The psychology of investor behavior: Stock market expectations and portfolio decisions during market volatility

Abstract

This dissertation aims to understand the psychological aspects of investor behavior, exploring the pivotal role of stock market expectations in the context of market volatility. Financial decision-making during times of heightened market volatility demands a delicate balance between potential gains and risks. The study seeks to gain a deeper understanding of how personality traits and emotional disposition influence stock market expectations and subsequently affect investment decisions, with a focus on an older population aged 50 and above. This demographic, approaching or entering retirement, faces unique challenges in making investment choices, where investor mistakes could have significant implications for funding retirement. Drawing on the theoretical foundations of behavioral finance and psychology, the research employs hierarchical and structural equation modeling to analyze data from the 2018 and 2020 waves of the Health and Retirement Study (HRS), a nationally representative sample of those aged 50 and older. The exploration begins by conceptualizing stock market outlook as an indicator of respondents' anticipations regarding future stock values. By evaluating individuals' stock market expectations, the study provides insights into their subjective assessments of potential risks and rewards associated with stock investments. Stock market outlook is posited as a situational trait, acting as a primary predictor of stock reallocation behavior. The study delves into the Big Five elemental traits, recognizing their significant roles in shaping financial decision-making. These elemental traits influence compound traits, specifically positive and negative affect, which in turn shape the situational trait of stock market expectations. The research focuses on stock market expectations as a core construct, representing individuals' anticipations about future stock market performance. This approach provides a comprehensive understanding of how individuals perceive and respond to uncertainty in the financial market. By exploring stock market expectations through the lens of personality and affect, this research illuminates the intricate relationships between psychological traits and investment decisions during times of market volatility. The study offers insights into the relationship between personality traits, emotions, and stock market expectations and how they collectively shape investment portfolio changes. Financial practitioners and firms can harness these insights to better understand investors' stock market expectations, thereby providing tailored guidance during market volatility. Such informed support can lead to more rational financial decisions, advising investors on the potential negative consequences of reacting to short-term market fluctuations. Additionally, the study contributes to the literature on the relationship between psychology and financial markets, deepening the understanding of how individuals navigate investment decisions amidst economic turbulence. Focusing on the unique challenges faced by the older demographic underscores the importance of targeted support to mitigate the impact of investor mistakes and protect the financial well-being of this population.