The Entropy Theory of Mind and Behavioral Finance

29 Pages Posted: 5 Jan 2011 Last revised: 14 Mar 2011

Jing Chen

University of Northern British Columbia - School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: January 3, 2011

Abstract

Rapid accumulation of empirical studies in behavioral finance calls for a unified and consistent theoretical synthesis. Instead of building up a behavioral theory of economics directly, we present the entropy theory of mind, which is an economic theory of mind. Then we integrate the value and cost of information processing into the overall picture in economic decision making. The entropy theory of mind includes a theory of judgment, which provides a common framework to integrate behavioral and informational theories of investment. The theory of judgment provides a quantitative link between investors’ judgment and their trading activities. It offers a simple and unified understanding of major patterns in market activities and investor behaviors. As an application, a simple mathematical model based on the entropy theory of mind is constructed to understand many empirical patterns related to the cycles of momentum and reversals in asset markets. During various phases of the cycles, trading volumes and trading behaviors of investors of different sizes often show distinct characteristics. It has been a long standing challenge to describe the multiple patterns simultaneously from a quantitative theory. In this paper, we show that the predictions derived from the model are consistent with the multiple empirical patterns of trading volumes and investor activities at the different phases of the cycle of momentum and reversal.

Suggested Citation

Chen, Jing, The Entropy Theory of Mind and Behavioral Finance (January 3, 2011). Available at SSRN: https://ssrn.com/abstract=1734526 or http://dx.doi.org/10.2139/ssrn.1734526

Jing Chen (Contact Author)

University of Northern British Columbia - School of Business ( email )

Prince George, BC, V2N 4Z9
Canada
250-960-6480 (Phone)
250-960-5544 (Fax)

HOME PAGE: http://web.unbc.ca/~chenj/

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