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Chapter 1 Introduction

Abstract

This chapter outlines the structure of the study.

Traditional finance theory is drawn from the belief that all market participants are completely rational and calculating. However, given the recent unexpected financial crises, the inherent risks in relying too heavily on contemporary financial theory as the basis for policy discussion is inherently risky, as these theories are only suitable for problems that can be answered with scientific accuracy.

In the last decade, contemporary financial theory has come under severe criti- cism. Whilst it was once believed that patterns of past price behaviour will tend to recur in the future (Fama 1965), the rise of behavioural economics meant that the once lauded efficiency of the market has now made way for behavioural explana- tions such as herd behaviour and mass psychology (Nocera 2009). Some may believe that the environment in which the markets exist has altered, but this is not the case. People have always been irrational, contributing to market inefficiency (Fisher 2010). The only thing that has altered is that there is more focus on market participants. Thus, if financial theory is to grow and develop, researchers have to adapt to the more unpredictable and less tangible aspects of market reality.

Although financial theory has made headway into explaining stock market anomalies,[1] it has not attempted to explore the motivations behind these decisions. Without comprehending these motivations, the phenomena in question will only be observed and documented, never truly explained or understood. Delving into the motivations behind financial decisions may help in understanding how financial crises, driven by inexplicable market choices, come about. This book thus attempts to model the financial choices made by individual market participants to gain a deeper understanding into financial decision-making.

As indicated, this book aims to explore how individuals make financial decisions. One's asset and portfolio[2] allocation decisions were used to proxy for financial decisions. These model the day-to-day financial allocation decisions made by con- sumers. A psychological approach, regulatory focus theory, is used to explain these allocation decisions. Regulatory focus theory explores the relationship between one's motivation and means of goal pursuit (Higgins 2000). It states that individuals have a dominant regulatory focus, either promotion or prevention. This dominant focus is known as chronic regulatory focus. People with different chronic regulatory foci have varying means of approaching the same goal. For example, a promotion-focused individual who wants to do well on a quiz would study hard at the library, and a prevention-focused individual would turn down an invitation to go out drinking with friends the night before (Crowe and Higgins 1997). Regulatory focus guides decision-making, and affects financial allocation decisions (Scholer et al. 2004), modelled in this book by asset and portfolio allocation decisions. In previous studies, respondents were primed [3] and their asset and account decisions were recorded (Zhou and Pham 2004). In reality, consumers do not make personal investment choices after being primed, and their chronic regulatory focus would be more of an influence. As such, this book hopes to explore how chronic regulatory focus affects asset and portfolio allocation decisions, giving rise to the research question:

Does chronic regulatory focus affect asset and portfolio allocation decisions?

The research objective of this book is to explore the relationship between chronic regulatory focus and asset and portfolio allocation:

To investigate the effect of chronic regulatory focus on asset and portfolio allocation decisions.

To measure the association between chronic regulatory focus and allocation

decisions (asset and portfolio), two measures were employed; a behavioural mea- sure using the eye tracker and self-report, using a questionnaire. Two measures were utilised to reduce the likelihood of spurious results (see Sect. 3.2) (Podsakoff et al. 2003). Utilising the eye tracker to collect behavioural data may also provide deeper understanding into how individuals make their asset and portfolio allocation decisions, primarily because the former can capture visual behaviour prior to decision-making, possibly recording subconscious behaviour (Strandvall 2013; Yarbus and Riggs 1967). The following section illustrates the significance of the research, focusing on the theoretical and practical implications of this book.

1.1 Significance

1.1.1 Theory

From a financial perspective, there has been limited research involving regulatory focus theory (Zhou and Pham 2004) or eye tracking (Shavit et al. 2010). Thus, this book hopes to deepen existing understanding in the fields of finance, consumer behaviour and eye tracking.


1.1.2 Corporations

This book may be of use for the private sector, specifically financial institutions. Research indicates that certain financial products are sensitive to regulatory foci (Zhou and Pham 2004). By classifying customers based on their chronic regulatory focus, banks will be able to market products tailored specifically to the customers' regulatory foci. In addition, when banks are aware of the chronic regulatory foci of their clients, they may be better able to create portfolios that reduce their clients' perceived risk.

1.1.3 Consumer Education

1.1.3.1 Public

Once it is understood how chronic regulatory focus guides one to particular financial decisions, governments will be able to craft policy decisions that specif- ically cater to these foci. For example, in implementing financial literacy programs, policymakers can design versions of these programs for those of differing foci, ensuring effectiveness.

1.1.3.2 Participants

This book may benefit participants involved. They can have a greater understanding of the subconscious processes that underlie their own decision-making processes. With this knowledge, they may be able to construct less risky portfolios, not giving into their own inherent biases. In addition, the participants in this book will be able to find out their chronic regulatory focus, and thus made more aware of how they make the different decisions in their lives.

Table 1.1 Structure of book


1.2 Structure of Study

A detailed literature review follows, which builds the theory underpinning the study detailed in this book and outlines the process and development of the hypotheses, along with a methodology section. The results, discussion and conclusion chapters end this book. Table 1.1, briefly indicates the structure of this book.


  • [1] Behavioural finance, explained in Sect. 2.1
  • [2] Portfolios denote a collection of investments, with its own risk/return profile, held by a company,financial institution or individual
  • [3] Priming is an implicit memory effect in which exposure to a certain stimulus influences a response to a later stimulus
 
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