History, Application, and Outlook of Behavioral Finance
Behavioral Finance is a subject closely related to Behavioral Economics. Scientific research on human, social, cognitive and emotional biases is used to better understand economic decisions and how they affect Finance, in particular market prices, returns and the allocation of resources. There is a very interesting and rich history of Behavioral Finace rooted in Behavior Economics and psychology, and today Behavioral Finance is a very important fundamental of finance and can be used to making financial decisions.
During the Classical Period there was a very close link between economics and psychology. Noted Author Adam Smith wrote meaningful words in his 1759 text The Theory of Moral Sentiments. This was an important text in describing an individual 's behavior based on psychological principles. Smith 's views closely followed those of his mentor Francis Hutcheson. The Theory of Moral Sentiments, Smith 's first and in his own mind most important work, outlines his view of proper conduct and the institutions and sentiments that make men virtuous (Smith, 2000) Here he develops his doctrine of the impartial spectator, whose hypothetical disinterested judgment we must use to distinguish right from wrong in any given situation (Smith, 2000). Smith believed people by nature pursue their own self-interest. This makes independence or self-command an instinctive good. And neutral rules are as difficult to craft as they are necessary.
But society is not held together merely by neutral rules, instead society is held together by sympathy (Smith, 2000). Smith argues that we naturally share emotion and to a certain extent the physical sensations we witness in other people. Sharing the sensations of our fellow people, we seek to maximize their pleasures and minimize their pains so that we may share in their joys and enjoy their expressions of affection and approval (Smith, 2000). This was the first real writings on behavior where an educated person could put two and two
During the Classical Period there was a very close link between economics and psychology. Noted Author Adam Smith wrote meaningful words in his 1759 text The Theory of Moral Sentiments. This was an important text in describing an individual 's behavior based on psychological principles. Smith 's views closely followed those of his mentor Francis Hutcheson. The Theory of Moral Sentiments, Smith 's first and in his own mind most important work, outlines his view of proper conduct and the institutions and sentiments that make men virtuous (Smith, 2000) Here he develops his doctrine of the impartial spectator, whose hypothetical disinterested judgment we must use to distinguish right from wrong in any given situation (Smith, 2000). Smith believed people by nature pursue their own self-interest. This makes independence or self-command an instinctive good. And neutral rules are as difficult to craft as they are necessary.
But society is not held together merely by neutral rules, instead society is held together by sympathy (Smith, 2000). Smith argues that we naturally share emotion and to a certain extent the physical sensations we witness in other people. Sharing the sensations of our fellow people, we seek to maximize their pleasures and minimize their pains so that we may share in their joys and enjoy their expressions of affection and approval (Smith, 2000). This was the first real writings on behavior where an educated person could put two and two
Cited: Kahneman, D., Slovic P., Tversky A. (1982) Judgment Under Uncertainty: Heuristics and Biases Cambridge: Cambridge University Press Lo, A., MacKinlay C., (1999) A Non-Random Walk Down Wall Street New Jersey: Princeton U Smith, Adam (2000) Theory of Moral Sentiments New York: Prometheus Prospect Theory (February 9, 2007) Prospect Theory from Wikipedia, the free encyclopedia http://en.wikipedia.org/wiki/Prospect_theory Cumulative Prospect Theory (CPT) (February 9, 2007) Cumulative Prospect Theory from Wikipedia, the free encyclopedia http://en.wikipedia.org/wiki/Neo-classical_economics Is Behavioral Finance a Growth Industry? (October 10, 2001) Knowledge@Wharton