A Survey of Behavioral Finance

Abstract

Beginning in the early 1970`s, the Efficient Market Hypothesis (EMH henceforth) became very dominant in academic circles trying to understand the rules of return in the equity market. After a long period of successes, faith in this Hypothesis was gradually eroded by the discovery of several anomalies. The last decades now showed immense research efforts to find new models accurately predicting market behavior. These efforts build the foundation for what is called “Behavioral Finance”. During all this time researchers have identified two major reasons why the EMH fails to deliver correct results in so many cases.

While the first is called “Limits to arbitrage” and it shows why even well informed, completely rational investors can be limited in their ability to use market options; 
the second relates to an application of behavioral psychology on individual investors, cataloguing the kinds of deviations from full rationality in investment decisions.

In this paper I will present a survey of this huge, vastly expanding field of research by summarizing working papers recently published at the “National Bureau of Economic Research”, as well as including foundational principles and recent journal articles from renowned magazines.

Keywords: Behavioral Finance, Behavioural Finance, Irrational Markets, Limits to Arbitrage, Psychology, Volatility, Investors Beliefs, Efficient Market Hypothesis, Demand Curves, Survey, Literature Review

JEL Classification: D52