Behavioral Finance and Market Psychology

Catalog description

What moves market prices for instruments like stocks? Is it fundamentals like earnings, growth, discount rates etc. or something else like psychology & frictions or a combination of both. Finance theory has long relied on a descriptively sparse model of behavior based on the premise that investors and managers are rational at a collective level and that arbitrage frictions are minimal. In recent years both assumptions have been questioned as the standard model, called the Efficient Market Hypothesis (EMH), fails to account for various aspects of actual fluctuations that appear not to be connected to fundamentals. Behavioral finance (BF) allows for the condition that investors and managers are not always rational and may make systematic errors of judgment that affect market prices. At the extreme these errors are bubbles or crashes. We begin by identifying the respective assumptions of each finance model - EMH and BF and then explore practical, real-world examples of these two model assumptions in liquid markets by examining various investing biases and market frictions.