Behavioural Finance

Theories of Behavioural Finance

Behavioural finance tries to explain how investors behave, rather than how they should act. There are four theories of Behavioural Finance: Prospect theory, Regret theory, Anchoring, Over- and under-reaction. 

Prospect theory states that investors react differently in the same situation, depending on if they are in a loss or gain position. Investors tend to be more or less risk-averse depending on their position. 

Regret theory is about the emotional reaction that investors have when they make a mistake. For instance, investors may buy a stock again that they recently sold, if the stock prices goes up, not down. 

Anchoring is where investors have a ‘feeling’ that current stock prices are right, without really knowing. Over- and under-reaction relates to how investors over or under-react to new information about a stock.  

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