Economic Themes (2020) 58 (1) 5, 75-96
Miljan Leković
Abstract: The complex world of finance is characterised by numerous irrationalities that representatives of behavioral finance seek to explain by cognitive biases (flaws, inclinations or anomalies). Cognitive biases represent imperfect perception of reality and are caused by limited cognitive capacities of decision-makers. By analysing cognitive biases, the paper aims to answer the following questions that standard finance fails to address the following questions: Why active portfolio strategy is still the most influential strategy in portfolio management despite the mounting evidence of unsuitability of its application? Why investors prefer dividend payout over increase in capital value (dividend puzzle)? Why investors ignore benefits of investment diversification and choose to invest in a small number of shares of well-known local businesses (diversification puzzle)? Why investors avoid to sell “loser” shares and thus reduce the tax burden? Why shares of small companies usually bring higher returns compared to shares of large companies? The answers to these questions are obtained by using qualitative research methodology, which also represents the main result of the research.
Keywords: cognitive biases; behavioral finance; financial decision making
COGNITIVE BIASES AS AN INTEGRAL PART OF BEHAVIORAL FINANCE
Miljan Leković
Abstract: The complex world of finance is characterised by numerous irrationalities that representatives of behavioral finance seek to explain by cognitive biases (flaws, inclinations or anomalies). Cognitive biases represent imperfect perception of reality and are caused by limited cognitive capacities of decision-makers. By analysing cognitive biases, the paper aims to answer the following questions that standard finance fails to address the following questions: Why active portfolio strategy is still the most influential strategy in portfolio management despite the mounting evidence of unsuitability of its application? Why investors prefer dividend payout over increase in capital value (dividend puzzle)? Why investors ignore benefits of investment diversification and choose to invest in a small number of shares of well-known local businesses (diversification puzzle)? Why investors avoid to sell “loser” shares and thus reduce the tax burden? Why shares of small companies usually bring higher returns compared to shares of large companies? The answers to these questions are obtained by using qualitative research methodology, which also represents the main result of the research.
Keywords: cognitive biases; behavioral finance; financial decision making
