Provide a 6 pages analysis while answering the following question: Behavioral Finance and its Assumptions. Prepare this assignment according to the guidelines found in the APA Style Guide. An abstract is required. Hersh’s Beyond Greed and Fear provides an opening argument to the public on behalf of behavioral finance, building on three themes: errors based on rules of thumb, identifying risk depending on how problems are framed, and deviations of markets from the fundamental value (Shefrin 4-10). Both Hersh’s text and the field generally rely on concepts borrowed from psychology, perhaps to its discredit, making itself a subset of a social science rather than of financial analysis. Throughout this paper, several objections to behavioral finance will be presented along with reasons why these objections are significant both in Hersh’s text but also in terms of shaping the way that finance generally is conducted in the 21st century.
Although a relatively new field, behavioral finance already has attracted a fair amount of attention in the literature, including from Eugene Fama, who is a well-known American economist working in portfolio theory and asset pricing. Fama is considered one of the founders of the efficient-market hypothesis, which is the idea that financial markets are “informationally” efficient meaning that the market has already priced all of the available information into the price of an asset. The efficient market theory rests on a different underlying assumption than behavioral finance, which thinks that random, unpredictable behavior (that is, behavior which is not rational) can make a significant impact on the price of assets. As a result, Fama and other supporters of the efficient market hypothesis tend to see behavioral finance as a set of anomalies and biases established in the social sciences rather than as a true branch of finance (Fama 3-6). Anomalies like those studied in behavioral finance and in psychology will eventually be explained by logic, according to the efficient market hypothesis.
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