Behavioural and Psychological Factors in Financial Markets: A Review

It has been well documented that individuals have a fascination and preoccupation with numbers in general life and this fascination also
pervades through to financial markets. This is reflected in the fact that a section of the investment community has a view that behavioural and psychological factors are important in the setting of price. Coupled with this there has been a renewed focus on the clustering phenomenon in relation to financial markets encompassing equity/share, foreign exchange, commodities and derivative markets. Furthermore. recent concern on the identification and testing of the phenomenon of price barriers has emerged. Behavioural and psychological explanations for clustering and barriers are common and these areas are of increasing interest to practitioners and academics alike. The aim of this paper is to provide (i) an overview of behavioural and psychological issues pervasive in capital markets and (ii) a review of some of the empirical evidence specifically relating to price clustering and psychological barriers in financial markets.
Results of the review reveal that clustering is pronounced and pervasive across most types of financial markets. Further, based on the testing of a transgressional effect, studies have confirmed that barriers exist across financial
markets. That said, the interpretation of the clustering and barrier effects are not clear-cut. It is likely to be a combination of behavioural, cultural and economic factors that contribute to the price setting process. Based on these documented effects across financial markets it can be concluded that traders impute some form of information content into numbers or digits. The implications and potential for trading strategies are apparent and highlighted.