Behavioral Finance
                     BEHAVIORAL FINANCE
WHAT IS BEHAVIORAL 
FINANCE?
Behavioral finance is the study of the 
influence of psychology on the behavior of 
investors or financial analysts. It also 
includes the subsequent effects on the 
markets.
Source: corporatefinanceinstitute.com
FOCUS 
It focuses on the fact that investors are not 
always rational, have limits to their self-
control, and are influenced by their own 
biases.
Source: corporatefinanceinstitute.com
TRADITIONAL FINANCIAL 
THEORY
Traditional finance includes the following beliefs:
Both the market and investors are perfectly rational
Investors truly care about utilitarian characteristics
Investors have perfect self-control
They are not confused by cognitive errors or 
information processing errors
Source: corporatefinanceinstitute.com
TRAITS OF BEHAVIORAL 
FINANCE
• Investors are treated as “normal” not 
“rational”
• They actually have limits to their self-
control
• Investors are influenced by their own biases
• Investors make cognitive errors that can 
lead to wrong decisions
Source: corporatefinanceinstitute.com
DECISION-MAKING 
ERRORS AND BIASES
Behavioral finance views investors as 
“normal” but being subject to decision-
making biases and errors. We can break 
down the decision-making biases and errors 
into at least four buckets.
Source: corporatefinanceinstitute.com
SELF-DECEPTION
The concept of self-deception is a limit to 
the way we learn. When we mistakenly think 
we know more than we actually do, we tend 
to miss information that we need to make an 
informed decision.
Source: corporatefinanceinstitute.com
HEURISTIC 
SIMPLIFICATION
We can also scope out a bucket that is often 
called heuristic simplification. Heuristic 
simplification refers to information-
processing errors.
Source: corporatefinanceinstitute.com
EMOTION
Another behavioral finance bucket is related 
to emotion, but we’re not going to dwell on 
this bucket in this introductory session. 
Basically, emotion in behavioral finance 
refers to our making decisions based on our 
current emotional state.
Source: corporatefinanceinstitute.com
SOCIAL INFLUENCE
What we mean by the social bucket is how 
our decision-making is influenced by others.
Source: corporatefinanceinstitute.com
BIASES IN BEHAVIORAL 
FINANCE
Common biases include:
Overconfidence and illusion of control
Self Attribution Bias
Hindsight Bias
Confirmation Bias
The Narrative Fallacy
Representative Bias
Framing Bias
Source: corporatefinanceinstitute.com