In every market there are some trading or buying anomalies that cannot be explained by financial instruments and theories alone. For this reason the field of behavioral finance was developed. As investors are humans, they sometimes act in according to their instinct rather than strict financial rules, principals or inputs. There have been many events in the last century that do not have a clear financial explanation but rather seem more possibly explained by psychological factors. One of the most recent events that has been witness to this financial anomaly is the “Flash Crash of 2010”. This research will look into the event as well as examine how behavioral finance theories can be used to create a rational explanation to this seemingly irrational event.
Table of Contents
CHAPTER 1: INTRODUCTION
STRUCTURE OF THE PAPER
CHAPTER 2: LITERATURE REVIEW
BEHAVIORAL FINANCE
MAJOR LITERATURE
STATUS QUO BIAS
TRANSITORY COMPONENTS
UTILITY HYPOTHESIS IS QUESTIONED
GENDER AS A FACTOR IN DECISION MAKING
BEHAVIOR OF INDIVIDUAL INVESTORS
FEEDBACK THEORIES
TWO TYPES OF INVESTORS: SMART MONEY VS. ORDINARY INVESTORS
THE NEED FOR BEHAVIORAL FINANCE
EVENTS LEADING UP TO THE CRASH
FLASH CRASH 2010: A BRIEF SUMMARY
NET RESULT OF FLASH CRASH
CHAPTER 3: RESEARCH QUESTION AND FRAMEWORK
RESEARCH QUESTIONS
QUESTION 1: WHICH THEORIES EXPLAIN THE FLASH CRASH?
QUESTION 2: WHICH COMPANIES?
QUESTION 3: CIRCUITBREAKERS
CHAPTER 4: RESEARCH METHODOLOGY
OBJECTIVE OF THE RESEARCH
RESEARCH PROTOCOL
HOW RESEARCH QUESTIONS WERE ANSWERED?
STRENGTH OF ASSOCIATION
MATERIALS USED
HOW MATERIALS WERE PREPARED
DATA COLLECTION
TYPES OF DATA
JUSTIFICATION OF STUDY’S DESIGN
ESTABLISHING RIGOR
CHAPTER 5: ANALYSIS OF REASONS FOR FLASH CRASH 2010
LARGE DIRECTIONAL BETTING/TRADING
CHANGES IN MARKET STRUCTURE RESULTING IN THE DECENTRALIZATION OF TRADING
INFLUENCE OF HFT
HERD MENTALITY
HIGH FREQUENCY TRADERS AND THEIR CONTRIBUTION
ORDER FLOW TOXICITY METRIC
TECHNOLOGICAL GLITCHES
CHAPTER 6: INTERPRETATION OF RESULTS
CAN PROPOSED REASONS ADEQUATELY EXPLAIN EVENT
HOW DO THESE POSSIBLE EXPLANATIONS DIFFER FORM TRADITIONAL FINANCE EXPLANATIONS
CHAPTER 7: CONCLUSION
LESSONS LEARNED
CAN FINANCIAL INSTRUMENTS/REGULATIONS PREVENT FUTURE CRISIS?
CIRCUIT BREAKERS
RECOMMENDATIONS
FUTURE RESEARCH
Objectives and Research Focus
The primary objective of this dissertation is to investigate the "Flash Crash" of 2010 through the lens of behavioral finance, seeking to explain this seemingly irrational market anomaly by analyzing human-driven factors rather than relying solely on traditional economic models.
- Analysis of behavioral finance theories (e.g., herd mentality, overconfidence) in the context of market crashes.
- Evaluation of the influence of high-frequency trading (HFT) and large directional betting on market stability.
- Investigation of psychological triggers and feedback loops during rapid market downturns.
- Assessment of regulatory responses and the efficacy of "circuit breakers" as preventative measures.
Excerpt from the Book
Feedback Theories
Shiller, one of the leaders in behavioral finance came to the conclusion that mass psychology has a lot to do with the conditions in the market and that this can create a sort of feedback loop.
When speculative prices go up, creating successes for some investors, this may attract public attention, promote word-of-mouth enthusiasm, and heighten expectations for further price increases. The talk attracts attention to “new era” theories and “popular models” that justify the price increases. This process in turn increases investor demand and thus generates another round of price increases. If the feedback is not interrupted, it may produce after many rounds a speculative “bubble,” in which high expectations for further price increases support very high current prices (Shiller, 2003, p91-92).
Summary of Chapters
CHAPTER 1: INTRODUCTION: This chapter introduces the "Flash Crash" as a market anomaly and outlines how behavioral finance can provide deeper insights into the event than traditional finance.
CHAPTER 2: LITERATURE REVIEW: This chapter provides a theoretical foundation, exploring key concepts like status quo bias, feedback theories, and the distinction between smart money and ordinary investors.
CHAPTER 3: RESEARCH QUESTION AND FRAMEWORK: This section defines the primary research questions, focusing on the psychological aspects and the potential for regulatory safety mechanisms.
CHAPTER 4: RESEARCH METHODOLOGY: This chapter describes the qualitative and triangulation-based approach used to analyze the event, including the use of expert interviews and secondary data.
CHAPTER 5: ANALYSIS OF REASONS FOR FLASH CRASH 2010: This chapter presents the various factors posited to have caused the crash, ranging from directional betting and HFT to technological glitches.
CHAPTER 6: INTERPRETATION OF RESULTS: This chapter evaluates the proposed causes using behavioral finance theories to determine their credibility and impact on the 2010 market event.
CHAPTER 7: CONCLUSION: This chapter summarizes findings, discusses lessons learned, and offers recommendations for future market stability, including the implementation of circuit breakers.
Keywords
Behavioral finance, Flash Crash 2010, high-frequency trading, market anomaly, investor behavior, herd mentality, feedback loops, circuit breakers, market volatility, rational decision-making, financial regulation, algorithmic trading, stock market, investment psychology, economic crisis.
Frequently Asked Questions
What is the primary focus of this research?
The dissertation focuses on the "Flash Crash" of 2010, investigating it through the perspective of behavioral finance to understand why traditional financial models failed to account for this sudden market event.
What are the central themes of the study?
The core themes include the role of mass psychology in trading, the impact of high-frequency trading (HFT) algorithms, the influence of directional betting, and the necessity of improved market regulations.
What is the main research objective?
The objective is to determine the underlying factors of the 2010 crash and analyze how behavioral economic theories can help explain the seemingly irrational behavior of investors and automated systems during the event.
Which scientific methodology is applied?
The research uses a qualitative, triangulation-based approach, combining extensive secondary source analysis (academic journals, SEC reports) with firsthand perspectives obtained from expert interviews.
What does the main body of the paper cover?
The main body examines behavioral finance theories, reviews the timeline and causes of the Flash Crash, and provides a critical analysis of factors like herd mentality and technological failures in computer-trading systems.
How is the paper characterized by keywords?
The research is defined by terms such as behavioral finance, market anomalies, herd mentality, HFT, and investor psychology, reflecting its focus on the non-traditional side of market economics.
How does the author define the "disposition effect" in this context?
The author discusses this as a behavioral tendency where individual investors sell winning stocks too early while holding onto losing investments, often influenced by past return performance and limited attention.
What is the conclusion regarding regulatory "circuit breakers"?
The research concludes that while circuit breakers are a necessary tool to prevent future catastrophic sell-offs, they must be implemented carefully to avoid unintended consequences in market liquidity and informational transparency.
- Quote paper
- Jovana Paraca (Author), 2013, An Investigation of the “Flash Crash” of 2010 using the principles of behavioral finance, Munich, GRIN Verlag, https://www.hausarbeiten.de/document/270372
