Unit 3: Investor behaviour
Behavioural Finance notes · PTU syllabus (MBA 913-18)
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Unit summary
Different investors behave differently, and groups — from markets to boards — can amplify errors. This unit covers types of investors by risk appetite, conformity and contrarian investing, group psychology on the board, resistance to recognising failure, conflicts of interest, value vs growth investing, and stock market bubbles.
After this unit you can
- Classify investors by risk appetite and behaviour
- Compare conformity and contrarian investing
- Explain group psychology on boards, resistance to recognising failure and conflicts of interest
- Compare value and growth investing and explain bubbles
PTU syllabus topics
- Types of investors by risk appetite
- conformity and contrarian investing
- group psychology on the board
- resistance to recognizing failure
- conflict of interest
- value vs growth investing
- stock market bubbles
Buys
Cheap stocks below intrinsic value
Fast-growing companies
Metrics
Low P/E, low P/B, high dividend
High earnings and sales growth
Mindset
Contrarian
Momentum
Topic 1
Types of investors by risk appetite
Conservative (risk-averse)
Capital protection, fixed income
Moderate
Balanced equity and debt
Aggressive (risk-seeking)
High equity, small caps, derivatives
Adventurer
Confident, willing to take risks
Celebrity
Follows trends, wants to be in the action
Individualist
Confident, careful, analytical
Guardian
Careful, wants safety
Straight arrow
Balanced, average
- Pompian's behavioural investor types: preserver, follower, independent, accumulator — advisers tailor advice to each type's biases.
Topic 2
Conformity and contrarian investing
Approach
Follow the crowd and popular stocks
Go against prevailing sentiment
Psychology
Social proof, fear of missing out
Independence, patience
Risk
Buying near peaks, selling near troughs
Being early; prolonged underperformance
Example
Buying tech stocks at the 2000 peak
Buying quality stocks during the March 2020 crash
Topic 3
Group psychology on the board
- Groupthink (Irving Janis): cohesive groups suppress dissent to maintain harmony — illusion of invulnerability, collective rationalisation, self-censorship, pressure on dissenters.
- Board effects: dominant CEO or promoter, deference to authority, escalation of commitment to failing projects, overconfident acquisitions.
- Remedies: independent directors, devil's advocate, encouraging dissent, separating chair and CEO, external advice, structured decision processes.
Topic 4
Resistance to recognising failure
- Escalation of commitment and sunk-cost fallacy: continuing to invest in a failing project because of money already spent.
- Causes: loss aversion, self-justification, reputation concerns, regret avoidance.
- Remedies: pre-set exit criteria, independent reviews, separating decision makers from evaluators, rewarding honest reporting.
Topic 5
Conflicts of interest
- Sources: analysts whose firms have investment-banking relationships, commission-driven distributors, fund managers' career concerns, auditors with consulting income, promoters vs minority shareholders.
- Behavioural angle: people underestimate how conflicts bias their own judgement; disclosure alone may not fix the bias.
- Regulation in India: SEBI (Research Analysts) Regulations 2014, Investment Adviser Regulations 2013 (separating advice from distribution), direct plans of mutual funds, related-party transaction rules.
Topic 6
Value vs growth investing
Focus
Stocks priced below intrinsic value
Companies with high expected earnings growth
Metrics
Low P/E, low P/B, high dividend yield
High revenue and earnings growth, high P/E
Psychology
Exploits over-reaction and pessimism
Investors may over-extrapolate growth
Proponents
Benjamin Graham, Warren Buffett
Philip Fisher, T. Rowe Price
- Behavioural explanation of the value premium: investors extrapolate past growth (representativeness) and overpay for glamour stocks.
Topic 7
Stock market bubbles
- 1Displacement
New technology or policy creates opportunity
- 2Boom
Prices rise, media attention grows
- 3Euphoria
Speculation, easy credit, "this time is different"
- 4Profit-taking
Smart money exits
- 5Panic
Prices crash, forced selling
- Examples: Tulip mania (1637), South Sea bubble (1720), dot-com bubble (2000), US housing (2008); in India — Harshad Mehta (1992) and Ketan Parekh (2001) episodes.
- Behavioural drivers: herding, overconfidence, extrapolation, availability of success stories, limits to arbitrage.
Key terms
- Herding
- Following the actions of the crowd
- Contrarian investing
- Acting against prevailing market sentiment
- Groupthink
- Suppression of dissent in cohesive groups
- Sunk-cost fallacy
- Continuing because of past investment
- Bubble
- Prices far above fundamental value driven by speculation
Quick revision
- Risk appetite types; BB&K model; Pompian's types.
- Conformity vs contrarian investing.
- Groupthink on boards; escalation of commitment; remedies.
- Conflicts of interest and SEBI regulations.
- Value vs growth; Minsky–Kindleberger bubble stages; examples.
Important exam questions
Practice questions written to the PTU exam pattern for this unit's syllabus: short answers (Section A style) and long answers (Sections B and C style).
Short-answer questions
- Q1.Name the five BB&K investor types.
- Q2.What is contrarian investing?
- Q3.What is groupthink?
- Q4.What is escalation of commitment?
- Q5.Distinguish value and growth investing.
- Q6.Name the stages of a bubble.
Long-answer questions
- Q1.Explain the classification of investors by risk appetite and personality.
- Q2.Compare conformity and contrarian investing.
- Q3.Discuss group psychology on boards and resistance to recognising failure.
- Q4.Explain stock market bubbles with behavioural explanations and examples.
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