LUẬN văn THẠC sĩ (KINH tế) the impact of the sunk cost fallacy and other behavioural biases on individual irish investors

4.2.4 Risk-takingfor GainsandLosses...404.2.5 InvestorsandRegretAversion...42 4.2.6 DecisionMakingandMentalAccounting...44 4.3 Conclusion...45 CHAPTER5–DISCUSSION...46 5.1 ResearchQuesti

I,StefphaneSamanthaPercivaldeclarethatthisresearchismyoriginalworkandthatithasn e v

e r b e e n p r e s e n t e d t o anyi n s t i t u t i o n o r u n i v e r s i t y f o r t h e awardo f DegreeorDiploma.Inaddition,IhavereferencedcorrectlyallliteratureandsourcesusedinthisworkandthisthisworkisfullycompliantwiththeDublinBusinessSchool’sacademich o n e s t y policy

Signature:Stefphane Percival

Date:28/05/2016

Iwo ul d l i k e t o t a k e t h i s o p p o r t u n i t y tot h a n k m y supervisorM r E d d i e McConnonf o r h

i s continuouss u p p o r t andguidancew i t h o u t w h o m I w o u l d n o t havebeenablet o f i n i s h thisdissertationsuccessfully

MyfamilyhavealsoendlesslysupportedmeduringthecourseofmyMBAdegree.IwouldalsoliketothankafewnewcontactsImadeMr.MarcMacEodhasa,MrDenisDalyandMr.E n d a McNicholas.ThehaveprovidedassistanceofwhichIwillalwaysbegrateful

This hasbeenafulfillingandenrichingexperienceforme becauseofallyourhelp!

Thankyou

Thisdissertationaimst o p r o v e t h a t i n d i v i d u a l s make irrationaldecisionswhenundersuchcircumstancesasuncertaintyandrisk.Theresearchconductedassessesforty-

twoIrishprofessionalsandt h e i r behaviourw h i l e m a k i n g decisionsp e r t a i n i n g s p e c i f i c a l

l y t o t h a t o f i n v e s t i n g ins t o c k s andshares.Inp a r t i c u l a r , th e dissertationfocusesp r e d

i.e.A m o s TverskyandDanielKahnemanw h i c h wast h e ProspectTheory.T h e researchs t r o

n g l y utilisesthis theorythroughoutthedissertation

CHAPTER1 -INTRODUCTION 7

1.1 ResearchAimsandObjectives 8

1.2 ResearchQuestionsandHypotheses 8

1.2.1 ResearchSub-questions: 9

1.2.2 Hypotheses 10

1.3 DissertationRoadmap 10

1.4 MajorContributions ofResearch 11

CHAPTER2 -LITERATUREREVIEW 13

2.1 Introduction 13

2.2 ProspectTheory 13

2.3 BehaviouralFinance 16

2.4 Sunk-CostEffect/Fallacy 16

2.4.1FactorsAffectingSunk-Cost 17

2.5 Overconfidence Bias 18

2.6 RegretAversion 19

2.7 MentalAccountingHeuristic 20

2.8 HindsightBias 21

2.9 Conclusion 22

CHAPTER3 -RESEARCHMETHODOLOGYANDMETHODS 24

3.1.Introduction 24

3.2ResearchDesign 25

3.2.1ResearchPhilosophy 26

3.2.3 ResearchApproach 27

3.2.4 ResearchStrategy 29

3.2.5 TimeHorizon 30

3.3 SamplingSizeandSelectingRespondents 32

3.4 ResearchEthics 32

3.5 PossibleResearchLimitationsandScope 33

CHAPTER4 -DATA ANALYSISANDFINDINGS 34

4.1 Introduction 34

4.2 QuantitativeAnalysisandResearchFindings 34

4.2.1 OptimismandOverconfidence Bias 37

4.2.2 Long-termInvestors,FixedAssetsand OtherVariables 39

4.2.3 IrishInvestorsandtheSunk-CostFallacy/Effect 39

4.2.4 Risk-takingfor GainsandLosses 40

4.2.5 InvestorsandRegretAversion 42

4.2.6 DecisionMakingandMentalAccounting 44

4.3 Conclusion 45

CHAPTER5–DISCUSSION 46

5.1 ResearchQuestionandInterpretation 46

5.1.2 PossibleReasonsandImplicationsfor theSunk CostEffect 46

5.2 ResearchSub-questionsandInterpretation 47

5.3 ResearchHypotheses 51

CHAPTER6–CONCLUSIONSANDRECOMMENDATIONS 52

6.1 Conclusions 52

6.2 Recommendations 53

CHAPTER7–REFLECTION 54

BIBLIOGRAPHY 58

APPENDIXI 62

LISTOF FIGURESANDTABLES Figure2.1 AHypotheticalValueFunction 15

Figure3.1ResearchOnion 15

Figure3.2ResearchStrategies 30

Figure4.1 AgeGroupofIrishInvestors 36

Figure4.2 OptimismMagnitudeofIrishInvestors 37

Figure4.3 Respondents ProfitabilityandConfidenceinInvestmentPortfolio 38

Figure4.4 RespondentsDescriptionofConfidence (Scale) 38

Figure4.5 Risk TakingUnderUncertaintyforGains 41

Figure4.6 Risk TakingUnderUncertaintyforLosses 42

Figure4.7 RespondentsRegretSpectrum 43

Figure4.8DecisionMakingandMental AccountinginIrishInvestors 44

CHAPTER1 -INTRODUCTION

Itisoftenarguedthattheglobalfinancialcrisiswasnotalonecausedbyaseriesofeconomicfactorsandshocksatplaybutbyvariouspowerfulimperilingpsychologicalforces.Fromblind-faithinever-

risinghousingpricestoplummetingconfidenceincapitalmarkets,‘animalspirits’areadrivingforceinfinan

cialanomaliesgloballywithrespecttothefinancialmarkets(AkerlofandShiller,2009)

Inthelast halfdecade,academicfinancehasexperiencedtwomajor revolutionsi.e.neoclassicalandbehavioural.Academicfinancebeforet h e 1 9 6 0 s wasr o u g h l y organisedaroundacollectionofanecdotes,investmentphilosophiesandpuzzles(Shefrin,2015)

BehaviouralFinanceisarelativelynewconceptthatintegratesconventionaleconomictheories,cognitivepsychologyandtraditionalfinance.In1979,DanielKahnemanandAmosT v e r s k y wr

oteasignificantpaperinthefieldofeconomicsandcognitivepsychologycalled‘ProspectTheo

ry:AnAnalysisofDecisionUnderRisk’.Thispaperbroughttolightvarioush u m a n biasesa

makingunderrisk(KahnemanandTversky,1979).Morebroadly,behaviouraleconomicsisastudythatfocusesontheunanticipatedirrationalbehaviourandfinanciald e c i s i o n -

nderrorsthataremadeunderuncertainty.Prospectsorgamblesareviewedaschoicesofdecision-m a k i n g processt h a t v a r i o u s i n v e s t o r s nderrorsthataremadeunderuncertainty.Prospectsorgamblesareviewedaschoicesofdecision-m a k e w h i l e p u r c h a s i n g o r s e l l i n g certainfinancial products orservices

‘Sunk-costfallacy’isanaspectofbehaviouralfinance.Thisaspectistheprimaryfocusofthes t u d y condu

ctedonIrishinvestors

incommonstocksandshares.Asunkcostisabasicconceptofeconomicsandbusiness.Itsunderstandingissignificantinordertoactasarationaldecision-

makerespeciallyw h i l e consideringi n v e s t m e n t s i n securities.C o m m o n phraseso r expressionssuchas“don’tcryoverspiltmilk”areusedin-linewiththeaforementionedfallacy.Sunk-

costisunderstoodtobethatlosswhichcannotberecoveredandintermsofrationality(HastieandDawes,2009).Itis the investorsirrationaldecision to hold on to abadinvestmentf o r

t o o long.Psychologistsoftenrefertothisjudgementalbiasby‘cognitivedissonance’,itist h a t ju

dgementalbiasthatpeopletendtomakewhentheyfailtobelieveitiswrong.Accordingt o KahnemanandTversky,thiscanbeexplainedbythevaluefunctionofwhichlossaversionplaysasignificantroleintheprospecttheory

Othersignificantthemeso f behaviouralfinanceconsideredi n t h e researchs t u d y

areover-confidencebias, regretaversion andhindsightbias.Theresearchdetermin estoexplore the

p o s s i b i l i t y andimpactthepreviouslymentionedhumanerrorsandbiaseshaveontheindividual

m a k i n g u n d e r u n c e r t a i n t y a g a i n s t t h a t o f t h e i n d i v i d u a l Irishi n v e s t o rwhilemakinginvestmentchoicesinsharesandstocks.

Therefore,thestudywillalsoprovideaplatformfordebateforthe‘irrationalexuberance’oft h e Irishcreditbubble

HumansinarguablymakeirrationalchoicesunderriskaccordingtoKahnemanandTversky.T h esignificanceoftheresearchconductedidentifiesthesechoicesandhumanfailingstomakerationaldecisionsatthetimeofinvestinginthesecuritiesmarket.Thiscan helpindividual i n v e s t o r s i

dentifysuchbehaviouralpatternsoranomalieswhileinvestinginsharesallowingf o r “valu

einvesting”.Theresearchalsoenablesindividuals tomakebetterchoicesindailyactivitiesi.e.su

nk-costsdonotonlyapplytofinancialdecisions,itidentifiesbetterutilisationo f opportunitycostinthatofdailyactivitiessuchasgoingforawalkintheparkinsteadofw a t c h i n g therestofabadmovieflickallowingtheindividualtooptimallyutilisehis/hertime

i.e to makethe most of anindividual’smarginalutility

Withrespecttoconsumerism,thisresearchwouldinformindividualsofmarketingploysandm a n

i p u l a t i o n thatexistwithinthemarket.Therefore,makingtheconsumerinformedoftheirinherentjudgementalerrorsandbiaseswhichthisresearchsetsout totestifpresentornot

1.2 ResearchQuestionsandHypotheses

Doesthe“sunk-costfallacy”applytotheindividualIrishinvestorwhilemakinginvestmentdecisionswithrespecttocommonstock?

Investorscanbesometimesattachedtopastinvestmentfortoolongdespitetheinvestmentbeinganirrationalbadinvestmentwhichp o s i t i o n s t h e i n v e s t o r i n a s u n k -

c o s t t r a p p r e d o m i n a n t l y dueto his/her aversion to loss(Snopek,2012)

This questionexaminesthe extent to which thesunk-cost fallacyhasanimpactoninvestorsifapplicableinthe secondary capitalsecuritiesmarket.The researchwillenablerecipientsto haverationalexpectationsandmakeoptimaldecisionsbasedonconstrainedbudget.Thiswillallowfor

unbiasedchoicestobemadewithoutallowingforanindividuals’overconfidencetoseepin.Itfurtherprovidesin-depthanalysisforthesamewithadescripto-explanatorypurposet o serve asaprecursorfortheexplanationofthesunk-costfallacyin behaviouralfinance

1.2.1 ResearchSub-questions:

Whataretheimplications(ifany)oftheotheraspectsofbehaviouralfinancethatplayarolei n theindividual Irishinvestor’s decision -

makingprocesswhile investing in capitalmarketsecurities?

Theresearchwillalsotrytodetermineotheraspectsofbehaviouralfinance(hindsightbias,overconfidence,regretaversionandsoon)affectingtheindividualIrishinvestorfrombeingrational.Behaviouralfinancehasincreaseditssignificanceovertheyearsespeciallyafterthefinancialcrisisof2007/08 in whichcriticsstartedtodoubtthe efficientmarkethypothesis Investorsneedtounderstandthepossibilityoftheirirrationalbehaviour,judgementalerrorsandanimalspiritswhichisevenarguedbyShiller(2009)tobeamajordrivingforceintheprecedingeventsleadinguptotheglobalfinancialcrisis.Thesehumanfailingsandperceptiono f riskdiffershighlyandcanbemanipulatedundertherightcircumstancesasdecisionsarem a d e

1.2.2 Hypotheses

Theresearchadoptsaquantitativeresearchdesignwithadeductiveresearchapproachandassuchwillformthefollowingresearchhypothesestotestfromtheprimarydatathatiscollectedandanalysedinlinewiththepreviouslyformedresearchquestions:

Hypothesis1 (H1)T h e s u n k

-c o s t f a l l a -c y d o e s a p p l y to t h e i n d i v i d u a l Irishi n v e s t o r w h i l e makinginvestments inthestockmarketsecurities

Hypothesis2

(H2)IndividualIrishinvestorsaremoreriskseekingforlossesandriskaverseforgains

Hypothesis3

(H3)ThemoreoptimisticandconfidentanIrishinvestoris,thehigherw i l l b e theirrisktakingabilities

1.3 DissertationRoadmap

Thisdissertationhasbeendividedandcompiledinto7differentchapterswhichisclassifiedandillustratedasfollows:

 Chapter2 -LiteratureReview

Then e x t chaptert h a t f o l l o w s t h e introductioni s t h e LiteratureReview.T h i s chapterw i l l i

n c l u d e

sixmainliteraturethemesi.e.prospecttheory,behaviouralfinance,sunk-costfallacy,overconfidencebias,regretaversionandhindsightbias.Literaturefromdifferentsourcesarel i s t e d , reviewedandcasesarebuilt andmadeforeachargumentin theliteraturethemes

 Chapter3 -ResearchMethodsandMethodology

TheResearchM e t h o d s andM e t h o d o l o g y chapterdiscussest h e v a r i o u s researchactivitiesundertaken,assumptionsandt h e researchd e s i g n i n greatd e t a i l Itjustifiest h e rationale,clarifiesweaknessesandstrengthsoftheresearchmethodsandmethodology ofthis dissertation

Furthermore,t h i s chapteralsoillustratesanddiscussest h e researchp h i l o s o p h y , a p p r o a c h ,strategy,timehorizon,datacollectiontechniques,samplingmethodsandsize,researchethicsandlimitations of theresearchstudyundertaken

 Chapter4 -Data AnalysisandFindings

Thischapteraimsatpresentingthefindingsoftheprimaryresearchconductedi.e.informationgatheredonquestionnaires.Itillustratesanddescribesthefindingsofthedatacollectedinlinew i t h

t h e researchaimandobjectives

 Chapter5–DiscussionandConclusions

Chapterfiveisthe‘Discussion’sectionofthedissertation,asthepreviouschapterdescribest h e findingsoftheprimaryresearch,thischapterwillinterprettheresultsofthefindingsaswellasanswertheresearchquestions.Additionally,thischapterwillalsodiscusswhetherthehypothesesmentionedearlierhavebeenfoundtobetrueorfalse,itthenfurtherexplainstheimplicationtheconclusionsthatwould bedrawn

 Chapter6–ConclusionsandRecommendations

Thischapterwillsummariseallthefindingsanddrawgeneralconclusionsthat willilluminateandclarifytheissuesthatareprevailinginthepresentwhichwerepresentedintheliteraturereview chapter

Itw i l l aimto integrateallthe conceptsandtheories that werepreviouslymentioned intheliteraturereview,dataanalysisanddiscussionwhichthenprovidesrecommendationsforthesame

 Chapter7–Reflection

Thischapterwillaimtocriticallyassesstheresearcher’slearningduringthewholedissertationprocessaswellasduringtheMBAprogram.Thisisaninformalaccountoftheaspirations,goals,objectives,experiencesandso on of theresearcher

1.4 MajorContributionsofResearch

Theresearchwillcontributetoitsrecipientsbyprovidingaplatformfordebateasthesubjectm a t t e risonethatisofacontroversialnaturesincecriticsstillarguethatthesecuritiesmarketfunctionsrationallyinadditiontoindividualsbehavingaccordingtotheaxiomsoftheEfficientMarketHypothesis

Therehasalsobeenlimitedresearchifanyintermsofthesunk-costfallacyinrelationtothei n d i v i d u a l Irishinvestor.Aselectedfewbehaviouralbiasesandjudgementalerrorsaresoughtandt h e i r applicationt o t h e Irishs e c u r i t i e s market.Itsimplications

w i l l b e describedande x p l a i n e d s o ast o drawconclusionsandp r o v i d e recommendations

t o raiseawarenessandi m p r o v e t h e individual’sd e c i s i o n

-makingprocessatt i m e s o f u n c e r t a i n t y andr i s k Furthermore,theresearchaimstocontributetothefieldofbehaviouralfinancebytestingtheaforementionedh y p o t h e s i s

o f regrettheorys p e c i f i c a l l y w i t h t h a t o f t h e i n d i v i d u a l Irishi n v e s t o r

CHAPTER2 -LITERATUREREVIEW

2.1 Introduction

Accordingtoapredominantprincipleofclassicaleconomictheory,investmentdecisionsareaffectedbyrationallyformedexpectationsbymakinguseofallavailableinformationinanefficientmanner(ScharfsteinandStein,1990)but

contrarytocommonassumption,economistJ o h n MaynardKeynesarguesinTheGeneralTheoryof

Employment,Interestand Moneythatt h e

“long-terminvestor”isconcernedwiththeaverageopinionandthecriticismofothersinordertomakeasoundjudgement.The individualalsobehavesinthemanneroffollowing thegeneralbeliefofthecrowd(Keynes,1936)

Inthischapter,variousliteraturethemes will beexaminedallhavingrelevancetotheresearchs t u d y andthesethemesallrevolvearoundbehaviouralfinanceormorebroadlybehaviouraleconomics.Aliteraturereviewwillconsistofreviewingearlierandrecentworkofthelistedthemessoastoidentifyareaswhereinfurtherresearchwillbebeneficialtohelptheresearchs t u

d y concludewithvarious propositions andmethodologies(RowleyandSlack,2004)

Thedifferentliteraturethemesillustratedarethatofprospecttheory,behaviouralfinance,sunk-costfallacy,overconfidencebias,regretaversionandhindsightbias.Theliteraturethemesandresearcharegroundedintheconceptoftheprospecttheorythatwaspostulated in1979byKahnemanandTversky

Prospecttheoryhaschangedt h e waye c o n o m i s t s t h i n k aboutdecisionm a k i n g underu n c

e r t a i n t y buttherehavebeenveryfewapplicationsofthetheoryandthoseappearingmostlyi n finance(Heimanetal.,2015).Thisliteraturethemeaddressestheaforementionedgapwithregardstoapplicabilityinrelationtothesunk-

costfallacyandtheprospecttheoryaswellast h e i r possibleexistencewithintheIrishinvestordecision-makingprocesswhileinvestinginshares

2.2 ProspectTheory

ProspectTheorypavedthewayandwasthebasisforthedevelopmentofBehaviouralFinance.T h e conceptofProspectTheorywasfirstpostulatedbypsychologistsDanielKahnemanandA m o s Tv

erskyin1979.Theypresentedapaperthatwascalled“ProspectTheory:AnAnalysiso f DecisionUnderR