Behavioral Finance

Studies how psychological biases affect investor decisions and market outcomes.

Behavioral finance challenges the Efficient Market Hypothesis by documenting systematic psychological biases that cause irrational investment decisions. Key biases: Overconfidence (investors overestimate their skill), Loss aversion (losses hurt 2x more than gains feel good), Herding (following the crowd), Anchoring (fixating on irrelevant reference points), Recency bias (overweighting recent events). Market implications: These biases create anomalies: momentum (trends persist due to underreaction), value premium (mean reversion after overreaction), bubbles and crashes. Contrast with EMH: EMH assumes rational investors; behavioral finance assumes humans are predictably irrational. Practical: Understanding biases helps avoid costly mistakes (panic selling, chasing performance, overtrading).