Behavioral Finance
Behavioral Finance
Jay R. Ritter
Cordell Professor of Finance
University of Florida
P.O. Box 117168
Gainesville FL 32611-7168 http://bear.cba.ufl.edu/ritter jay.ritter@cba.ufl.edu
(352) 846-2837
Published, with minor modifications, in the
Pacific-Basin Finance Journal Vol. 11, No. 4, (September 2003) pp. 429-437.
Abstract
This article provides a brief introduction to behavioral finance. Behavioral finance encompasses research that drops the traditional assumptions of expected utility maximization with rational investors in efficient markets. The two building blocks of behavioral finance are cognitive psychology (how people think) and the limits to arbitrage (when markets will be inefficient).
The growth of behavioral finance research has been fueled by the inability of the traditional framework to explain many empirical patterns, including stock market bubbles in Japan, Taiwan, and the U.S.
JEL classification: G14; D81
Keywords: Behavioral finance; arbitrage; psychology; market efficiency
A modified version of this paper was given as a keynote address at the July, 2002
APFA/PACAP/FMA meetings in Tokyo. I would like to thank Ken Froot and Andrei Shleifer for sharing their data and ideas, and Rongbing Huang for research assistance.
Behavioral Finance
1. Introduction
Behavioral finance is the paradigm where financial markets are studied using models that are less narrow than those based on Von Neumann-Morgenstern expected utility theory and arbitrage assumptions. Specifically, behavioral finance has two building blocks: cognitive psychology and the limits to arbitrage. Cognitive refers to how people think. There is a huge psychology literature documenting that people make systematic errors in the way that they think: they are overconfident, they put too much weight on recent experience, etc. Their preferences may also create distortions. Behavioral finance uses this body of knowledge, rather than taking the arrogant
Jay R. Ritter
Cordell Professor of Finance
University of Florida
P.O. Box 117168
Gainesville FL 32611-7168 http://bear.cba.ufl.edu/ritter jay.ritter@cba.ufl.edu
(352) 846-2837
Published, with minor modifications, in the
Pacific-Basin Finance Journal Vol. 11, No. 4, (September 2003) pp. 429-437.
Abstract
This article provides a brief introduction to behavioral finance. Behavioral finance encompasses research that drops the traditional assumptions of expected utility maximization with rational investors in efficient markets. The two building blocks of behavioral finance are cognitive psychology (how people think) and the limits to arbitrage (when markets will be inefficient).
The growth of behavioral finance research has been fueled by the inability of the traditional framework to explain many empirical patterns, including stock market bubbles in Japan, Taiwan, and the U.S.
JEL classification: G14; D81
Keywords: Behavioral finance; arbitrage; psychology; market efficiency
A modified version of this paper was given as a keynote address at the July, 2002
APFA/PACAP/FMA meetings in Tokyo. I would like to thank Ken Froot and Andrei Shleifer for sharing their data and ideas, and Rongbing Huang for research assistance.
Behavioral Finance
1. Introduction
Behavioral finance is the paradigm where financial markets are studied using models that are less narrow than those based on Von Neumann-Morgenstern expected utility theory and arbitrage assumptions. Specifically, behavioral finance has two building blocks: cognitive psychology and the limits to arbitrage. Cognitive refers to how people think. There is a huge psychology literature documenting that people make systematic errors in the way that they think: they are overconfident, they put too much weight on recent experience, etc. Their preferences may also create distortions. Behavioral finance uses this body of knowledge, rather than taking the arrogant
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