HOW DO BEHAVIOURAL BIASES INFLUENCE ASSET PRICING AND THE EFFICIENCY OF FINANCIAL MARKETS?

Abstract

This paper investigates how behavioural biases influence asset pricing and financial market efficiency. Classical finance theory conceptualizes the EMH; it assumes financial markets to be rational, with the efficient market passing on all available information to reflect prices. However, where behavioural finance does oppose this assumption is in its acceptance of the presence of psychological factors leading to deviations from rational decision-making. This paper looks at the traditional behavioural biases that, in common sense, lead to decisions on the part of investors with an overview or projection of how asset prices will behave. Price bubbles, excessive volatility, and mispricing of assets all emerge as market anomalies, so opportunities to exploit inefficiency are created. As indicated by the other writer's works and empirical studies, it describes how biases due to behaviour run through an investor's perception and behaviour and how it causes inefficient pricing mechanisms to develop. It also analyzes the influence of these biases in matters related to asset allocation, risk management, and market stability. The research suggests while behavioural biases limit any normal economic functioning of the market, acknowledging and understanding these behavioural biases could present numerous opportunities to formulate more impressive investment options and policy interventions for a better working market