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 ?
The "magnitude effect" examined in economic psychology concerns reductions in the implied discount rate as the amount of money at issue increases (Thaler, 1981).
Are the Enron debacle, the accounting issues, the liability question for corporate boards, and other corporate governance issues dampening the economic psychology among corporate decision makers?
1997), "Gender differences in risk behaviour in financial decision-making: An experimental analysis", Journal of Economic Psychology 18, 605-628
Diacon, S and Hasseldine, J (2006) "Framing Effects and Risk Perception: The Effect of Prior Performance Presentation Format on Investment Fund Choice" Journal of Economic Psychology, Forthcoming 2006
Treating the consumer debt problem early before the consumer gets too "ill", coupled with a customer centric debt collection approach will benefit both consumers and banks according to Professor Alan Lewis, a leading academic of economic psychology (University of Bath) and author of the report.
The economic psychology is shifting quickly and seems to be trending in a largely negative direction.
2003) "The relationship of materialism to spending tendencies, saving and debt" Journal of Economic Psychology, 24:723-739.
Specialists in economic psychology were studying risk strategy and homed in on the very specialised business of penalty kicks.
1914) situated the model within educational and economic psychology.
This research provides empirical backing for the many adages cautioning against lending to a friend: lending can be hazardous to a relationship," said Dezso, a pre-doctoral candidate in economic psychology.
Published as a topical issue of the journal Zeitschrift fur Psychologie/Journal of Psychology, this volume provides 7 empirical papers on economic psychology.
1990), "The Sacred Meanings of Money", Journal of Economic Psychology, num.