Behavioural finance theory and anomalies

Isaac Kofi Bekoe and Joshua Yindenaba Abor

Chapter 14 in The Elgar Companion to Financial Economics, 2025, pp 260-275 from Edward Elgar Publishing

Abstract: Traditional finance theories typically portray investors as rational actors who make decisions based solely on logical assessments. However, the speculative behaviors observed in financial markets often defy these traditional theories. Behavioural finance offers an alternative perspective, suggesting that certain financial phenomena can be more accurately explained by models that incorporate the notion that some investors are not entirely rational. This approach posits that individual investors often make irrational financial decisions influenced by various biases and psychological factors. Behavioural finance delves into the psychological underpinnings of investors and their impact on financial decision-making processes. This chapter starts with an overview of the history of behavioural finance, tracing its development and highlighting key milestones. It then contrasts traditional finance theories with behavioural finance, emphasizing how the latter addresses the limitations of the former. The core components of behavioural finance are explored in detail, focusing on the limits of arbitrage and the role of psychology in financial markets. The chapter also provides an in-depth analysis of specific behavioural biases that affect investors; these biases demonstrate how investors often act on subjective beliefs and emotions rather than objective analysis. The chapter also suggests mechanisms to overcome behavioural finance issues by helping investors blend traditional and behavioural finance principles to make informed financial decisions, and ends by speculating about its future course.

Keywords: Behavioural finance; Financial markets; Financial decision-making (search for similar items in EconPapers)
Date: 2025
ISBN: 9781035341399
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