Traditional Finance And Behavioral Finance: Understanding The Rationality Paradigm In Financial Decision-Making

Abstract

: This paper explores the intersection of Traditional Finance and Behavioral Finance to understand the dynamics of financial decision-making. Traditional finance has long been grounded in the assumption of rationality among investors and market efficiency, guiding principles such as the Efficient Market Hypothesis (EMH) and the Capital Asset Pricing Model (CAPM). However, empirical evidence often shows deviations from these rational behaviors, suggesting that psychological biases significantly influence investor decisions. Behavioral finance addresses these anomalies by incorporating psychological insights into financial models, examining how factors such as emotions, cognitive biases, and social pressures distort economic decisions. This study employs a quantitative methodology, gathering data through a structured questionnaire administered to 194 investors across various regions of Bangalore, India. The research analyzes the correlation between traditional and behavioral finance variables to evaluate their impact on investment practices. The findings highlight a clear preference among investors for integrating rigorous data-driven analysis with an understanding of behavioral influences, suggesting a trend toward more comprehensive investment strategies that balance empirical rigor with psychological insights. The paper concludes that while traditional finance provides a robust framework for analyzing financial markets, it is complementarily enhanced by behavioral insights that reveal the underlying human elements driving market dynamics. Therefore, a synthesis of both traditional and behavioral finance approaches is crucial for a deeper understanding of financial markets and for devising more effective investment strategies and policies. This study underscores the necessity of embracing both rational analysis and behavioral insights to navigate the complexities of modern financial environments effectively.