The End of Behavioral Finance

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The End of Behavioral Finance Author(s): Richard H. Thaler Source: Financial Analysts Journal, Vol. 55, No. 6, Behavioral Finance (Nov. - Dec., 1999), pp. 12-17 Published by: CFA Institute Stable URL: Accessed: 17/04/2009 10:10 Your use of the JSTOR archive indicates your acceptance of JSTOR's Terms and Conditions of Use, available at JSTOR's Terms and Conditions of Use provides, in part, that unless you have obtained prior permission, you may not download an entire issue of a journal or multiple copies of articles, and you may use content in the JSTOR archive only for your personal, non-commercial use. Please contact the publisher regarding any further use of this work. Publisher contact information may be obtained at Each copy of any part of a JSTOR transmission must contain the same copyright notice that appears on the screen or printed page of such transmission. JSTOR is a not-for-profit organization founded in 1995 to build trusted digital archives for scholarship. We work with the scholarly community to preserve their work and the materials they rely upon, and to build a common research platform that promotes the discovery and use of these resources. For more information about JSTOR, please contact

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RichardH. Thaler


Tn 1985,WernerDe Bondt and I published an article that asked the question: "Does the stockmarketoverreact?" articlewas conThe troversialbecauseit gave evidence to support the hypothesis that a cognitive bias (investoroverreactionto a long seriesof bad news) could produce predictable mispricing of stocks traded on the NYSE.Although this idea was hardly shocking to practitioners, the conventional wisdom among finance academicswas that we must have made a mistake somewhere. The academic community considered several possibilitiesto explain our results:We made a programming error;the results were correctly measured but explainable by chance variation (data mining);the resultswere correctandrobust(no data mining), but rather than discovering mispricing caused by cognitive errors, we discovered some new riskfactor.Thepossibilitythatwe had both the facts and the explanation right was thought by many academicsto be a logical impossibility,and the demise of behavioralfinancewas considereda sure bet. Fifteenyears later,many respectablefinancial economists work in the field called behavioral finance.1 I believe the area no longer merits the adjective "controversial." Indeed, behavioral financeis simply a moderate,agnosticapproachto studying financialmarkets.Nevertheless,I too predict the end of the behavioral finance field, although not for the reasons originallyproposed. To understandwhat behavioralfinanceis and why it was originallythoughtto be a fleetingheresy, one must firstunderstandthe standardapproachto financialeconomics and why those who used this approach believed,on theoretical grounds,thatcognitive biases could not affectasset prices.

Why Behavioral Finance Cannot Be Dismissed
Modern financialeconomic theory is based on the assumption that the "representative agent" in the

RichardH. Thaleris RobertP. Gwinn Professor of Behavioral Science the University Chicago at of Graduate School Business. of 12

economy is rationalin two ways: The representative agent (1) makes decisions according to the axioms of expected utility theory and (2) makes unbiased forecasts about the future. An extreme version of this theory assumes that every agent behaves in accordance with these assumptions. Most economists recognizethis extremeversion as unrealistic;they concede that many of their relatives and acquaintances-spouses,...
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