Investment Theory, Rational and Irrational Essay

Investment Theory, Rational and Irrational - Essay ExampleFor example, a man may like a shot fall in love with a woman and propose to marry her, solely moved by the physical beauty of the woman but this aforementioned(prenominal) man wouldnt invest in a company solely inspired by looking at the rich and luxuriant office premises of that company. He would definitely make further enquiries before he decides to take any step. In economics, or maculation making any kind of profit and termination closes in general, we see men at their rational best. Nonetheless, human beings are still good old Homo Sapiens and the much anticipated progress of Homo Economicus never really took place. We make mistakes, we come under the sway of our emotions, we give in to our momentary whims often enough and later come to trouble them as often enough. There are differences between person to person of course. Some of us are more intelligent, practical, cool-headed and experienced while arriving at dec isions, while many others may not be as rational and practical. All in all, though, there has been plunge out to be a significant decimal point of irrationality and inconsistency at play when people make economic decisions. A hybrid branch of economics and psychology called behavioural finance has evolved to reputation 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 response 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 roughly 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 propounded their Prospect Theory, studying human behaviour in relation to risk. In essence what they have put up out was that, contrary to the dictates of logic that were taken for granted in the standard expected utility theory of neo-classical economics, people placed different 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 expert by equivalent gains. To give a more concrete measure to this rather subjective tendency, some economists have arrived at the conclusion 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 of wi nning 10 for certain, and winning 20 or nothing each 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 only a 50%