Decision Making under Uncertainty the Impacts of Emotional Intelligence and Behavioral Patterns

(ProQuest: . denotes formulae omitted.)INTRODUCTIONSince the early 2000s an exciting school of thought has emerged in exploring the role of emotional intelligence in the investment management process as a result of the interaction between neuroscience and financial economics. Emotions are unconsciously experienced as outcomes are guessed or imagined by an investment manager when faced with information disadvantage or partial ignorance in a highly dynamic and competitive investment environment. It is shown that indicators and ranking criteria for evaluating the degrees of emotional intelligence (for example, Mayor, Salovey and Caruso, 2002), generally reveal that investors with the ability to analyze and evaluate their emotional states as well as regulating and managing their emotional intelligence tend to make better decisions and appear to learn much from their mistakes especially when faced with an uncertain environment in which exact calculations are not possible (Ameriks, Wranik and Salovey, 2009). This is further reinforced in findings by Coricelli, Critchley, Joffily, O'Doherty and Sirigu (2005) who show a strong relationship between emotions and signals encoded in the brain in that emotions such as regret or excitement appear to be tied to reward prediction errors that are processed in the regions of the brain similar to a mathematical risk prediction error function. Blackman (2014) states that "great strategies seem to draw on emotional and intuitive parts of the brain. " shown by neuroimaging. And that "A good strategic thinker would pay attention to emotion and social thinking, social temperature. and neuro-feedback for training the brain in learning endeavors. " Loewenstein (2000) stresses that emotions were included as a part of utility analysis in 1789 by Jeremy Bentham in the decision making process. Maximization of the utility of the final wealth, for example, has been the prevalent rule in investment decisions since thel950s with the development of the mean-variance analysis leading to the capital asset pricing model in portfolio theory.Modern theories of finance are however based on the notion of rational behavior in the decision making process and on restrictive assumptions including the existence of complete information regarding the payoff structure of financial assets. This implies that the average return and the likely fluctuations around it are known in advance. Furthermore, investors are assumed to be risk averse and thus would be willing to invest as long as the average payoff is expected to exceed the cost of the asset. An investor who is risk averse is expected to take a risky venture when the rise in wealth is expected to be greater than the fall in wealth. While the pleasure of gaining a dollar, on average, is less than the suffering from losing a dollar, investments are made as long as there is a net premium or reward for taking the risk involved.Investors however may possess a loss aversion behavior and aim for avoiding the decline in wealth. Empirical evidence during the past three decades shows that investors appear to sell financial assets that have risen in price too quickly while keeping the loss producing ones for a long time. That is, investors react differently to gains and losses as they feel positive emotion from a gain in price but a much stronger negative emotion from an equal amount of loss. This behavioral financial pattern is, in part, due to cognitive heuristics and biases. In the mind of an investor a dollar gained in the retirement account does not cancel a dollar lost in the personal account. Furthermore, investors view a dollar received in dividend income differently from a dollar gained in capital gain even in the absence of differential taxes and transactions costs as they appear to consume the dividend while saving the capital gain. The feeling is that earning the capital gain had required more effort-taking more risk-as compared with the receiving the predictable stream of dividend income ( Kahneman and Tversky, 1979; Thaler, 2000 and Statman, 2010). …