Question

Using the theories of behavioral finance, modern portfolio, and efficient markets, create a basic case study to illustrate how/if these theories are relevant in contemporary financial planning investment decision.

Answer 1

All these theories namely behavioral finance, modern portfolio & efficient markets are from different schools of thought that attempt to explain the behavior of the investors.

The modern portfolio theory is the basis for conventional wisdom that underpins the investment decision making. The theory considers the financial markets to be efficient; there are informed market participants & also rational decisions that are made by the investors. As everyone has the access to same information all the securities are appropriately priced at a given time. If markets are efficient and current, it means that prices always reflect all information, so there are no way you'll ever be able to buy a stock at a bargain price.

The theories developed by traditional researchers only evaluate the risk & expected returns on investments while making the decision. In all these theories of behavioral finance, modern portfolio & efficient markets they focus on the role of human sight in modeling markets is of great importance. All these theories study the psychology of human beings in finance or investing.

There has been recent research which shows that the average investor makes decisions based on emotions & not on logic. All these theories study decision making under uncertainty & how an individual must choose between various options when faced with uncertain outcomes.

For example, if we consider the theory of behavioral finance, the discipline of behavioral finance will likely to evolve in tenacity and sphere; it will likely to continue to provide a strong financial tool. Due to the buoyancy of markets, behavioral finance influential investment is contemplated to be one of many f fundamental investment procedures and approaches in a diversified portfolio (Stewart, 2006). The discipline of behavioral finance is widening to include the discipline of neuro- economics. Neuro economics is a field of study that assimilates neurology, economics, and cognitive psychology to understand how people make various investment choices. Neuro economics widen behavioral finance by enumerating the variables of the nervous system as a determinant in financial decision-making. At the end, conclusively, the expansion of the behavioral finance area allows for better consideration of the manner in which psychological parameters influence investment fallout and market performance.