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Behavioral finance assumes that investors are not always rational, have limited self-control, and are influenced by cognitive and emotional biases.
Behavioral finance studies how psychological, emotional, and social factors influence investor decisions, financial analysts, asset prices, and market outcomes. It challenges the traditional assumption that investors are fully rational, have unlimited self-control, and consistently process information correctly. Instead, investors may display systematic biases, make errors, and respond emotionally to information, producing market inefficiencies and deviations from fair value. The field developed as an alternative and complement to traditional finance theories such as Modern Portfolio Theory and the Efficient-Market Hypothesis. Historical works on crowd psychology, financial panics, and investor emotions helped establish its interdisciplinary foundations in psychology, sociology, economics, and finance. Market bubbles and crashes—including the 1987 stock market crash, Japan’s asset bubble, and the dot-com boom and bust—provided important evidence against the idea that prices always accurately reflect available information. Behavioral finance therefore examines both individual cognitive biases and social feedback effects that can cause underreaction, overreaction, excessive volatility, and persistent market anomalies.
Behavioral finance assumes that investors are not always rational, have limited self-control, and are influenced by cognitive and emotional biases.
It explains how systematic investor errors can affect security prices, returns, volatility, and overall market efficiency.
The field contrasts with Modern Portfolio Theory and the Efficient-Market Hypothesis, which assume rational decision-making and prices that incorporate available information.
Its foundations draw on psychology, sociology, economics, behavioral economics, anthropology, and business disciplines.
Historical bubbles, crashes, and experimental markets have challenged traditional financial theories and supported the study of behavioral effects.
Individual biases may sometimes be averaged out by markets, while social biases can create reinforcing feedback loops that push prices away from fair value.
The study of how psychological, emotional, and social influences affect investor behavior and financial markets.
The theory that asset prices rapidly and accurately reflect available public information.
A framework for constructing portfolios by balancing expected returns, risk, and correlations among assets.
A systematic pattern of judgment or decision-making that can lead investors away from fully rational choices.
A condition in which asset prices do not fully or accurately reflect relevant information or fundamental value.
A tendency for investors or markets to respond too strongly or for too long to news or information.
A tendency for investors or markets to respond too slowly or insufficiently to relevant information.
The study of how group behavior and collective emotions influence individual decisions and market movements.
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