Christopher Betts
December 5, 2018
Executive Summary
This article provides how people behave in the finance realm and how behavioral finance
uses different models that are not always rational to the human eye. This article was
commissioned to examine how people think in the finance world and why investors have little
diverse mindsets when making large financial decisions. The author of the article, Behavioral
Finance, is Jay R. Ritter. Ritter is a professor of Finance at the University of Florida. This article
was published, with minor modifications, in the Pacific-Basin Finance Journal Volume 11,
Number 4 on September 2003. In this article, Ritter intended for his audience to find out that the
human mind and how people think can make the wrong financial choice for investors and other
companies.
One important finding from the Ritter’s article is arbitrageurs. These are individuals who
take advantage between other investors and markets over a price difference. In some cases,
studies have found the arbitrageurs who have limited funds to invest in, don’t trade in large
markets because of the potential for failure and loss of investment. The way arbitrageurs think
are ways how they can make the most money from companies and use it for their own advantage.
They are in a strict mindset that the markets are not rational because they can’t predict the future,
but investors can if they are open-minded.
Another important finding from Behavioral Finance, is cognitive biases. This report
addresses the issues about diversification and how it is needed to make a smart investment on
return. Having too little diversification leads to the likelihood of investors investing too much
into a company because they are familiar with trends. These findings have led to many bad
investment decisions because the investor feels overconfident about their investing abilities. This
bias argues that competition between investors seeking abnormal profits will drive to their
correct values in their head and not the actual correct value in the real world. From the cognitive
biases standpoint, investors only have one way of thinking and get used to same patterns they
cognitively think in their mind what will be a success and what will be a complete failure.
One last crucial finding in this article is prospect theory. This theory goes in depth about
someone the most on he/she’s financial investment because open mindsets lead to open wealth
opportunities for investors.