From Efficient Markets to Behavioral Finance

27 Pages Posted: 3 Feb 2004

See all articles by Raffaella Barone

Raffaella Barone

University of Salento - Department of Law

Date Written: December 2003

Abstract

In this paper I point out the role assumed by behavioral finance in order to explain financial market trend in the last few years, which doesn't seem to respect classical financial theory principles: price equals stock fundamental value.

The two approaches make two different assumptions. The efficient market theory assumes that:

a) investors are rational b) they have a complete information c) they maximize expected utility.

Behavioral finance asserts individuals are not always rational, hence it supplies new hypothesis on individuals preferences and it proposes a new expected utility theory (Prospect Theory). Such theory points out as individuals try to obtain the best for themselves and as individuals are characterized by cognitive bias in every decision making step. Therefore, considering human weaknesses, which push an individual into making anomalous selections, behavioral finance seems a more realistic approach.

In conclusion, investor rationality, which was assumed by efficient market hypothesis, just is an illusion, little by little this theory will be supplanted by behavioral finance.

Note: Downloadable document is in Italian.

Keywords: behavioral finance, efficient markets, limited arbritrage, prospect theory, disposition effect

JEL Classification: G10, G11, G12, G30

Suggested Citation

Barone, Raffaella, From Efficient Markets to Behavioral Finance (December 2003). University of Lecce Economics Working Paper No. 46/24. Available at SSRN: https://ssrn.com/abstract=493545 or http://dx.doi.org/10.2139/ssrn.493545

Raffaella Barone (Contact Author)

University of Salento - Department of Law ( email )

Campus Universitario - Via Li Tufi
LECCE, LE 73020
Italy

Register to save articles to
your library

Register

Paper statistics

Downloads
3,633
rank
2,527
Abstract Views
10,118
PlumX Metrics