Examing the Effects of Investor Biases on Asset Allocation
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Behavioral finance, a concept that began in the late 20th century, is a pillar of finance that has made its way into a solid structure of current theory. The goal of behavioral finance is to challenge the assumptions of the traditional theories of rationality, efficient market hypothesis and the modern portfolio theory. The theory looks at how under most cases people do not fit the assumptions that have dominated the markets over the past century. Behavioral finance looks at this claim by stating that people have different behavioral biases, and that individuals are not as rational as past theories explain. This study utilizes the tools of a survey in which 25 individual investors were surveyed to try to uncover any variances from a rational model. This study found that all participants, when tested for four different behavioral characteristics, exhibited at least one of the behavioral biases. Furthermore, this study found that even through some participants indicated that they were risk seeking, it was contradicted through the uncovering of these biases. This study attempts to further the argument that most investors are indeed not rational, and that the markets and theories should not treat them as such. Future research can be extended from this. For example, researchers could attempt to uncover even more biases that people have and develop a concrete model as to how a portfolio should accurately be adjusted for the presence of particular behaviors.