Tits is a summary on What is behavioral finance.
“What is Behavioral Finance?”
Over the last forty years, standard finance has been the dominant theory within the
academic community with its foundation associated with the modern portfolio theory and
the efficient market hypothesis. Where Modern Portfolio Theory is a stock or portfolio
expected return, standard deviation, and its correlation with the other stocks or mutual
funds held within the portfolio. With these three concepts, an efficient portfolio can be
created for any group of stocks or bonds. Similarly another main theme in standard finance
is known as the Efficient Market Hypothesis. The efficient market hypothesis states the
premise that all information has already been reflected in a security’s price or market
value, and that the current price the stock or bond is trading for today is its fair value.
However, scholars and investment professionals have started to investigate an alternative
theory of finance known as behavioral finance. Behavioral finance makes an attempt to
explain and improve people’s awareness regarding the emotional factors and psychological
processes of individuals and entities that invest in financial markets. Essentially,
behavioral finance attempts to explain the what, why, and how of finance and investing,
from a human perspective. Behavioral finance scholars and investment professionals are
developing an appreciation for the interdisciplinary research that is the underlying
foundation of this evolving discipline. Behavioral finance studies the psychological and
sociological factors that influence the financial decision making process of individuals,
groups, and entities
According to the behavioral finance school of thought, the behavior and psychology
influence individual investors and portfolio managers regarding the financial decision
making process of establishing information regarding suitable levels of a risk and the way
investors process information and make decisions depending on how it is presented. So,
behavioral finance is the interaction of psychology with the financial actions and
performance of all types and categories of investors. Therefore Behavioral finance enriches
economic understanding by incorporating these aspects of human nature into financial
models.
This paper has discussed four themes within the arena of behavioral finance, which are
overconfidence, cognitive dissonance, regret theory, and prospect theory. These four topics
are an introductory representation of the many different themes that have started to occur
over the last few years within the field. Along with that this paper has also discussed some
trading approaches for investors in stocks and bonds to assist them in manifesting and
controlling their psychological roadblocks. These “rules of thumb” are a starting point for
