Behavioral Finance-A Review

Abstract

Behavioral Finance is the study of the impact of psychology and its influence on the behavior of market practitioners. Its study covers both; the individual level and the group level. Behavioral finance has two building blocks: cognitive psychology and the limits to arbitrage. People are many times overconfident; gut feel, anchoring, cognitive dissonance, wishful thinking bias, etc. often mar their thought process even while making decisions about rather important issues such as how to invest in a pension plan, or how to invest their savings of a life time. Behavioral finance is an attempt to study these human reactions and provide an underlying basis to predict and understand human behavior which has a tendency to knowingly make irrational investment decisions. Mispricing of assets in the markets are mostly blamed on the behavioral inefficiencies of the market participants, however they many times find a cause in the simple demand supply imbalances in the markets.