Financial Decision-Making in Markets and Firms: A Behavioral Perspective

Werner F. M. De Bondt, Richard H. Thaler

NBER Working Paper No. 4777
Issued in June 1994

In its attempt to model financial markets and the behavior of firms, modern finance theory starts from a set of normatively appealing axioms about individual behavior. Specifically, people are said to be risk-averse expected utility maximizers and unbiased Bayesian forecasters, i.e., agents make rational choices based on rational expectations. The rational paradigm may be criticized, however, because (1) the assumptions are descriptively false and incomplete, and (2) the theory often lacks predictive power. One way to make progress is to characterize actual decision- making behavior. Efforts along these lines are made by behavioral economists and psychologists. This paper provides a selective review of recent work in behavioral finance. First, we ask why economists should be concerned with the psychology of decision-making. Next, we discuss a series of key behavioral concepts, e.g., people's well-known tendencies to give too much weight to vivid information and to show excessive self-confidence. The body of the paper illustrates the relevance of these concepts to important topics in investment theory and corporate finance. In each case, behavioral finance offers a new perspective on results that are anomalous within the standard approach.

download in pdf format
   (1657 K)

download in djvu format
   (977 K)

email paper

This paper is available as PDF (1657 K) or DjVu (977 K) (Download viewer) or via email.

Machine-readable bibliographic record - MARC, RIS, BibTeX

Document Object Identifier (DOI): 10.3386/w4777

Published: Handbook in Operations Research and Management Science, Vol. 9, Finance, North Hollan 1996.

Users who downloaded this paper also downloaded these:
Lo, Repin, and Steenbarger w11243 Fear and Greed in Financial Markets: A Clinical Study of Day-Traders
Baker and Wurgler w17333 Behavioral Corporate Finance: An Updated Survey
Lusardi w17821 Numeracy, financial literacy, and financial decision-making
Jorgenson The Theory of Investment Behavior
Vissing-Jorgensen Perspectives on Behavioral Finance: Does "Irrationality" Disappear with Wealth? Evidence from Expectations and Actions
NBER Videos

National Bureau of Economic Research, 1050 Massachusetts Ave., Cambridge, MA 02138; 617-868-3900; email:

Contact Us