4. Behavioral Finance

g. describe behavioral finance and its potential relevance to understanding market anomalies.

What is behavioral finance? Behavior finance is a field of finance that proposes psychology-based theories to explain stock market anomalies.

What is the Loss Aversion theory? This is a theory that people value gains and losses differently and, asa result, will base decisions on perceived losses rather than perceived gains.

What is the Overconfidence theory? Most people consider themselves to be better than average in most things they do. For example, 80% of drivers contend that they are better than “average” drivers. Is that really possible? Studies show that money managers, advisors, and investors are consistently overconfident in their ability to outperform the market. Most fail to do so, however.

What is information cascading and herding? - Information cascading is defined as a situation in which an individual imitates the trades of other market participants and completely disregards his or her own private information. - Herding is clustered trading that may or may not be based on information.