Behavioural Finance: Beginnings and Applications
30 Pages Posted: 22 Apr 2017 Last revised: 23 Oct 2017
Date Written: May 2, 2017
The essay traces the beginning of behavioural finance by examining the development of expected utility model. Expected utility model is based on the assumptions of time consistent preferences of utility. However, experimental results in psychology regarding choice under risk and uncertainty shows well-defined deviations from the predictions of expected utility model. It was found that there were systematic biases and heuristics that economic decision makers use to make choices. In the next section, the essay describes some of these heuristics and how they modify the assumptions of utility model. Applications of behavioural understanding in finance is briefly discussed to show the widespread prevalence of behavioural heuristics in and beyond finance. The essay concludes by arguing that accommodating the behavioural variable is necessary to make neoclassical model more relevant to the real world.
Keywords: Behavioural finance, Psychology, Economics, Rationality
JEL Classification: G40; G41
Suggested Citation: Suggested Citation