Behavioral Economics

Behavioral Economics

A theory of economics that attempts to explain economic participants' decisions as those of rational actors looking out for their self-interest given the sometimes inefficient nature of the market. Tracing its origins to Adam Smith's The Theory of Moral Sentiments, one of behavioral economics' primary observations holds that investors and people in genera make decisions on imprecise impressions and beliefs rather than rational analysis. A second observation states that the way a question or problem is framed to an investor will influence the decision he/she ultimately makes. These two observations largely explain market inefficiencies; that is, behavioral economics holds that markets are sometimes inefficient because people are not mathematical equations. Behavioral economics stands in stark contrast to the efficient markets theory. See also: Naive diversification, Formula plan, Subjective probabilities.