Important Contributors Like every other branch of finance, the field of behavioral finance has certain people that have provided major theoretical and empirical contributions. The following section provides a brief introduction to three of the biggest names associated with the field.
Daniel Kahneman and Amos Tversky
Cognitive psychologists Daniel Kahneman and Amos Tversky are considered the fathers of behavioral economics/finance. Since their initial collaborations in the late 1960s, this duo has published about 200 works, most of which relate to psychological concepts with implications for behavioral finance. In 2002, Kahneman received the Nobel Memorial Prize in Economic Sciences for his contributions to the study of rationality in economics.
Kahneman and Tversky have focused much of their research on the cognitive biases and heuristics (i.e. approaches to problem solving)that cause people to engage in unanticipated irrational behavior. Their most popular and notable works include writings about prospect theory and loss aversion - topics that we'll examine later.
Richard Thaler
While Kahneman and Tversky provided the early psychological theories that would be the foundation for behavioral finance, this field would not have evolved if it weren't for economist Richard Thaler.
During his studies, Thaler became more and more aware of the shortcomings in conventional economic theoryies as they relate to people's behaviors. After reading a draft version of Kahneman and Tversky's work on prospect theory, Thaler realized that, unlike conventional economic theory, psychological theory could account for the irrationality in behaviors.
Thaler went on to collaborate with Kahneman and Tversky, blending economics and finance with psychology to present concepts, such as mental accounting, the endowment effect and other biases.
CriticsAlthough behavioral finance has been gaining support in recent years, it is not without its critics. Some supporters of the efficient market hypothesis, for example, are vocal critics of behavioral finance.
The efficient market hypothesis is considered one of the foundations of modern financial theory. However, the hypothesis does not account for irrationality because it assumes that the market price of a security reflects the impact of all relevant information as it is released.
The most notable critic of behavioral finance is Eugene Fama, the founder of market efficiency theory. Professor Fama suggests that even though there are some anomalies that cannot be explained by modern financial theory, market efficiency should not be totally abandoned in favor of behavioral finance.
In fact, he notes that many of the anomalies found in conventional theories could be considered shorter-term chance events that are eventually corrected over time. In his 1998 paper, entitled "Market Efficiency, Long-Term Returns And Behavioral Finance", Fama argues that many of the findings in behavioral finance appear to contradict each other, and that all in all, behavioral finance itself appears to be a collection of anomalies that can be explained by market efficiency.
Source: Behavioral Finance: Background
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