Critically discuss investor sentiment and the implications of their Essay

Critically discuss investor sentiment and the implications of their behaviour - Essay Example The role of investor sentiments and how it can affect their behavior has been in relatively direct contrast with the modern portfolio theory. Modern portfolio theory indicates that the investors always act rationally and also take into consideration all of the available information. However, a large number of empirical studies have actually shown the irrational behavior of the investors as well as repeated errors in overall judgment. The behavioral finance as a field therefore focuses upon understanding as to how such cognitive behaviors can be explained besides exploring as to why such errors occur in investor judgments. Behavioral finance therefore uses the theories from psychology as well as sociology and other disciplines to actually explore and understand basic investor behavior and how it may have an impact on the market. Investor Sentiments are generally defined as beliefs in the future cash flows as well as the investment risks which cannot be otherwise defined by the facts at hand. This is based upon the assumption that the investors are actually subject to sentiments and their decisions are subject to the way their sentiments interact with their overall decision making process. What is also critical to note that betting for such sentiments however, can have a relatively high risk? As such there are fundamental trade-offs need to be made in balancing the role of sentiments and the risks taken based upon those sentiments.( Ackert & Deaves, 2010). There have been many episodes where the investor sentiments actually drove the prices up without the fundamentals of the company or market supporting the same. The internet bubble as well as the inflated prices of telecom stocks on NASDAQ indicates that the investor sentiments can actually drive the prices to higher levels without actually assessing the actual risks and rewards associated with particular