The Role of Emotions in Financial Decisions – Behavioral Finance Approach

Abstract

Traditional finance theory tends to ignore effects of emotions as it assumes that people always behave rationally. Emerging empirical research in behavioral finance shows that feelings do play a role in investor decision making and that individual psychology affects subsequent asset pricing. This paper examines the role of emotions in decision making of economic agents while distinguishing between two sides of debate among researches: the first, analyzing enhancing role of emotions in investment decisions and the second, arguing that emotions detract good investments. Using a qualitative, explanatory approach, the study considers connection of emotions with concepts of behavioral finance, such as disposition effect or attachment bias, and discusses how feelings contribute to explanation of these irrational behaviors observed in empirical studies of financial markets.