THE ROLE OF SOCIO-ECONOMIC THEORY IN FINANCIAL MARKET: REVIEW OF INVESTORS BEHAVIOUR AND THEIR PSYCHOLOGICAL BIASES

Abstract

The efficient market hypothesis assumes that investors behave rationally, by using all relevant information, and analyse it in the most effective way to achieve the best possible outcome. However, many investors appear to behave in irrational ways. For example, irrelevant information, such as rumour, is used and the analysis may be subject to misinterpretation, emotion and other psychological bias. Investors may not base decisions on their own views about investments, but upon what they see as the majority view. The majority being followed are not necessarily well-informed rational investors. The investors that are followed may be uninformed and subject to psychological biases that render their behaviour irrational (from the perspective of economists). Rational investors may even focus on predicting the behaviour of irrational investors rather than trying to ascertain fundamental value. This may explain the popularity of technical analysis amongst market professionals. This paper compares and evaluates the existing literature of psychological bias, based on the critical analysis of uneconomic variables, such as weather and biorhythmic variables, on investors’ mood that are found in the literature. This paper argues for the need to develop a new methodology to examine the efficient market hypothesis by reflecting psychological bias as a main driver of financial market assessment.

Keywords

• Socio-economic theory,investors behaviour,psychological biases

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