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Investment Management and Financial Innovations, Volume 3, Issue 4, 2006

7

BEHAVIORAL FINANCE, BOUNDED RATIONALITY, NEURO-FINANCE, AND TRADITIONAL FINANCE
K.C. Tseng* Abstract
The principal purpose of this study is to piece together the important development and contributions by efficient market hypothesis, bounded rationality, behavioral finance, neurofinance, and the recently introduced adaptive market hypothesis. In the process the author will review the selected literature so that they can be linked together for further consideration and development. When monthly and daily data for S&P 500, DJIA, and NASDAQ indexes were analyzed from 1971 to 2005, the author found long string of positive and significant autocorrelations and great volatility, which were not consistent with the efficient market hypothesis. The international market indexes from Japan, Hong Kong, Singapore, Mexico, Taiwan, and Canada are also very volatile even though they show less volatility compared to the U.S. indexes. Since AMH was introduced in 2004, it is promising but is still at its infant stage of development. Finally, the neural/medical finance can help us understand the brain activities when investors are making investing and trading decisions, and the effect of drugs on brain and investment decision-making. The future of neurofinance and AMH appears to be promising. Key words: adaptive market hypothesis, affect and emotion, behavioral finance, bounded rationality, efficient market hypothesis, excessive volatility, neurofinance, and psychophysiology. JEL classification: N2, N20.

1. Introduction
In recent years new fronts have been rapidly developing in investments and financial markets. In particular, the behavioral finance, evolutionary finance, and neurofinance are challenging the traditional finance. Whether the financial markets, in particular the stock markets, are efficient or not and whether market participants are rational or not, depend to a large extent on the ways


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