The Rational-Behavioral Debate in Financial Economics

Journal of Economic Methodology, 11:4, 393–409 December 2004

17 Pages Posted: 14 Jul 2004 Last revised: 18 Feb 2019

See all articles by Alon Brav

Alon Brav

Duke University - Fuqua School of Business; European Corporate Governance Institute (ECGI); National Bureau of Economic Research (NBER)

J.B. Heaton

One Hat Research LLC

Alex Rosenberg

Duke University

Abstract

The contest between rational and behavioral finance is poorly understood as a contest over "testability" and "predictive success." In fact, neither rational nor behavioral finance offer much in the way of testable predictions of improving precision. Researchers in the rational paradigm seem to have abandoned testability and prediction in favor of a scheme of ex post "rationalizations" of observed price behavior. These rationalizations, however, have an unemphasized relevance for behavioral finance. While behavioral finance advocates may justly criticize rationalizations as unlikely to lead to a science of financial economics with improving predictive power, rational finance's explanatory power plays a key role supporting the limits of arbitrage arguments that make behavioral finance possible.

Keywords: Raional Finance, Behavioral Finance, Economic Methodolology

JEL Classification: B41, G12, G14

Suggested Citation

Brav, Alon and Heaton, J.B. and Rosenberg, Alex, The Rational-Behavioral Debate in Financial Economics. Journal of Economic Methodology, 11:4, 393–409 December 2004. Available at SSRN: https://ssrn.com/abstract=473807

Alon Brav (Contact Author)

Duke University - Fuqua School of Business ( email )

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J.B. Heaton

One Hat Research LLC ( email )

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Alex Rosenberg

Duke University ( email )

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United States
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