Emotion's component of expectations in financial decision making

Abstract

Purpose

The economic system is an expectation's feedback system, thus decisions made by economic agents are based on their expectations about the future state of the economy. These decisions affect actual realization of economic variables and this process leads to the new expectations. For a long period of time, economics was based on the erroneous belief that economic agents apply rational calculations to economic and financial decisions. The main purpose of the current paper is to present the theoretical model explaining emotion's component of expectations in the process of financial decision making.

Design/methodology/approach

The research is based on the generally accepted scientific qualitative and quantitative methods, including monographic method.

Findings

The paper shows how the expectations and subjective beliefs of different financial market participants could be translated into prices. After describing the main investor's categories, it is possible to model their subjective beliefs about the current price evolution on the stock exchange and formulate the demand strategy of each investor's group. Finally, the model shows mathematical considerations how prices result from demands, considering that they are set by the market maker.

Originality/value

The paper shows how emotions impact investors' beliefs and could be transmitted into prices. A particular agent category – the emotional investor – was formulated, who exclusively follows his intuition and whose presence influences market prices. So, there is no doubt that an appropriate rational strategy requires the adoption to the new kind of market agent and theoretical considerations presented in the paper could contribute to this process.

Citation

Kuzmina, J. (2010), "Emotion's component of expectations in financial decision making", Baltic Journal of Management, Vol. 5 No. 3, pp. 295-306. https://doi.org/10.1108/17465261011079721