Decision-making in investment strategies

Decisions in Investing

Managerial Decisions in Investing

Investors buying and selling stock causes fluctuations from fears and opportunities presented in the stock markets. The volatility of stock markets creates hyperbolic discounting with investor perceptions of near and far future. Hyperbolic discounting affects the level of risk associated with stock prices and interest rates.

The root cause of wild ups and downs in stock markets is unanticipated information, such as government announcements of buying and selling bonds, financial scandals, corporate bankruptcy, stringent IPO regulations, recession fear, repo hikes, or changes in interest rates (Admin, 2009). This allows investors to buy low and sell high for near future profits. Within acceptable limits, volatility is a sign of healthy markets.

A critical assumption leading up to hyperbolic discounting is that individuals perceive the probability of their wealth decreasing below current level is relatively small (Nir, 2004). A second assumption is understanding future fluctuations between periods due to stock market fluctuations, real price fluctuations, and unexpected expenditures or windfalls. Hyperbolic discounting causes inconsistencies in preference of smaller earlier rewards for near future, but larger later reward for the far future.

Markets influence how prices evolve, investor tastes, and investor preferences. Where preferences change over time and cause inconsistencies, future evaluation of investing is based on current preferences. The marginal utility becomes hyperbolically discounted with future perceptions of added utility decreasing at a decreasing rate over time, which generates hyperbolic marginal utility. In the near future, wealth increases causing an expected marginal utility decrease.

Perceptions can be driven by culture, heuristics (rule of thumb and shortcuts), trade-offs, and perceptions concerning the far future (Brugen, 2013). Culture has a strong influence on risk perception. High levels of uncertainty avoidance is associated with strong hyperbolic discounting. The use of heuristics enable individuals to adapt to changing environments, reduce cognitive loads, and save time. Decision making can involve trade-offs between immediate and delayed benefits and costs, especially in the long-term. Impatience causes preferences in the short-term. Future perceptions of how individuals feel about what resources will be available in the long-term as well as socio-demographics play a major role.

Hyperbolic discounting causes investors to desire short-term results (Zou, 2007). This depresses savings and reduces stock demand so stock prices fall and interest rates rise. It dampens the marginal risk effect on stock prices. People drive utility from the act of accumulating wealth. The rate of time grows. The hyperbolic discounting affects how stock prices and interest rates are affected by risk. This results in saving less to reduce stock demand to lower stock prices and raise the risk free rate.