Who has never made a decision based on impulse and then realized they made the wrong choice? After all, despite being rational, we are still beings with feelings and often act on intuition. This logic is no different when we talk about the financial market and, therefore, it is important to understand what we call behavioral finance, that is, the influence of emotions on financial decisions.
In an online class, Professor Bruna Losada , vice -rector of Saint Paul School of Business and professor at LIT in the courses Economic Feasibility Analysis of Investment Projects , Quantitative Methods Applied to Business and Corporate Finance I - Cost of Capital , sought to explain the dynamics between financial decisions that, in essence, must be extremely rational, and the feelings that are inherent to all human beings.
The efficient market hypothesis
First, it is necessary to understand the logic of the financial market, since everything is based on the confidence that it is efficient, that is, that everything is priced correctly and that its investors denmark whatsapp data act rationally based on relevant information. In this scenario, "a normal gain is one that gives you an expected return given the risk you run," explains Bruna.
However, in practice, we know that people are not completely rational and, therefore, several errors occur, creating a movement that, on the other hand, also creates opportunities for those, known as arbitrageurs, who see the imbalance and manage to make money by going against the grain.
The challenges of rationality
There are three challenges to rationality in the market that are linked to our emotional side and are common to all financial crises ever recorded.
Information
As we said before, the efficient market is based on the premise that people make decisions based on all relevant information. However, the processing capacity of the human brain is limited and, even if we could analyze everything that is available, this does not necessarily mean that our analysis will be reasonable since each of us has our own interpretation of the facts.
Furthermore, depending on the country and its financial structure, it is not possible to guarantee that all relevant information is available and of good quality.
Arbitration
The arbitrageur sees a flaw in the way the market works before anyone else, betting against the current in the hope of reaping great rewards. However, making a choice completely opposite to that of the rest of the people is an extremely difficult thing to do. Furthermore, to increase this pressure even further, there is no guarantee that the arbitrageur will not suffer great financial losses until his theory proves to be true.
"Betting against demands self-confidence and great courage, even for someone who is very qualified and rational. You will ask yourself: 'is everyone really wrong and I am the only one right?' Going against the herd makes you feel insecure. It is more pleasant to make mistakes with everyone else than to make the right choice alone, running the risk of making the same mistake", emphasizes Bruna.
Emotions
We are animals and, for evolutionary reasons, we often act automatically based on our intuition. In these cases, our emotional side overrides our rational side. Therefore, in order to avoid making bad financial decisions, it is necessary to identify these moments: