Behavioral finance argues that some financial phenomena can plausibly be understood using models in which some agents are not fully rational. The field has two building blocks: limits to arbitrage, which argues that it can be difficult for rational traders to undo the dislocations caused by less rational traders; and psychology, which catalogues the kinds of deviations from full rationality we might expect to see. We discuss these two topics, and then present a number of behavioral finance applications: to the aggregate stock market, to the cross-section of average returns, to individual trading behavior, and to corporate finance. We close by assessing progress in the field and speculating about its future course.
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ReDIF This chapter was published in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.) Handbook of the Economics of Finance, , chapter 18, pages 1053-1128, 2003.
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This chapter was published in the following book, which is listed on IDEAS: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), 2003.
"Handbook of the Economics of Finance,"
Handbook of the Economics of Finance,
Elsevier,
edition 1, volume 1, number 2.
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