Using behavioral finance for marketing

Since the time I was introduced to the concept of Behavioral Finance by Prof Uday Damodaran at XLRI, I have been greatly influenced by this topic. For the uninitiated, Behavioral Economics and Finance is a branch of economic and financial analysis that tries to understand economic decision of consumers including investors through social, cognitive and emotional factors. The premise is that human beings show repeated patterns of irrationality when making decisions.

A search for behavioral finance on Google would throw up multiple theories explaining this but I am trying to present below a very simplified interpretation and how it has been used by marketers around the world to their advantage.

1. Overconfidence- As human beings, we are generally overconfident of the results. This explains why even knowing the probability of success with a lottery, people would still buy it. This also explains why an investor would get into a high debt leverage knowing fully well that it may turn against him in bad times.

2. Herd like behavior- We tend to believe what the majority is doing. This 'behavior' is exploited by companies rolling out an IPO. Marketing glitz talking about company's prosperity, positive critic’s reports tempts investors into investing into that stock. As another example, stock analyst at a trading company, for example, would tend to buy what his colleagues are buying ignoring his analysis and judgment just to be sure that he won’t be fired in case his preferred stock turns out to be bad.

3. Loss Aversion- People feel pain of loss twice as much as they derive pleasure from an equal gain. A good example for this would be that people tend to retain a stock than to sell it at minimal loss knowing fully well that it would not give them a profit in near future. Mentally they would be most happy if they could even sell such a stock at 1 cent profit.

4. Consistency in thoughts- As human being, we have a tendency to have a thought process and then to stick to it. As a result, we tend to overlook any inconsistent information. Again an example could be about the way people would hold onto stocks and their investment irrespective of the updated market information available.

5. Emotional Attachment- Taking decisions based on emotions, such as love for a country, love for a brand, love for a region etc. There are many examples to this and has been used frequently by marketers across the world.  

6. Poor computation- People put undue weight on recent events and too little on far-off ones; they cannot calculate probabilities well and worry too much about unlikely events; and they are strongly influenced by how the problem/information is presented to them.