Behavioural finance perspective in theory of international portfolio investment

Abstract

Behavioural theory has become a driving force for relaunching and rethinking the conceptual foundations of conventional economic theory, giving impetus to the study of behavioural economics, including behavioural finance and the theory of international portfolio investment. The theory of international portfolio investment justifies the benefits of international diversification of investment portfolios and the possibility of generating returns in different markets. However, international investment practice and empirical research show that investor behaviour is often non-rational, and investment decisions are influenced by psychology, emotions, and cognitive biases. The purpose of this paper is to compare traditional and behavioural finance and study the implications of behavioural finance in modern portfolio theory. It has been established that classical finance is based on neoclassical economics and assumes that people are rational, risk-averse, have complete information, and are focused on utility maximisation. In contrast, behavioural finance assumes that people can be rational, but in most cases, their behaviour is better explained by emotions and psychology. Investors do not always make decisions that are consistent with utility maximisation. The paper emphasizes that modern portfolio theory is based on the efficient market hypothesis, which behavioural finance rejects, as it assumes that investors' behaviour may be non-rational and influenced by psychological and behavioural factors that affect decision-making. It was revealed that today, there is no single theory of behavioural finance, but there are several theoretical concepts that describe investor behaviour from the perspective of behavioural theory. Among the most influential are the behavioural capital asset pricing model, behavioural portfolio theory, adaptive markets hypothesis, behaviourally modified asset allocation, and goal-based investing. International investment decisions and the formation of international investment portfolios are influenced by investors' behavioural biases, among which the most researched and influential are home bias, which refers to investors' preference for domestic investments, and cultural differences, which can influence risk perception and investment preferences.