Behavioral finance seems to take a really important and significant
place into all segments of the finance world and the decision making. The
behavioral finance supported by psychological elements and influences gave the
new perspective to the economic view. Consumer behavior and psychological facts
having impacts on certain decisions made where presented to the public (Thaler, 1985). Certain number of
papers and books were written examining the different variables from the area
of the economy and finance connected with the field of the behavioral finance.
Although, this field was opened for research and interest from the public, it
still can be a source of new findings and correlation in the economic world. This
field is consist of examining phenomena under the name Heuristics (Tversky &
This subject is connected with few topics including the one of the biases. Cognitive biases are
biases in judgment and decision making that have been demonstrated in research
in psychology and behavioral economics. (Haden, 2011). Academic literature and research
till this point, made scientific summaries and conclusions on the relationship
of the biases and different variables.The presence of effect of the biases and decision
making process, explained by the non-rational decision making models from
behavioural decision theory made differentiation between entrepreneurs and
managers and raised the question of the distinction in the preferences for
making investment decisions in the investors view. (W.Busenitz & B.Barney, 1997)
Starting from the strategic decision making process,
the cognitive perspective have taken its place in major topics and made it a
good foundation for raising for the future research on correlation and
influence with the biases. (Schwenk, 2006).
The effects this biases are causing is
1.2 The Herding Behavior
The Herding behavior bias represents tendency of a
subject to mimic certain actions coming from a larger group, no matter if they
are qualified as rational or irrational actions.
It has been argued that
herding behavior might
have several negative impacts
on the market: phenomenon distorts the public knowledge aggregation process, intensify volatility of the
markets, and takes part in the creation of bubbles and crashes
When financial markets
behave madly, the financial comments often attributes such behavior to
investors “herd” instincts. Preferring rational explanations, economists have
picked up the notion and strived to describe situations when investors “herd”
in a rational fashion, although initially outside the sphere of finance .Such informational herding arises in
situations where people observe the actions of others, derive information from
them and then, seemingly disregarding their own information, follow the
majority action. Applying this idea to financial markets, one could argue that
a few early, perhaps incorrect, movements by visible traders induce others to
follow, causing discontinuous price jumps in one direction or the other with
prices deviating far from the asset’s fundamental value. Herding behavior hits the financial markets in many
aspects and makes impact on different basis. Academic literature and research gives
different occasions of the appearance of the herd behavior provide the theory
of herding in the perspective of reputation of traders, managers and other
financial subjects under the influence of the herding. (Stein, 1990)
Herding as an appearance in the stock market can be noticed as average
tendency for buying (selling) particular stocks at a certain point of time,
rather than traders acting independently. Several papers and research
experiment and used statistical measure for the herding behavior and examine
the correlation of a trading patterns between certain groups and set of stocks. (Lakonishok,
et al., 1992).
Stocks are distinguished with different characteristics
These papers leaves a space to raise questions and doubts and search for
certain explanation for another patterns and correlation incentified from this
previous research and results gotten.
As follow, this paper work will try to fulfill a bigger picture and go
deeper into the relationship of the herd bias and the stock market.
This paper will try to connect
the characteristics of different types of stocks and the preferences for them,
with the behavior of the investors under the influence of the herding as bias.
It will develop the changes (if any) of the trading and price movements
on the four specific above mentioned types of stocks when investors will act
under the herding bias.
So can rational herd
behavior at least partially explain persistent price spikes and crashes, linked
movements across national boundaries, and generally “crazy” market behavior?
1.3 Types of stocks based on company specifics
1.1.3 Blue chip stocks
The word ‘blue chip’ has come originally from gambling where it is used
for the highest value of a gambling chips. With the term being used for a few
different context, in its fundamental the meaning is company that in some way
are superior. This tag seems to be applied for the stock market`s largest, well
known and good established companies. The status of a stock, ‘blue chip’ is
more rather dynamic than static concept just because a company that is known as
blue chip in the future may not be regarded as a one. In relation with new
business appearing and company`s stocks trading on the stock market, there is a
need to distinguish a company`s type of stock, whether is characterized as a
blue chip or not. For example, this criteria might be important for the equity
or debt providers that want to know the quality of the company, or analysts and
fund managers need to know the risk they are about to face.
blue chip stock is might be classified as a market leader or one of the top
companies in the sector with its market capitalization running into thousands.
These stocks are typically known for paying dividends to their shareholders
consistently. They have a consistent record of growth and give stable,
inflation beating returns to the shareholders for their investments. A blue
chip stocks are
generally a components
of the benchmark indexes as
well.The criteria for what qualifies as a blue chip
stock is relative and subjective. A market leader could be a
large capitalization company or a mid capitalization company. There is no particular criteria which
qualifies a company to be a blue chip one.
Generally, there is a perception that investment in blue chip stocks is a safe
investment as the company has survived major challenges and market cycles but
this is certainly not the case. a lot of time and effort needs to be spend by
investors in figuring if a stock is actually a blue chip or not. Talking for the criteria required
for one stock to be classified as a blue chip, there are no very clear
boundaries and specifications. Usually for a stock to be tag as a blue chip,
needs to be from a company with large or middle market capitalization, to have
a consistent growth and good growth visibility for the future and to keep the
sustainability of the return of equity and capital, as well as cash flows.
Taking into account the features of this type of stock, in my paper I
can develop …..
2.1.3 Income stocks
stock is presented as an equity security
that pays regular, steady increasing dividends, and usually offers a high yield that may generate the majority of
overall returns. There are no certain bounds for deciding but, most income stocks are charactehave lower levels of volatility than the overall stock market, and offer higher-than-market dividend yields. Income
stocks may have limited future growth options, thereby requiring a lower level
of ongoing capital investment.
3.1.3 Value stocks