By Jason Hreha

Glossary

Behavioral Finance

Reviewed by Jason Hreha

Published 1 min read

What is behavioral finance?

Behavioral finance studies how psychological factors and limits on market correction can help explain financial decisions and market outcomes. Its questions include investor judgment, trading, asset prices, and corporate decisions.

Psychology and limits to arbitrage

Barberis and Thaler’s survey (2002) identifies two main foundations: psychology and limits to arbitrage. The latter concerns why informed traders may not easily correct prices influenced by other participants.

What can behavioral finance explain?

Fear, greed, and overconfidence may help frame questions about investment choices. But naming an emotion does not explain a market. The field does not require every investor to be irrational. A behavioral explanation of a market pattern needs evidence and comparison with other explanations. Even if a price looks wrong, correcting it through a trade may involve risk, cost, or a long wait. Recognizing a pattern is not a reliable trading rule by itself.