Behavioral Finance

Behavioural finance is the study of the effects of psychological effects on decision making on financial investors, thereby effecting market outcomes. So, basically, it studies the psychology of financial decision making

Traditional finance theories had assumed that investors have little difficulty making financial decisions and are well informed, careful and consistent. It holds that investors are rational and not confused by emotions or other factors. Fama's efficient market hypothesis says that at any given time, a highly liquid market, stock prices are efficiently valued to reflect all the available information. However, studies have documented long-term historical phenomenon in securities market contradict the efficient market hypothesis which cannot be captured by models assuming rationality. 

The EMH is based on the belief that the market participants see prices based on all current and future intrinsic and external factors. In the behavioural side, the researchers consider that markets are not fully efficient. This allows them to see the physiological effects on markets.

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Covered:

1.1 Utility of money 

    1.1.1 St. Petersburg paradox 

    1.1.2. Are we Rational Decision, makers

1.2. Regret Theory

    1.2.1 Omission Bias

    1.2.2. Risk-averse vs Risk loving

    1.2.3. Loss Aversion

    1.2.4. Prospect Theory

    1.2.5. Gains and losses vs Absolute Wealth

    1.2.6. Disposition effect and Prospect theory

1.3. Problems with probability

    1.3.1. Juror's fallacy: Base rate fallacy

    1.3.2. Correlation/Causation error

    1.3.3. Invisible correlation error

    1.3.4. Confusion of inverse

2. Weighting probability

2.1. Subjective Probability

    2.1.1. Probability weighting function

    2.1.2. Probability weighting examples

    2.1.3. Absolute vs relative probabilities

2.2. Availability

    2.2.1. Imagination and vividness

    2.2.2. Effect of salience

    2.2.3. Endorsements

    2.2.4. Signal vs Noise

    2.2.5. Impact of frequency and timing

    2.2.6. More on availability

2.3. Framing

    2.3.1. Mental accounting

    2.3.2. Endowment effect

    2.3.3. Status quo bias

    2.3.4. Loss aversion and disposition effect

    2.3.5. Anchoring

    2.3.6. Framing

2.4. Representativeness

    2.4.1. Gambler's fallacy

    2.4.2. Non-regressive prediction bias

    2.4.3. Sample size neglect

    2.4.4. Conservatism

2.5. Over-confidence

    2.5.1. self-attribution bias

    2.5.2. Self-fullfilling prophecy

    2.5.3. Corporate finance and overconfidence

    2.5.4. Belief perseverance and confirmation bias

    2.5.5. Case study

3. Market bubbles and crashes

    3.1. Behavioural biases

    3.2. Phases in bubbles

References:

[1] Vanguard

[2] Investopedia