Editing Behavioral economics (section)

== Behavioral finance ==
Behavioral finance<ref>Glaser, Markus and Weber, Martin and Noeth, Markus. (2004). [https://madoc.bib.uni-mannheim.de/2770/1/dp03_14.pdf "Behavioral Finance"], pp. 527-546 in ''Handbook of Judgment and Decision Making'', Blackwell Publishers {{ISBN|978-1-405-10746-4}}</ref> is the study of the influence of [[psychology]] on the behavior of investors or [[financial analysts]]. It assumes that investors are not always [[rational]], have limits to their self-control and are influenced by their own [[Biases in inductive reasoning|biases]].<ref name="corporatefinanceinstitute.com">{{Cite web|title=Behavioral Finance - Overview, Examples and Guide|url=https://corporatefinanceinstitute.com/resources/knowledge/trading-investing/behavioral-finance/|access-date=2020-09-21|website=Corporate Finance Institute|language=en-US}}</ref> For example, behavioral law and economics scholars studying the growth of financial firms' technological capabilities have attributed decision science to irrational consumer decisions.<ref>{{Cite journal|last=Van Loo|first=Rory|date=2015-04-01|title=Helping Buyers Beware: The Need for Supervision of Big Retail|url=https://scholarship.law.bu.edu/faculty_scholarship/29|journal=University of Pennsylvania Law Review|volume=163|issue=5|pages=1311}}</ref>'''{{rp|1321}}''' It also includes the subsequent effects on the markets. Behavioral Finance attempts to explain the reasoning patterns of investors and measures the influential power of these patterns on the investor's decision making. The central issue in behavioral finance is explaining why market participants make irrational [[systematic errors]] contrary to assumption of rational market participants.<ref name="ssrn.com" /> Such errors affect prices and returns, creating market inefficiencies.

=== Traditional finance ===
The accepted theories of finance are referred to as traditional finance. The foundation of traditional finance is associated with the [[modern portfolio theory]] (MPT) and the [[efficient-market hypothesis]] (EMH). Modern portfolio theory is based on a stock or portfolio's expected return, standard deviation, and its correlation with the other assets held within the portfolio. With these three concepts, an efficient portfolio can be created for any group of assets. An efficient portfolio is a group of assets that has the maximum expected return given the amount of risk. The efficient-market hypothesis states that all public information is already reflected in a security's price. The proponents of the traditional theories believe that "investors should just own the entire market rather than attempting to outperform the market". Behavioral finance has emerged as an alternative to these theories of traditional finance and the behavioral aspects of psychology and sociology are integral catalysts within this field of study.<ref>{{Cite web|title=Harry Markowitz's Modern Portfolio Theory [The Efficient Frontier]|url=https://www.guidedchoice.com/video/dr-harry-markowitz-father-of-modern-portfolio-theory/|access-date=2020-09-21|website=Guided Choice|language=en-US}}</ref>

=== Evolution ===

The foundations of behavioral finance can be traced back over 150 years. Several original books written in the 1800s and early 1900s marked the beginning of the behavioral finance school. Originally published in 1841, MacKay's ''[[Extraordinary Popular Delusions and the Madness of Crowds]]'' presents a chronological timeline of the various panics and schemes throughout history.<ref>{{Cite journal|last=Ricciardi|first=Victor|title=What is Behavioral Finance?|url=https://www.academia.edu/413591|journal=Business, Education & Technology Journal|date=January 2000|page=181|language=en}}</ref> This work shows how group behavior applies to the financial markets of today. Le Bon's important work, ''[[The Crowd: A Study of the Popular Mind]]'', discusses the role of "crowds" (also known as [[crowd psychology]]) and group behavior as they apply to the fields of behavioral finance, social psychology, sociology and history. Selden's 1912 book ''Psychology of The Stock Market'' applies the field of psychology directly to the stock market and discusses the emotional and psychological forces at work on investors and traders in the financial markets. These three works along with several others form the foundation of applying psychology and sociology to the field of finance. The foundation of behavioral finance is an area based on an interdisciplinary approach including scholars from the social sciences and business schools. From the liberal arts perspective, this includes the fields of psychology, sociology, anthropology, economics and behavioral economics. On the business administration side, this covers areas such as management, marketing, finance, technology and accounting.

Critics contend that behavioral finance is more a collection of [[Market anomaly|anomalies]] than a true branch of [[finance]] and that these anomalies are either quickly priced out of the market or explained by appealing to [[market microstructure]] arguments. However, individual [[cognitive bias]]es are distinct from social biases; the former can be averaged out by the market, while the other can create positive [[feedback loop]]s that drive the market further and further from a "[[fair price]]" equilibrium. It is observed that, the problem with the general area of behavioral finance is that it only serves as a complement to general economics. Similarly, for an anomaly to violate market efficiency, an investor must be able to trade against it and earn abnormal profits; this is not the case for many anomalies.<ref>{{Cite web|title=Fama on Market Efficiency in a Volatile Market|url=http://www.dimensional.com/famafrench/2009/08/fama-on-market-efficiency-in-a-volatile-market.html|url-status=dead|archive-url=https://web.archive.org/web/20100324015212/http://www.dimensional.com/famafrench/2009/08/fama-on-market-efficiency-in-a-volatile-market.html|archive-date=March 24, 2010}}</ref> A specific example of this criticism appears in some explanations of the [[equity premium puzzle]].<ref>{{Cite web|last=Kenton|first=Will|title=Equity Premium Puzzle (EPP)|url=https://www.investopedia.com/terms/e/epp.asp|access-date=2020-09-21|website=Investopedia|language=en}}</ref> It is argued that the cause is [[barriers to entry|entry barriers]] (both practical and psychological) and that the equity premium should reduce as electronic resources open up the stock market to more traders.<ref>See Freeman, 2004 for a review</ref> In response, others contend that most personal investment funds are managed through superannuation funds, minimizing the effect of these putative entry barriers.<ref>{{Cite journal|last1=Woo|first1=Kai-Yin|last2=Mai|first2=Chulin|last3=McAleer|first3=Michael|last4=Wong|first4=Wing-Keung|date=March 2020|title=Review on Efficiency and Anomalies in Stock Markets|journal=Economies|language=en|volume=8|issue=1|pages=20|doi=10.3390/economies8010020|doi-access=free|hdl=10419/257069|hdl-access=free}}</ref> In addition, professional investors and fund managers seem to hold more bonds than one would expect given return differentials.<ref>{{Cite web|title=U.S. Equity Market Structure: Making Our Markets Work Better for Investors|url=https://www.sec.gov/news/statement/us-equity-market-structure.html|access-date=2020-09-21|website=www.sec.gov|language=en}}</ref>

=== Quantitative behavioral finance ===
[[Quantitative behavioral finance]] uses mathematical and statistical methodology to understand [[behavioral bias]]es.
Some [[financial model]]s used in money management and asset valuation, as well as more [[financial economics|theoretical models]], likewise, incorporate behavioral finance parameters. Examples:
* Thaler's model of price reactions to information, with three phases (underreaction, adjustment, and overreaction), creating a price [[market analysis#Market trends|trend]]. (One characteristic of overreaction is that average returns following announcements of good news is lower than following bad news. In other words, overreaction occurs if the market reacts too strongly or for too long to news, thus requiring an adjustment in the opposite direction. As a result, outperforming assets in one period is likely to underperform in the following period. This also applies to customers' irrational purchasing [[habit]]s.<ref>{{cite web|url=http://flevy.com/blog/why-people-wont-buy-your-product-even-though-its-awesome/|title=Why People Won't Buy Your Product Even Though It's Awesome|last=Tang|first=David|date=6 May 2013|publisher=Flevy|access-date=31 May 2013}}</ref>)
* The [[stock valuation|stock image]] coefficient
* [[Artificial financial market]]
* [[Market microstructure]]