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Financial regulations, risk management and value creation in financial institutions: evidence from Europe and USA

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par Agborya-Echi Agbor-Ndakaw
University of Sussex - Master of Science 2010

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1.2 Rationale of Study and Gaps in Existing Research

Although there are numerous conceptual evidence on the validity of classical financial theories such as the CAPM, MPT and EMH, in trying to provide insights and explanations to the general idea of the investment decision-making process, there is a need for reviewing the existing literature revealing that very little attention is being given to the behavioural aspects influencing the entire process. The classical finance school of thought seeks in portraying investment decision-making processes as processes which can be studied and applied properly in real life. With investors bearing this in mind, they will be allowed to be able to predict as well as beat the market hence the issue of human error and irrationality will not arise.

On the other hand, behavioural finance has proven to have very strong implications especially when seeking to provide cover for the lacuna done by the classical finance school of thought when trying to stress on the investment decision-making process. Behavioural finance researchers try in providing detailed explanations for the existence of irrationality and human errors as far as investment decision-making are concerned so as to reduce risk if it cannot be avoided. It is evident that the behavioural finance scholars always try to stress on the fact that in order not to avoid any investment mistakes caused by human beings, then the practitioners (financial) should always try to understand the factors of finance brought out by the behavioural finance scholars. This is because these scholars try to provide an adequate understanding of the application of socio-psychological factors in the investment decision-making processes. This can successfully be done by looking at the way individual investors are influenced by certain cognitive illusions especially as they try to arrive at a decision. As these behavioural finance scholars struggle to provide an adequate understanding into the investment decision-making processes, they have as well failed to look at the proposed sociopsychological factors in details alongside with the classical finance scholars thereby resulting in a gap in the entire investment decision-making processes which therefore calls for concern.

Nevertheless, it has been argued that the theories of classical finance such as CAPM are based on many assumptions some of which are obviously unrealistic?.... «The true test of a model lies not just in the reasonableness of its underlying assumptions but also in the validity and usefulness of the model?s prescription. Tolerance of CAPM?s assumptions, however fanciful, allows the derivation of a concrete, though idealized, model of the manner in which financial markets measure risk and transform it into expected return.» (Mullins, 1982).

This then implies that such important classical finance theories should never be underestimated or disregarded when trying to provide explanations for other factors influencing investment decision-making process.

Judging from the above mentioned points, it can be concluded that the main reason of this research is filling that gap left by the financial researchers by way of critically analysing the process of investment decision-making. That is finding out if the different financial scholars' factors have been assimilated by other different scholars influencing the decision-making process. This therefore leaves us with the question of determining the extent to which the behavioural as well as the classical factors influence the investment decision-making processes thereby giving room to actually understand the domain of finance and investment and how the investment process works as a whole.

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