Chapter 3: Behavioral Economics, Thinking Processes, Decision-Making, and Investment Behavior

Investor Behavior: The Psychology of Financial Planning and Investing. H. Kent Baker and Victor Ricciardi, editors, 43-61. Hoboken, NJ: John Wiley & Sons, Inc., 2014

Posted: 19 Feb 2014 Last revised: 10 May 2014

Date Written: February 10, 2014

Abstract

This chapter provides a critical review of behavioral economic approaches to decision-making with a focus on the thinking processes of investors. It discusses the bounded rationality approach to decision-making as compared to the errors and biases approach for better understanding decision-making processes and outcomes. The latter focuses on the importance of cognitive illusions and biases whereas the former pays more attention to the optimality of institutional design and the limited information processing capacity of the human brain. Both approaches attempt to make sense of and explain why decision-making outcomes tend to be inconsistent with the predictions of the conventional economics wisdom, especially regarding the efficient market hypothesis. The chapter also extends the analyses of the behavioral understanding of decision-making, especially from the bounded rationality modeling perspective.

Keywords: Behavioral economics, traditional economics, thinking processes, heuristics, trust, investment behavior, behavioral finance, behavioural finance, behavioural economics

JEL Classification: A12, D81, G00, G30, G10, M00, M10, M41

Suggested Citation

Altman, Morris, Chapter 3: Behavioral Economics, Thinking Processes, Decision-Making, and Investment Behavior (February 10, 2014). Investor Behavior: The Psychology of Financial Planning and Investing. H. Kent Baker and Victor Ricciardi, editors, 43-61. Hoboken, NJ: John Wiley & Sons, Inc., 2014. Available at SSRN: https://ssrn.com/abstract=2397713

Morris Altman (Contact Author)

University of Newcastle ( email )

University Drive
Callaghan, NSW 2308
Australia

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