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Market Volatility vs. Economic Growth: The Role of Cognitive Bias

Author

Listed:
  • Neha Parashar

    (Symbiosis School of Banking and Finance, Symbiosis International (Deemed University), Pune 412115, India)

  • Rahul Sharma

    (School of Business, Skyline University College, Sharjah P.O. Box 1797, United Arab Emirates)

  • S. Sandhya

    (IBS Hyderabad, ICFAI Foundation for Higher Education, Hyderabad 501203, India)

  • Apoorva Joshi

    (Symbiosis School of Banking and Finance, Symbiosis International (Deemed University), Pune 412115, India)

Abstract

This study aims to investigate the interaction between market volatility, economic growth, and cognitive biases over the period from April 2006 to March 2024. Market volatility and economic growth are critical indicators that influence economic stability and investment behavior. Financial market volatility, defined by abrupt and erratic changes in asset values, can have a big impact on the expansion and stability of the economy. According to conventional economic theory, there should be an inverse relationship between market volatility and economic growth since high volatility can discourage investment and erode trust. Market participants’ cognitive biases are a major aspect that complicates this connection. Due to our innate susceptibility to cognitive biases, including herd mentality, overconfidence, and loss aversion, humans can make poor decisions and increase market volatility. These prejudices frequently cause investors to behave erratically and irrationally, departing from reasonable expectations and causing inefficiencies in the market. Cognitive biases have the capacity to sustain feedback loops, which heighten market turbulence and may hinder economic expansion. Similarly, cognitive biases have the potential to cause investors to misread economic indicators or ignore important details, which would increase volatility. This study uses the generalized autoregressive conditional heteroskedasticity (GARCH) model on GDP growth data from the US, the UK, and India, alongside S&P 500, FTSE 100, and NIFTY 50 data sourced from Bloomberg, to examine evidence of these biases. The results show evidence of the predictive nature of market fluctuations on economic performance across the markets and highlight the substantial effects of cognitive biases on market volatility, disregarding economic fundamentals and growth, emphasizing the necessity of considering psychological factors in financial market analyses and developing strategies to mitigate their adverse effects.

Suggested Citation

  • Neha Parashar & Rahul Sharma & S. Sandhya & Apoorva Joshi, 2024. "Market Volatility vs. Economic Growth: The Role of Cognitive Bias," JRFM, MDPI, vol. 17(11), pages 1-16, October.
    • Handle: RePEc:gam:jjrfmx:v:17:y:2024:i:11:p:479-:d:1505263
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    References listed on IDEAS

    as
    1. Manika Sharma & Mohammad Firoz, 2020. "Do Investors¡¯ Exhibit Cognitive Biases: Evidence From Indian Equity Market," International Journal of Financial Research, International Journal of Financial Research, Sciedu Press, vol. 11(2), pages 26-39, April.
    2. McFadden, Brandon R. & Lusk, Jayson L., 2015. "Cognitive biases in the assimilation of scientific information on global warming and genetically modified food," Food Policy, Elsevier, vol. 54(C), pages 35-43.
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