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.
Copyright © 2012, Campbell R. Harvey. All Rights Reserved.

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.
Farlex Financial Dictionary. © 2012 Farlex, Inc. All Rights Reserved

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.

Dictionary of Financial Terms. Copyright © 2008 Lightbulb Press, Inc. All Rights Reserved.
References in periodicals archive ?
"Whether this is that point in time, we won't know until we get past it but it's definitely a consideration in terms of the market psychology."
A big part of market psychology has been the faith that the Fed will be inclined to repeatedly intervene in markets with more stimulus to hedge against financial volatility at the expense of controlling inflation.
Although concerns over privacy have little technical merit -- the device has no processing capability unless the trigger word is recognised -- market psychology is a current obstacle.
Market psychology suggests that investors tend to overreact to unexpected news or announcements that affect movement of the stock.
I do, however, believe that sporadic interventions may be needed to punish speculators who are taking advantage of temporary market psychology to keep the yen far above its market value.
Reserve currency status, with attendant market psychology, continuously ensures the United States, along with a few others like the EU, has a free pass from the problems facing the rest of the world due to weakening currencies and overspending.
By exacting sanctions relief early, Iran changed market psychology and improved the fundamentals of its economy.
"No correlation was found between oil prices and real estate prices or GDP and real estate prices, which are a function of supply, demand and market psychology. However, oil prices have an indirect influence on price: GDP fluctuations impact job growth and, thereby, impact demand," said Phidar.
But while market psychology supports a rising market, market history has been suggesting a severe correction for two years straight, meaning the ultimate crash should be harsh.
Most importantly, gold seems to have taken on a market psychology of its own that makes it difficult for the average investor to use it as a traditional investing safe haven, which may be another reason why Americans' interest in it has waned.
But the real wild card that determines market psychology can be much harder to predict or to pin down.
While that hardly seems like something to celebrate, any shift in market psychology at this point could be the start of something beneficial.