Former hedge fund manager Nick Bullman and Richard Fairchild of
the University of Bath School of Management explain the
importance of human emotions in investment and finance
Traditional approaches explaining human choices in financial
services have done little other than reveal our limited
understanding of this subject. Only in the last twenty years or so
with the advent of "behavioural finance" have we been afforded a
more colourful picture of the factors affecting peoples' decision
More recently, researchers have come to realise that far from
making rational, robotic decisions, in fact emotions such as first
impressions and "falling in love" actually have a more powerful
part to play in the decisions of casual consumers and professional
In this article, financial services risk expert and former hedge
fund manager Nick Bullman teams up with Richard Fairchild at the
University of Bath School of Management to explore some of these
new theories and their implications to understanding financial
- The rational choice model assumes that financial market
participants are fully rational, unbiased, emotionless
self-interested maximisers of expected utility (with stable
- A recent development, behavioural finance, recognises that
real-world actors may suffer from bounded-rationality, may have
psychological biases, may be captive to emotions, and may not be
maximisers of expected utility.
- The focus of this article is on a further, recent exciting
development: emotional finance. Emotional finance employs Freudian
psychoanalysis to study the effects of investors' and managers'
unconscious emotions on financial market behaviour.
- Unconscious emotions may cause bubbles and extreme crashes at
critical emotional tipping-points.
- Emotional finance emphasises the difference between actual and
- Investors' states of mind exists in two distinct phases: the
paranoid-schizoid phase (when perceived risk is low), and the
depressive phase (when the perceived risk is high).
- Emotional finance predicts a dynamic inverse relationship
between perceived and actual risk
- Perceived risk may be at its lowest precisely when actual risk
is at its highest.
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