The Impact of Behavioral Bias on Investment Decision-Making

Abstract

Behavioral finance is an emerging discipline that integrates theories from psychology with finance. Robert Shiller, a professor of economics at Yale University, is the originator of behavioral finance and was awarded the Nobel Prize in economics in 2013 for his successful prediction of the Internet bubble crisis and the subprime mortgage crisis. The major difference between behavioral finance and traditional finance is the difference in the underlying assumptions of the two. Behavioral finance attempts to explain how decision-makers make financial decisions in real life, and why their decisions may not be rational every time. This is in contrast to many traditional theories that assume that investors make rational decisions. Behavioral finance suggests that individuals may not make decisions based on rational analysis of all information. This may cause the stock prices of individual companies to deviate from a fair price and cause the stock prices of the entire market to collectively be at very high or very low levels over a period of time. Therefore, the different behaviors and differences that people generate when investing has an important impact on their investment decisions. This paper focuses on promoting a deeper understanding of behavioral finance and helping people to better analyze their investment decisions by reviewing the four more common types of behavioral finance: loss aversion, noise trading, momentum effect, and the endowment effect.