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Cognitive Biases as an Integral Part of Behavioral Finance

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  • Leković Milјan

    (University of Kragujevac, Faculty of Hotel Management and Tourism in Vrnjačka Banja, Republic ofSerbia)

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: 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.

Suggested Citation

  • Leković Milјan, 2020. "Cognitive Biases as an Integral Part of Behavioral Finance," Economic Themes, Sciendo, vol. 58(1), pages 75-96, March.
    • Handle: RePEc:vrs:ecothe:v:58:y:2020:i:1:p:75-96:n:5
    DOI: 10.2478/ethemes-2020-0005
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    References listed on IDEAS

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    More about this item

    Keywords

    cognitive biases; behavioral finance; financial decision making;
    All these keywords.

    JEL classification:

    • G40 - Financial Economics - - Behavioral Finance - - - General
    • G41 - Financial Economics - - Behavioral Finance - - - Role and Effects of Psychological, Emotional, Social, and Cognitive Factors on Decision Making in Financial Markets

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