance develop specific models by assuming the EMH and they explain  phenomena in markets; however, in the real financial market, many problems and cases cannot easily be explained via those standardized  models. In the cases involving managers or investors, unbiased forecasts about future events need to be developed and used to make decisions that best serve their own interests. In this type of situation, we need to entertain more realistic behavioral aspects, as there is evidence for irrational behavior patterns that cannot be explained by the traditional or standard financial theories. To be specific, Shefrin (2009) pointed out that the root cause of the global  achieve an excessive return over market returns on a risk-adjusted basis because all publicly available information is already reflected in a security’s market price, and the current security price is its fair value. Financial crisis of 2008 was a psychological, not fundamental phenomenon. Risk-seeking behaviors were evident in the loss-dominant markets, while excessive optimism and confirmation bias acted as driving factors behind the crisis, and not fundamental factors such as terrorism, skyrocketing oil prices, or disruptive changes in the weather. We can understand, identify, and address psychological distortions in judgments and decisions by considering behavioral concepts, and then we can integrate both traditional and behavioral factors to be better prepared for dealing with any psychological challenges. As mentioned, managerial decisions are strongly affected by cognitive biases and emotional aspects in real financial markets, as human beings are not machines. Additionally, evidence of  mispricing and market anomalies that cannot be fully explained by traditional models, is prevalent. Thus, we would like to propose behavioral finance in this paper to clearly explain a number of important financing and investment patterns, aiding  investors in understanding several abnormal phenomena by integrating behavioral concepts with existing. Ricciardi and Simon (2000) defined behavioral finance in the following manner: â€Å"Behavioral finance attempts to explain and increase understanding of the reasoning patterns of investors, including the emotional processes involved and the degree to which they influence the decision-making process. Essentially, behavioral finance attempts to explain the what, why, and how of finance and investment, from a human perspective† (Page 2) (See figure 1). Shefrin (2000), however, mentioned the difference between cognitive and affective (emotional) factors: â€Å"cognitive aspects concern the way people organize their information, while the emotional aspects deal with the way people feel as they register information† (Page 29). We understand that there are several survey literatures on behavioral finance. However, this paper differs from the literature in several aspects. We introduce more recent papers in the field and expand the research scope to studies on Korean financial markets. We introduce more literature on behavioral corporate finance, provide statistics on the recent trends that are evident in behavioral finance papers, introduce the specific funds that are using behavioral finance techniques, and discuss the challenges of the behavioral finance model. Source: Ricciardi and Simon (2000)  particularly regarding market anomalies and investor behavior, which cannot  be explained by traditional finance paradigms. In section 2, we introduce two topics in behavioral finance: cognitive biases and the limits of arbitrage. In section 3, we summarize the research on behavioral corporate finance. In section 4, we examine behavioral applications via two routes: evidence from real investments and specific evidence from the Korean financial market. In section 5, we analyze the recent developments in behavioral finance publications. Section 6 discusses several challenges to behavioral finance and ends with suggestions for future research. TWO TOPICS IN BEHAVIORAL FINANCE Behavioral finance is a study that combines psychology and economics, and it tries to explain various events that take place in financial markets. For example, from the behavioral finance  perspective, some individuals’ limitations and problems are shown in the expected utility theory and in arbitrage assumptions. In particular, there are two representative topics in behavioral finance: cognitive psychology and the limits of arbitrage.2) Cognitive Biases Under the traditional and standard financial theories, investors are viewed as being rational. Basically, a rational economic person is an individual who tries to achieve discretely specified goals in the most comprehensive and consistent way while minimizing any economic costs. A rational economic person’s choices are determined by his or her utility function.