Prudena

Behavioral Finance

Humans Vs. Econs

Historically, economic and financial models have depended on a fully-rational "decision-making agent." Partly this was because a well-formed model for an irrational agent did not exist and partly because the models developed with a fully-rational agent were superior than what they were replacing.

However, developments in cognitive psychology and economic theory have given rise to Behavorial Finance which develops economic models that incorporate a decision-making agent who is not fully rational. These models were developed in an effort to improve the predictive powers of econnomic models and to better understand the workings of markets.

In particular, Behavioral Finance seeks to explain certain anomolies that are incompatible with models that assume a fully-rational agent.

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