For a long time, the investors’ full rationality was the main hypothesis of the most financial academic research. In fact, it was mainly supposed that stock prices are fixed by rational investors’ anticipations and reactions. Rationality here refers to the two main factors, namely, the exhaustive and objective treatment of available and potential information. Because of its simplicity and its success to capture the stock price movements, this famous investor’s rationality hypothesis was for a long time supported by the financial academic researchers. Nevertheless and since recent movements, the financial academic researchers’ enthusiasm for this hypothesis becomes much weaker. This changing perceptions lead to experimental research by the psychologists by introducing the irrationality of human beings (von Neumann and Morgenstein, 1944). Researchers in finance were then motivated to break with the full rationality hypothesis and to recognise from now on the neutral effect of some psychological biases on the investors’ decisions and reactions, and subsequently the effect of such reactions on the stock price movements.
Individuals behaviour influenced by several psychological biases reflects in their trading behaviour in stock markets, and subsequently causes momentum effects in stock prices, returns, and volatility. This behavioural aspect has been covered by a number of studies carried on data from different stock markets across the world.
In our forthcoming posts, we will explore in details about the dynamic relationship between individual trading behaviour and stock prices, returns, and volatility in an entirely Indian context.
Cheers to Behavioural Finance!!