The Impact of Psychological Biases on Asset Pricing in Behavioral Finance

This paper focuses on how psychological bias affects the asset pricing in behavioral finance, an emerging field that attempts to integrate psychological theory into the market realties. Simple postulates from conventional finance theories such as Efficient Market Hypothesis indicate that markets are efficient while practicing finance in real life scenarios demonstrates that there are inefficiencies elicited by behavioral biases in the pricing of assets. This research employs both qualitative and quantitative approaches to explore how factors like overconfidence, anchoring and loss aversion bias psychological influences financial decisions and upset the efficiency of markets. In this paper, using the systematic analysis of financial literature and the meta-analysis of available financial data, the author demonstrates several specific psychological biases that affect asset prices. Profound peer research analysis shows excessive trading and increased information risk results from overconfidence and impacts IPOs and market entry points by anchoring. The finding revealed that loss aversion played crucial role in the sell decisions during bear market and as a result aggravated the extent of price drop. The fact of this means a rationality of markets and the finding of these patterns poses profound questions and shows that prices of assets are often the result of irrational behavior of investors. Based on a choice of three alternative portfolios by Yaari, this paper calls for the integration of psychological factors into the models that explain the asset pricing behavior and presents recommendations to the practitioners in the field of finance.