Behavioural finance

Question

What is behavioural finance?

Answer

Behavioural finance is a field which seeks to explain why people make irrational financial decisions, which often results in people making decisions that go against their best interest. Behavioural finance goes against the conventional methods of finance such as the capital asset pricing model and the efficient market hypothesis. The conventional methods of finance are logically based, as well as being good at predicting and explaining certain events. More specifically, they assume that investors are rational, as such conventional methods of finance do not explain how people behave in the real world and also overlook the possibility for emotions and psychology to influence investors’ financial decisions. On the other hand, behavioural finance explains how people behave irrationally or without having a logical reason. As a result, behavioural finance takes into account behavioural and cognitive psychology theory along with conventional economics and finance when explaining why people make illogical financial decisions.

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