Financial regulations, risk management and value creation in financial institutions: evidence from Europe and USA
par Agborya-Echi Agbor-Ndakaw
University of Sussex - Master of Science 2010
Reading from Saunders et al, 2007, it is evident that the general research approach adopted just for study purposes is based mainly on the philosophical stance which is adopted for the research with the deductive approach normally based on positivism and the inductive approach on interpretivism. Contrary to the deductive approach which focuses on the formulation of the hypotheses and the use of statistical methods in the data analysis process, the inductive approach helps in establishing links between the research objectives as well as assisting in the production of reliable and valid findings. Note that the deductive approach will be used in presenting the findings and conclusions.
According to Trow, 1957, the application of the philosophical assumptions of positivism and interpretivism to this study is an indication that this study took a pluralist methodological stance. This is so because this study focuses on understanding, interpreting, describing and explaining how financial regulations, risk management and value creation influence investment decision-making combine with some socio-psychological factors.
For the purpose of this study, we will be using the secondary and tertiary methods of data collection. Reading from Saunders et al, 2003, secondary data is a form of data that has been collected for use for other purpose(s) but can still be used in answering the designed research questions. In other words, these are can be referred to as ready-made materials. These are often used in providing foundations for present day studies by helping in the investigation and provision of some already existing theories in classical and behavioural finance that relate to the study. While secondary data is mostly gotten from textbooks, newspapers, journals and magazines, tertiary data is gotten from the internet and encyclopaedias.
ANALYSIS AND DISCUSSION OF FINDINGS 4.1 Purpose of the Chapter
This chapter will focus on the presentation of the results obtained from the findings. These results will be analysed by bringing out the difference between the classical and behavioural schools of finance as well as testing the hypotheses. Also, within the content of this section, we will be explaining how the concept of behavioural finance best explains and contributes to the outbreak of the present global crisis. Note that the analysis and results are dependent upon the findings of this study. In this chapter, the results of the findings will be described and presented.
Statistics has proven that risk plays a very important role in investment no doubt it is considered to be a very important topic in investment. This is because an understanding of risk and how it is measured is cardinal to the development of investment strategies and the subsequent making of investment decisions. As pointed out by Blume (1971), risk constitutes a controversy amongst different financial theories which can all be classified under the classical and behavioural schools of finance. Based on these differences, this section of the study will be responsible for the on going debate on the existing views of the risk concept.
Levy and Sarnat (1972) stress on the fact that some already existing classical financial theories such as the CAPM, MPT and EMH are all moving towards the direction of risk being a uni-dimensional concept since its measurement is so purely objective. Based on this, they try in providing very basic description of the classical finance school of thought's approach towards risk as follows:
«Subsequently, various economists have tried to evaluate investments with the aid of two (or more) indicators based on the distribution of returns. Generally one index reflects the profitability of the investment while the other is based on the dispersion of the distribution of returns and reflects the investment?s risk. The most common profitability index used is the expected return that is the mean of the probability distribution of returns; the risk index is usually based on the variance of the distribution, its range and so on». (p.303)
Following what Levy and Sarnat mentioned above, it is evident that risk has to do with; the standard deviation where by the volatility of the return can be measured with the beta coefficient responsible for comparing the volatility of the different security and portfolio within the market with that of the market as a whole. Risk is most often than not evaluated following the different variations of returns of an investment with reference to its expected return, hence confirming the fact that risk is a double sided coin. The main reason behind risk centres on the fact that risky investments stand better chances of higher expected returns unlike a risk-free investment. This is because it is assumed that during decision-making, investors try to make decisions with possible outcome being associated with specific expected return.
As such, there are two categories of risks as far as the classical financial theories are concern-systematic risk also known as non-diversifiable risk, is the risk type that can not be eliminated hence it is associated with the entire market. On the other hand, we have the unsystematic risk which is entirely associated with particular companies, thereby making this risk type unique and diversifiable (Bodie et al, 2008).
Within the content of the classical financial investment decision theories, it is assumed that individual investors behave in a rational manner and make optimal decisions when confronted with judgements regarding risk and uncertainty.
In addition to the above, this research equally revealed the fact the behavioural finance scholars just as the name `behavioural' try to provide an absolute understanding of the behaviour of investors in general. As a result, they look into the general idea on risk and investment from all fields of life no doubt it is mostly referred to as an interdisciplinary field which developed from all subjects in life be it sociology, psychology, finance as well as behavioural economics hence greatly influencing some investment decisions.
This boils down to the fact that behavioural finance, unlike classical finance, takes a completely radical view when it comes to the subject of decision-making. As if that is not enough, behavioural finance researchers claim that investors do not need to always seek the highest return for a given level of risk at any given point in time as assumed by MPT.
In the course of our study, it was realised that unlike the classical financial school of thought, the behavioural financial school of thought views the decision-making process to be a rationality bounded process. This is fully supported by Bajeux-Besnainou and Ogunc, 2003 when they stated that:
«Satisficing? is an optimization methodology that involves emotions, adaptive learning and cognitive biases. Simon calls for individuals to satisfice?, that is, to optimize until it is close enough in the traditional sense of optimization. By contrast, the traditional way of optimizing is a maximization of a utility function subject to budget constraints, as in the classic economics framework». (p.119)
Contrary to the views of classical finance, with behavioural finance, it is assumed that an important aspect in investment decision-making process is subjective to aspects perceived by risk investors. No doubt they look at risk to be multidimensional unlike it being unidimensional therefore implying a blend of accounting and financial variables. Looking at risk at a greater in-depth, it has revealed that individual attitudes towards risk are far from being
logical. This is so because in real day to day decision-making situation, people are faced with the need to address risk in situations that they have never come across and which they might never encounter thereafter, thus the reliance on statistical techniques is sometimes largely irrelevant and can hardly have any impact on their decisions. As a result, behavioural finance stands a better chance of providing very convincing explanations for the causes of the global financial crisis.
All in all, through out our study, we realised that everything on the investment decision-making process centred on these two schools of finance. Both schools stressed on the fact that some aspect of risk needs to be taken in order to expect any form of return, therefore investors need to take on to the risk in order to create an expected return.