Behavioral finance challenges traditional economic theories from "summary" of Advances in Behavioral Finance by Richard H. Thaler
Traditional economic theories assume that individuals are rational actors who make decisions based on careful weighing of costs and benefits. However, behavioral finance challenges this assumption by demonstrating that individuals often make irrational decisions due to cognitive biases and emotional influences. These deviations from rationality can have significant implications for asset pricing, market efficiency, and investment behavior. One of the key insights of behavioral finance is the recognition that individuals do not always act in their best interests when making financial decisions. For example, people may exhibit overconfidence bias, leading them to believe they have more knowledge or skill than they actually do. This overconfidence can result in excessive trading, higher transaction costs, and lower investment returns. Moreover, individuals may also fall prey to mental accounting, a phenomenon where they compartmentalize the...
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