Behavioral Finance
Behavioral Finance
Behavioral finance attempts to explain what, why, and how of finance and investing from a human perspective. More specifically, behavioral finance integrates psychology and economics into the study of human judgment and biases in decision making under conditions of uncertainty. (David, 2004)
In order to clearly define and explain the origin of behavioral finance, it is important to first define finance, which is the foundation of behavioral finance. Finance is a field within economics that deals with the allocation of assets and liabilities over time under conditions of certainty and uncertainty. Finance aims to price assets based on their risk level and their expected rate of return (“Finance”, 2014).
Within finance, there are many types of financial models and theories. The Modern Portfolio Theory (MPT), Capital Asset Pricing Model (CAPM) and Arbitrage Pricing Theory (APT) are the quantitative models that form basis theories for modern finance. Back in the 1980s, researchers found that there were many anomalies in the finance markets that could not be explained. In 1990, a large number of high-quality theoretical and empirical literature research emerged on the study to apply behavior on the finance.
One must know the Efficient Market Hypothesis (EMH) in order to understand behavioral finance. The Efficient Market Hypothesis is the theory that prices of securities fully reflect all available information and that all market participants receive and act on all relevant information as soon as it becomes available. (Ricciardi & Simon, 2000) Shiller (2013) defines it as the idea that speculative assets prices such as stock prices always incorporate the best information about fundamental values and that prices change only because of good, sensible information meshed very well theoretical trends.
The Efficient Market Hypothesis was developed by Professor Eugene Fama at Booth School of Business of the
Behavioral finance attempts to explain what, why, and how of finance and investing from a human perspective. More specifically, behavioral finance integrates psychology and economics into the study of human judgment and biases in decision making under conditions of uncertainty. (David, 2004)
In order to clearly define and explain the origin of behavioral finance, it is important to first define finance, which is the foundation of behavioral finance. Finance is a field within economics that deals with the allocation of assets and liabilities over time under conditions of certainty and uncertainty. Finance aims to price assets based on their risk level and their expected rate of return (“Finance”, 2014).
Within finance, there are many types of financial models and theories. The Modern Portfolio Theory (MPT), Capital Asset Pricing Model (CAPM) and Arbitrage Pricing Theory (APT) are the quantitative models that form basis theories for modern finance. Back in the 1980s, researchers found that there were many anomalies in the finance markets that could not be explained. In 1990, a large number of high-quality theoretical and empirical literature research emerged on the study to apply behavior on the finance.
One must know the Efficient Market Hypothesis (EMH) in order to understand behavioral finance. The Efficient Market Hypothesis is the theory that prices of securities fully reflect all available information and that all market participants receive and act on all relevant information as soon as it becomes available. (Ricciardi & Simon, 2000) Shiller (2013) defines it as the idea that speculative assets prices such as stock prices always incorporate the best information about fundamental values and that prices change only because of good, sensible information meshed very well theoretical trends.
The Efficient Market Hypothesis was developed by Professor Eugene Fama at Booth School of Business of the
References: Barber, B., & Odean, T. (1999). The courage of misguided convictions. Financial Analysis Journal 55 (6): 41-55. Barber, B., & Odean, T. (2001). Boys will be boys: gender, overconfidence, and common stock investment. The quarterly Journal of Economics 116(1): 261-292. D’Amour, A. (2011). Overcoming behavioral investing. Retrieved from http://www.shavemagazine.com/finance/Overcoming-Behavioral-Investing David, A Fama, E. (1998). Market efficiency, long-term returns, and behavioral finance. Journal of Financial Economics, 9(3), Pages 283–306. Retrieved from http://www.sciencedirect.com/science/article/pii/S0304405X98000269 Efficient Market Hypothesis Finance. (n.d) In Wikipedia. Retrieved March 14, 2014, from http://en.wikipedia.org/wiki/Finance Fisher, Rene and Ralf Gerhardt Harrington, B. (October, 2010 31). On the limitations of behavioral finance. Retrieved from http://thesocietypages.org/economicsociology/2010/10/31/on-the-limitations-of-behavioral-finanance/ Kalen, S Lawrence, E., McCabe, G. & Prakash, A. J. (2007). Answering financial anomalies: Sentiment-based stock pricing. Journal of Behavioral Finance. 8 (3), 161-171. Ricciardi, V., & Simon, H. K. (2000). What is behavioral finance?. Business, Education and Technology Journal, Retrieved from http://www.researchgate.net/publication/234163799_What_is_Behavioral_Finance/file/32bfe50f9696f22858.pdf Shiller, R Tversky, A. (1990). “The Psychology of Risk”. Association of Investment Management and Research, 62-73.