PREDICTING STOCK RETURNS USING THE BEHAVIOURAL APPROACH

Extensive literature exists on forecasting stock market returns. However a gap still exists in accurately predicting stock returns. This might have been due to the fact that many of these models base their forecasts solely on the fundamental factors, whilst ignoring the behavioral attitudes of investors that may also affect the dynamics of stock returns. The primary objective of this research is to develop a predictive regression model of stock returns that uses the behavioral approach. The model is based on two distinct behavioral attitudes of investors, which are rational behavior and irrational behavior. We argue that given information that may affect stock returns, a market participant either decides to react rationally or irrationally. This argument allows us to capture the reaction of market participants to both rational behavioral attitudes and as well as irrational behavioral attitudes that may affect stock returns.