Behavioural Approach to Asset Pricing An empirical study on BSE stocks

Abstract

Since the mid-1950s, traditional finance models have relied on the assumption of rational newlineinvestor behaviour, positing that stock and bond markets operate efficiently. However, newlinepsychological research has shown that cognitive errors and emotional biases often lead to newlineirrational financial decisions. This has given rise to the field of Behavioural Finance, which newlineintegrates psychological insights into financial decision-making, challenging the rationality newlineassumption of traditional finance. Pioneered by Daniel Kahneman and Vernon Smith, newlineBehavioural Finance explores how personal, social, and psychological factors influence newlineinvestor behaviour and market outcomes. This study aims to understand the empirical efficacy newlineof behavioural models of asset pricing, particularly focusing on investor sentiment and trading newlinebehaviour. Using the Fama-Macbeth methodology, we test whether these behavioural factors newlinesignificantly affect stock market returns. Models from Yang and Zhou (2015) and Baker and newlineWurgler (2006) provide the framework for this analysis. A time-series data analysis is newlineconducted on the SandP BSE Sensex from 2012 to 2022, employing factor analysis, regression, newline newlineand correlation techniques. Our findings indicate that, while the traditional Fama-French three- newlinefactor model has limited explanatory power regarding behavioural factors, reducing the sample newline newlinesize to three years significantly improves the explanatory power of investor sentiment and newlinetrading behaviour indices. This suggests that short-term data better captures the impact of newlinebehavioural factors on asset pricing, though this may vary with different contexts and newlineapplications. Overall, our research contributes to the understanding of how behavioural finance newlinecan explain market anomalies and investor decision-making, challenging the efficient market newlinehypothesis and highlighting the need for advanced asset pricing models that incorporate newlinebehavioural implications. newline