Behavioral Finance

Behavioral finance integrates ideas from the fields of individual and social psychology with classical financial theory to understand the performance of markets. Behavioral finance is closely related to behavioral economics. The key idea of behavioral finance is that market participants do not always make decisions rationally. Behavioral finance recognizes several deviations from rationality such as the use of heuristics, or rules of thumb; that framing or the way a problem is stated, can affect the decision made; and that biases exist. Daniel Kahneman and Amos Tversky published the seminal ideas underpinning behavioral finance in their decision science research in the 1970s. Some of the best-known behavioral finance experts today include Richard Thaler, George Akerlof, and Robert Shiller. Behavioral finance represents a paradigm shift away from efficient market theory, which is still advocated by some prominent theorists, such as Eugene Fama. The 1987 Black Monday stock market crash is best explained from a behavioral finance perspective.