Senior Honors Theses

Publication Date

Spring 4-25-2017

School

School of Business

Major

Business: Finance

Keywords

behavioral finance, investing, psychology, efficient market hypothesis, prospect theory

Disciplines

Behavioral Economics | Cognitive Psychology | Finance and Financial Management | Portfolio and Security Analysis

Abstract

The field of behavioral finance has seen incredible growth over the past half century as it has explored the effect that cognitive psychological biases can have on investors’ financial decisions. Behavioral finance stands in stark contrast to the efficient market hypothesis, as it attributes market inefficiencies to investors who are not perfectly rational human beings. It offers a solution to the observed 3.5% gap that active equity investors miss out on in the market compared to passive index funds, which it attributes to their emotions and psychological biases. These common human biases can be grouped into five major categories: heuristics, prospect theory, overconfidence, misperceiving randomness, and herding. This thesis will conclude with applications drawn from the field of behavioral finance that can be applied to both the individual investor and the financial advisor to help achieve better investment returns.