Read the text and explain all concept discussed in the text below: (This subject is Behavioral Finance)

Ethics

Standards of ethics and ethical decision making are important for the functioning of the investment industry and the wider financial system. Decisions on ethical issues, like decisions of any kind, are driven by the psychology of the decision maker. Oberlechner (2007) provides an extensive review of psychology research relevant to ethical decision making in the finance and investment industries. He notes that ethics goes beyond restraining from unethical behavior because of the potential costs of exposure. Some psychology research suggests people want to be ethical, an intrinsic interest that does not rely on a desire to avoid punishment. Psychological concepts used in behavioral finance, heuristic biases or cognitive dissonance, for example, can also affect ethical decision making. The review presents arguments that situational and social forces can result in otherwise ethical individuals committing unethical acts. Notably, in the financial sector the temptation to act unethically can be high because of the large sums of money involved.

Prentice (2007) provides another broad review of ethical decision making in a financial context. He argues that well-intentioned people can have ethical lapses if they find themselves in particular circumstances and do not take account of the errors in judgment that humans are behaviorally inclined to make. In short, bad acts are not committed only by bad people. Sometimes good people act in an unethical manner, out of a desire to conform with others around them or because they are overconfident, for example.

An alternative perspective on the psychology of ethics can be found in Daniel, Hirshleifer, and Teoh (2002). They argue that behavioral biasesfor example, limited attention and processing capacitymake many investors credulous and thus overly inclined to take at face value the advice of parties in the financial industry. They do not consider the incentives for interested parties, such as corporate management, brokers, and analysts, to manipulate available information. This bias suggests that regulations mandating the increased disclosure of incentives and conflicts of interest may be beneficial.

Neuroeconomics

Neuroeconomics uses knowledge of brain functions to understand the aspects of brain activity that contribute to different types of decision making. Brain imaging and other types of neuroscientific techniques supply insight into the responses produced by particular situations and choices. Camerer, Loewenstein, and Prelec (2005) provide a comprehensive review of the literature of neuroeconomics.

A key finding from neuroscience is that brain processes can be subdivided into controlled and automatic processes and, further, between cognition and affect. The processes are sometimes simplified into two systems with various labels (e.g., system one and system two, X-system and C-system, associative and rule-based, or experiential and rational systems).

Camerer et al (2005) note that:

First, much of the brain implements automatic processes, which are faster than conscious deliberations and which occur with little or no awareness or feeling of effort. Because people have little or no introspective access to these processes, or volitional control over them, and these processes were evolved to solve problems of evolutionary importance rather than respect logical dicta, the behavior these processes generate need not follow normative axioms of inference and choice. Second, our behavior is strongly influenced by finely tuned affective (emotion) systems whose basic design is common to humans and many animals. These systems are essential for daily functioning, and when they are damaged or perturbed, by brain injury, stress, imbalances in neurotransmitters, or the heat of the moment, the logical-deliberative systemeven if completely intactcannot regulate behavior appropriately. (p. 11)

Put simply, traditional economics assumes that humans make decisions using a controlled cognitive process. In practice, decisions are often made using an automatic process, subject to biases caused by mental shortcuts, or an affective process influenced by emotions.

Behavioral finance has evolved based on observing how individuals make decisions. Advances in neuroscience now make direct measurement of thoughts and feelings possible and offer the potential to understand why individuals make these decisions. This information may help explain anomalies in decision making.