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 ?
INVESTMENT RISKS: The Fund is subject to the typical risks of equity investing, which include, but are not limited to: loss of money, company-specific risks, the effects of interest rate fluctuations, investor psychology, and negative market or other general economic news.
The slide represents a shift in investor psychology.
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Lest one get pulled over the cliff by a market returning to rational behavior, let's take a look at investor psychology at work.
During a bubble period, investor psychology shifts.
Today's release of April's jobs data was a real game changer for investor psychology.
This finding, however, seems to suggest that the intense federal policy battles associated with today's divided government may be having a more negative than positive influence on investor psychology.
Crosthwaite said: "Economists and financial policymakers must recognize that investor psychology is far more complex than their models have allowed up to now.
Dr Crosthwaite said: "Economists and financial policymakers must recognise that investor psychology is far more complex than their models have allowed up to now.
In the second part of the series on investor psychology, we consider why herd behaviour can make you lose, rather than gain, money
Summary: In the second part of the series on investor psychology, we consider why herd behaviour can make you lose, rather than gain, money.
Vogel analyzes multiple factors that contribute to the formation of asset price bubbles, including technological innovation, credit expansion, and investor psychology.

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