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The Contrast Between Behavioural Finance and Traditional Financial Theory
By Graham Elliott Shircore, CFA

The volatility seen across a variety of financial assets in recent years has once again brought traditional financial theory into question and left the Efficient Market Hypothesis (EMH), which has formed the backbone of accepted financial theory for decades, open to question.

The basis of one of the most-widely discussed challenges to traditional financial theory is the impact of psychological influences on people’s behaviour. Behavioural Finance, as this school of thought is commonly termed, argues that a completely rational marketplace is not applicable in practice due to the impact of psychological biases that systematically influence the investment decision-making process. While, in its simplest form this way of thinking appears logical-psychological biases can be found in all walks of life so why not the financial world?-the fact that it is a largely qualitative phenomenon poses significant obstacles for practitioners and academics alike.

Unlike EMH, behavioural finance isn’t underpinned by a set of unifying principles that tie together all observations of psychological influences. For this reason, it cannot be articulated as a clearly, narrowly-defined conceptual framework and attempting to practically integrate the theories of behavioural finance into an investment process has no one correct methodology. That said, from a practical perspective, neither does it need to be overly complex, Warren Buffet’s infamous quote, ’be fearful when others are greedy and greedy when others are fearful’ is a perfect example of appreciating the impact of psychological influences in its simplest form.

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viladmin
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Tue April 12, 2011, 15:32:43
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