Investment Theory, Rational and Irrational Essay

Investment Theory, keen and Irrational - Essay ExampleFor example, a man may instantly fall in making love with a woman and propose to marry her, solely moved by the physical beauty of the woman but this same man wouldnt invest in a company solely inspired by looking at the rich and luxuriant office premises of that company. He would definitely make nevertheless enquiries before he decides to intromit any step. In economics, or while making any assortment of profit and loss decisions in general, we see men at their rational best. Nonetheless, gracious beings are lock in good old Homo Sapiens and the a good deal anticipated rise of Homo Economicus never real took place. We make mistakes, we come under the sway of our emotions, we bind in to our momentary whims often enough and posterior come to regret them as often enough. There are differences between person to person of course. whatever of us are more intelligent, practical, cool-headed and experienced while arriving a t decisions, while many others may not be as rational and practical. All in all, though, there has been found out to be a significant degree of irrationality and inconsistency at play when hoi polloi make economic decisions. A hybrid branch of economics and psychology called behavioural finance has evolved to study the element of irrationality in the process of decision making it endeavours to better understand and explain how emotions and cognitive errors influence people when they are making investment-related or other kinds of monetary decisions. But, in fact, behavioural economics consists of theories and empirical investigations into human reception to risk, and as such its insights are relevant to any field where decision making is involved and a significant aspect of risk is present.A basic, and almost commonsensical, finding in this field of study is that people tend to be generally more risk-averse than generally thought of. In 1979, Daniel Kahneman and Amos Tversky propo unded their Prospect Theory, studying human behaviour in relation to risk. In essence what they have found out was that, contrary to the dictates of system of logic that were taken for granted in the standard expected utility theory of neo-classical economics, people placed varied weights on gains and losses and on different ranges of probability. Translated in simple terms, this means that individuals are generally much more distressed by prospective losses than they are happy by equivalent gains. To give a more concrete mea certainly to this rather subjective tendency, some economists have arrived at the end point that the difference is almost twice, i.e., people perceive the loss of 1 twice as painful as the pleasure derived from the gain of 1. But there is an interesting twist to this observation. It has been found that faced with a sure gain, individuals become risk-averse, while faced with a sure loss they become more willing to take risk. For example, between a situation o f winning 10 for certain, and winning 20 or nothing from each one with a 50% chance - it has been shown that most people would go for the former. In a real-life situation, faced with a sure gain of 10, people become risk-averse and are less likely to go for 20 with still a 50%