Behavioral finance


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Behavioral finance

An important subfield of finance. Behavioral finances uses insights from the field of pyschology and applies them to the actions of individuals in trading and other financial applications.

Behavioral Finance

A theory of finance that attempts to explain the decisions of investors by viewing them as 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 its primary observations holds that investors (and people in general) 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, behavior finance holds that markets are sometimes inefficient because people are not mathematical equations. Behavioral finance stands in stark contrast to the efficient markets theory. See also: Naive diversification, Formula plan, Subjective probabilities.

Behavioral finance.

Behavioral finance combines psychology and economics to explain why and how investors act and to analyze how that behavior affects the market.

Behavioral finance theorists point to the market phenomenon of hot stocks and bubbles, from the Dutch tulip bulb mania that caused a market crash in the 17th century to the more recent examples of junk bonds in the 1980s and Internet stocks in the 1990s, to validate their position that market prices can be affected by the irrational behavior of investors.

Behavioral finance is in conflict with the perspective of efficient market theory, which maintains that market prices are based on rational foundations, like the fundamental financial health and performance of a company.

References in periodicals archive ?
Behavioral Finance strategies have significant impact on our clients' success," says Hayes.
By applying behavioral finance techniques to 401 (k) plan design and implementation, plan sponsors have found they can successfully address many of the challenges presented by participant choice plans.
LIMITS ON ARBITRAGE Limited arbitrage is critical to the behavioral finance perspective, and the problem is more general than the simple case of closed-end mutual funds.
When we set out to develop a solution to this growing problem, we knew we had to apply behavioral finance to technology.
14, 2015 /PRNewswire-USNewswire/ -- The annual RAND Behavioral Finance Forum, in partnership with the Aspen Institute and in collaboration with the Institute for the Future, will host a day-long conference in Washington, D.
Langan has embraced the concepts associated with Behavioral Finance and has become skilled in delivering those concepts through the Plan Sponsor University,” stated Steff Chalk, Executive Director of The Plan Sponsor University.
Lovelady (chief investment strategist and portfolio manager, Oceans 4 Capital Group LLC) suggests a form of "synthetic annuity" that he characterizes as a style of investing that reflects the following beliefs: that diversification is not sufficient for managing market volatility, that there are effective ways to increase dividends for dividend-paying stocks and manufacturing them for non-dividend-paying stocks, that there is a need to come up with real-time and forward-looking measures of risk that are better than current methods, that risk allocations and risk budgeting offer new ways to limit losses by including elements of hedging and insurance, and that behavioral finance is useful in recognizing behavioral influences on decision-making and the value we place on investment outcomes.
Her areas of expertise include banking and financial institutions, behavioral economics, behavioral finance, corporate finance, emerging markets, and the regulation of financial markets, private equity, and venture capital.
Thaler has since written a number of books intended for the lay reader on the subject of behavioral finance, including Quasi-rational Economics and The Winner's Curse.
The amount of luck as opposed to skill is incredible, yet most people attribute their performance to skill, not luck" says Hersh Shefrin, author of Beyond Greed and Fear: Understanding Behavioral Finance and the Psychology of Investing.
Thus, the contribution of behavioral finance is not to diminish the fundamental work that has been done by Markowitz, Sharpe, and other pioneers in MPT.

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