The influence of psychology on investment decision-making

Abstract

Classical or standard finance has shown certain limitations, particularly in explaining and predicting stock market dysfunction. Behavioral finance offers a complimentary perspective to the analysis of this dysfunction by integrating the psychology of the investor. It brings together several fields such as psychology, even sociology or anthropology and tries to integrate it with economics. It has shown the existence of many behavioral factors that often follow the decision-making of decision makers or investors. Thus, behavioral finance combines psychological, behavioral and cognitive theories with economics and finance in order to understand the irrationality of investors in their decision-making.

According to classical financial theory (Tobin 1958, Markowitz 1959 and Alexander 1961), humans are most often rational and logical in maximizing their wealth and making decisions. It has been attested by several researchers and scientists that human beings are capable of making complex analyses and decisions based on the conclusions they draw, but this puts them under many constraints that sometimes lead them to make shortcuts and rely on their intuition. Otherwise, the human being is not a machine that analyzes and gives a verdict according to a previously studied program. Researchers in economics and finance (Daniel Kahneman and Amos Tversky Who Won the Nobel Prize in Economics with Their Prospect Theory in 2002) have concluded that factors such as mood and psychology influence decision-making. Added to this are the discrepancies between reality and perception, between a past event and one's memory of it.

Thus, the purpose of this article is to provide a literature review covering as many aspects as possible, including biases and heuristics. Then, we will focus on the contribution of behavioral finance and the impact of emotions on decision-making.

JEL Classification: G4 – G40 – G41

Paper type: Theoretical Research