Behavioural Finance: An Islamic Perspective

Abstract

This paper discusses the issue of behavioural finance (BF) and its place in the Islamic financial system as well as the feasibility of applying Islamic finance and parameters to forecast the movement of Islamic securities prices. It also explores the possibility of harmonisation between the approaches of market efficiency and behavioural finance. The paper starts with questions about the credibility of the efficient market hypothesis (EMH) in determining the factors affecting the movement of prices in the securities market, especially after the severe financial crises that hit the financial market. The expectations of the positivist approach, which believes that the financial market is characterized by rationality and can correct any deviations of the market value from the fair value, were not borne out. The paper adopts the inductive approach, highlighting the most important views related to BF and EMH and their fundamentals, and also employs an analytical critical approach in analysing the two approaches. Furthermore, it adopts a comparative approach to collate the Islamic financial approach in studying the movement of stocks with the EMH and BF approaches. The paper concludes with a number of findings. The most important of these is that the approaches of market efficiency and behavioural finance do not, in general, contravene the principles of Islamic finance. Moreover, harmonisation between the rational approach based on market efficiency and behavioural finance is one of the best approaches to serve the price of Islamic securities and is in line with the fundamentals of Islamic finance. However, that harmonisation will remain an abstraction unless the market is regulated by Sharīʿah principles and legal rules.