For decades, investment
decisions have been guided by efficient markets theory.The theory
is based on the notion that investors behave in a rational, predictable
and an unbiased manner.
The model assumes that investors decisions and price of stocks reflect
all publicly available
information. Behavioral finance challenges this traditionally held notion.
Reliant upon cognitive psychology decision theory, behavioral finance
is the study of how investors' interpret and act on available, fallible
suggest, among other things, the existence of:(1)
individual investor heuristics; that is,
mental short cuts used in place of purely (unboundedly) rational thinking;
and (2) marketplace
anomalies; economic puzzles not explained by efficient markets theory,
consistent with the
conclusion that in general investors do not behave rationally. Thus, behavioral
finance identifies marketplace investor mistakes, with an expectation
that if one were to fully become knowledgeable
about the psychological (including quasi-rational) aspects of decision-making,
out-smart the market traders, and beat the market benchmarks.
Problems with observation,
processing and evaluation of information often play tricks on people.
Moreover, people are systematically influenced by motives underlying dissonance
the need for control when observing and judging.
The assimilation and processing of information is subject to systematic
distortions. Nevertheless, information is the main factor influencing
actual decisions in favor of or against a trade by traders
and all other market participants. Information increases the sense of
being in control of the future.
Additionally, most people do not assimilate and process information in
the sameway, even if it is comprehensive and freely available.