Department of Psychology
The Psychology of Decision-Making:
Lawrence J. Raifman, J.D., Ph.D.
Fall Semester 2001
Office Hours: Tuesdays 1-3 p.m.; 232 Ames Hall
Teaching Assistant: Rebecca Piorkowski
Meeting Time: Tuesdays 3-5 p.m., Shaffer Hall, room 303
What does psychology have to offer stock market investors, portfolio managers, and finance economists?
Over the past four decades, investment decisions have been guided by efficient markets theory. The theory is based on the notion that investors behave in a rational, predictable and an unbiased manner. The model assumes that investors in the aggregate correctly price stocks to reflect all publicly available information. Behavioral finance challenges this traditionally held notion. Reliant upon cognitive psychology decision theory, behavioral finance is the study of how investors’ interpret and act on available, fallible information. Its findings suggest, among other things, the existence of: (1) individual investor heuristics; that is, mental short cuts used in place of purely (unboundedly) rational thinking; and (2) marketplace anomalies; economic puzzles not explained by efficient markets theory, consistent with the conclusion that in the aggregate investors do not behave rationally. Thus, behavioral finance identifies marketplace investor mistakes, with an expectation that if one were to fully become knowledgeable about the psychological (including quasi-rational) aspects of decision-making, investors would out-smart the market traders, and beat the market benchmarks.
Behavioral finance has recently become a buzzword in the investment community. Numerous articles have appeared in the financial press reporting about behavioral finance studies, and there have been an increasing number of seminars on the subject. Despite its recent attention,