Behavioral finance

Behavioral finance is the study of how psychological biases, cognitive limitations, and emotional responses systematically distort financial decision-making. It rejects the premise of the Efficient market hypothesis that investors are rational expected-utility maximizers, and instead documents the predictable ways in which real humans deviate from optimality: overconfidence, loss aversion, herding, and recency bias among them. The field's central claim is not that people are irrational — it is that their irrationality is patterned, and those patterns leave detectable traces in market prices.

The tension between behavioral finance and traditional finance is not merely empirical. It is structural. Traditional finance treats anomalies as temporary deviations that arbitrage will eliminate. Behavioral finance treats them as persistent features of a system whose participants are not the homo economicus of theory but the homo sapiens of evolutionary history — a creature designed by natural selection for survival, not for portfolio optimization. The question is not whether biases exist; it is whether markets have sufficient adaptive capacity to arbitrage them away before the arbitrageurs themselves fall prey to the same biases.