Published: Barberis, Nicholas & Thaler, Richard, 2003. "A survey of behavioral finance," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 18, pages 1053-1128 Elsevier.
Among other things, it seeks to explain why humans behave how they behave, what are the impacts of this in the economy (here we are particularly concerned with financial markets), how we can avoid various biases to make better investment decisions.
In the many studies that have been conducted, secondary data was employed in carrying out a longitudinal examination and creation of particular indicators. These indicators would be used in identifying behavioral biases of business ventures. On the other hand, as a result of such behavior, finance delves into an investor’s psychological way of thinking with respect to investment decisions where the most important data can be used accurately to reveal the inner drive of an investor (Byrne, 2001).
Behavioral finance argues that some financial phenomena can plausibly be understood using models in which some agents are not fully rational. The field has two building blocks: limits to arbitrage, which argues that it can be difficult for rational traders to undo the dislocations caused by less rational traders; and psychology, which catalogues the kinds of deviations from full rationality we might expect to see. We discuss these two topics, and then present a number of behavioral finance applications: to the aggregate stock market, to the cross-section of average returns, to individual trading behavior, and to corporate finance. We close by assessing progress in the field and speculating about its future course.
Remember when I told everyone why we weren't refinancing our mortgage? And then I ate my words by posting about our upcoming mortgage refinance? Well, good news, ladies and gents! Our mortgage refinance has finally closed, and there were NO ISSUES! Yes, really, it was as smooth as the other side of the pillow (wait, what's the saying again?). Either way, it was awesome, and now we're saving $200 a month!Here's the breakdown:October 5th: Contacted the mortgage broker who I was referred to and discussed our options. We decided to go with the FHA Streamline refinance because our house …
Behavioral economics and behavioral finance
Behavioral finance is the analysis of psychology influence on the performance of financial specialists and the later effects on the market place. Whereas, behavioral economics refers to psychology and economics that examines what goes on in the market place where some representatives show human restrictions and complications. These two terms tend to be similar because of the way they are used in the economics and markets. Most economists use the term behavioral economics that combines the discipline of psychology and economics in order to explain the reason people make apparently irrational decisions when they spend money.
Behavioral finance admits the presence of decision favoritisms and reflects that most of them need to be eliminated. The main idea is not to be an alternative to the ancient or modern finances through rejecting all their properties, but to develop the financial models by incorporating behavioral tendencies like cognitive and emotional factors that are identified in the economic representatives. Therefore, behavioral finance assists the economic theory to clarify why financial markets may be inefficient (Brian, pg.390).
Behavioral economics has basically altered the way economists theorize the world. It is an umbrella of methods that pursue to spread the standard economics structure to account for important features of the human behavior that are not found in the standard economics structure.
Psychology analyzes the human judgment, conduct and wellbeing (Proctor, Robert, and Capaldi pg. 267). It may provide essential facts of how human beings vary on traditional economic assumptions. The modern financial economics adopts that individuals behave with extreme rationality in which they do not. People’s deviances from rationality are usually systematic. Behavioral finance eases these molds of financial economics from rationality to normal models of economic markets.
There are two features that backed the success of behavioral finance. The first is a general financial economics and the efficient market place hypothesis, which generated sharp predictions of observable occurrences. The second factor is the high-quality data that is available to test the sharp predictions. The rational, effective markets hypothesis denotes that stock prices are right in the logic that asset prices portray the exact or rational worth of the security. In most cases, this theory of an effective market hypothesis cannot be tested because the values cannot be observed.
On behavioral economics, scholars may ask whether a certain combination of marketplace forces, education and development render the human qualities irrelevant. The answer is no because arbitrage limits. Agents survive and impact marketplace outcomes.
How behavioral finance and economics determine selling prices
While academics talk of asset pricing and clarifying the cross-section of stock revenues, for specialists, the subject fall under the heading of stock picking. According to my opinion, behavioral biases amongst investors cause stock mispricing. Investor’s feelings have the potential to affect pricing of products. These sentiments may also affect the stock returns. Its effect is most manifest for products that are hard to value. These categories may include small stocks and unprofitable stocks. When the investor feelings are high, subsequent prices for these types of goods or stock tend to be low and vice versa. Investors may set prices according to the fear and anticipation that they have.
Papa John’s company manager observed that the pizza is the most preferred product of the company. The management decided to improve further the quality and hike prices because most customers never mind about prices if the quality is great.
Sumit’s research interests include issues relating to financial institutions, household finance, behavioral finance, international finance, real estate markets and capital markets. He has published over fifty research articles in journals like the , , , , , , , , , among others. Additionally, he has co-edited a collected volume on . He writes regular op-ed’s in the Straits Times and is featured on various media outlets like the BBC, CNBC, and Fox on issues relating to finance, banking, and real estate markets. Sumit’s research is widely cited in leading newspapers and magazines like the Wall Street Journal, The New York Times, The Economist, and the U.S Presidents Report to Congress. He also runs a blog on household financial decision making called .
Over the last decade, NSI has worked on hundreds of projects for government and commercial clients. Our clients have become increasingly aware of the importance of accounting for the human component in their analytical and decision-making processes. However, many of their existing practices do not sufficiently accommodate such considerations. Helping clients understand people and their behaviors is precisely what we do. Visit our page to learn more.
Armstrong, Mark, and Steffen Huck. “Behavioral economics as applied to firms: a primer.” (2010).
Bruce, Brian R. Handbook of Behavioral Finance. Cheltenham, UK: Edward Elgar, 2010. Internet resource.
Proctor, Robert W, and E J. Capaldi. Psychology of Science: Implicit and Explicit Processes. New York: Oxford University Press, 2012. Print.