Journal of Institutional and Theoretical Economics JITE · 2002 · 1.3K citations · 0 references
BusinessEconomicsFinanceBehavioral FinanceFinancial EconomicsFinancial MarketsArbitrage PricingCognitive Biases In InvestingInvestor PsychologyMarket AnomaliesMarket EfficiencyStock MarketsArbitrage Pricing Theory TestsAsset Pricing EfficiencyClosed-end Fund StructureFinancial Market EfficiencyInvestor Trading BehaviorStock Market AnomaliesStock Market BubblesTechnical Rationality
The efficient markets hypothesis has dominated finance for nearly thirty years, positing that prices reflect fundamental values through rational investors or arbitrage, yet real markets feature less‑than‑rational traders constrained by risk aversion, short horizons, and agency problems. This book introduces behavioral finance as an alternative framework, aiming to model and empirically evaluate market inefficiencies arising from psychological and institutional factors. The authors build models that challenge rationality and perfect arbitrage assumptions, empirically testing them against observed market behavior. Behavioral finance models better explain financial data, predict anomalies such as the value premium, closed‑end fund puzzles, high index returns, bubble persistence, and hedge fund collapses, thereby establishing a new empirical foundation for real‑world market analysis.
The efficient markets hypothesis has been the central proposition in finance for nearly thirty years. It states that securities prices in financial markets must equal fundamental values, either because all investors are rational or because arbitrage eliminates pricing anomalies. This book describes an alternative approach to the study of financial markets: behavioral finance. This approach starts with an observation that the assumptions of investor rationality and perfect arbitrage are overwhelmingly contradicted by both psychological and institutional evidence. In actual financial markets, less than fully rational investors trade against arbitrageurs whose resources are limited by risk aversion, short horizons, and agency problems. The book presents and empirically evaluates models of such inefficient markets. Behavioral finance models both explain the available financial data better than does the efficient markets hypothesis and generate new empirical predictions. These models can account for such anomalies as the superior performance of value stocks, the closed end fund puzzle, the high returns on stocks included in market indices, the persistence of stock price bubbles, and even the collapse of several well-known hedge funds in 1998. By summarizing and expanding the research in behavioral finance, the book builds a new theoretical and empirical foundation for the economic analysis of real-world markets.