A Survey of Behavioral Finance
77 Pages Posted: 4 Oct 2002
Date Written: September 2002
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.
Keywords: behavioral finance, market efficiency, limits to arbitrage, psychology, investor behavior
JEL Classification: G11, G12, G30
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