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 ?
At Voya, other leading academics on behavioral finance will be assisting Benartzi, including John Payne of the Duke University's Fuqua School of Business.
A fancy name researchers in behavioral finance use for stress.
When the rally ends, behavioral finance studies suggest many investors, trapped in their irrationality by the ability to sell, will sell at the bottom and fail to get back in as the market recovers.
Alternatively, it could be the result of investors' inability to fully exploit mispricings -- an effect behavioral finance researchers call "limits to arbitrage.
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.
On the more psychological end of behavioral finance is the importance of how an investment decision is framed.
Investors should remind themselves of the theory of behavioral finance, and thus stay alert and constantly reconsider their asset allocations.
No longer merely the rejection of rationality, behavioral finance has come to have a rigorous theoretical foundation of its own and a significant body of empirical evidence in its support.
Behavioral Finance & Investor Biases - Dimensions of Investing - Economic Update--Outlook for Real Estate and Impact on the Economy
Professor Shiller is one of the top people in the world in the field of behavioral finance," said Jack Nyman, director of the Newman Institute.
Behavioral finance generalizes from the accretion of empirical discrepancies to argue that many investors are not rational in their financial decision-making, that there are observable directional biases resulting from departures from rational decision-making, and that significant barriers prevent professional traders from fully correcting the mistakes made by less-than-rational investors.
In a nutshell, behavioral finance, or behavioral economics, is the study of why investors think and do what they do about money and investing.

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