The Role of Psychological Factors in Behavioral Finance

Abstract

This chapter introduces the role of psychological factors in behavioral finance, thus explaining the theory of behavioral finance, the application of behavioral finance theory, the empirical achievement in behavioral finance, the utilization of psychological factors in behavioral finance regarding beliefs (i.e., overconfidence, too much trading, optimism and wishful thinking, representativeness bias, conservatism bias, belief perseverance, anchoring, and availability bias) and preferences (i.e., prospect theory and ambiguity aversion). Behavioral finance is a comparatively new management field that seeks to combine behavioral and cognitive psychological theory with conventional economics and finance to provide descriptions for why people make unreasonable financial decisions. Psychological factors in behavioral finance hold out the expectation of a better understanding of financial market behavior and scope for investors to make better investment decisions. Applying psychological factors in behavioral finance will tremendously enhance financial performance and achieve strategic objectives in global finance.