Behavioral Finance at 40

Behavioral finance seeks to improve our understanding of markets, investors, and firms by adopting a psychologically realistic description of how people think. While behavioral finance ideas have been part of human discourse for decades if not centuries, the modern research effort in the field began in the 1980s. Forty years later, behavioral finance is a vibrant area of financial economics. In this article, I explain why by reviewing some of its recent progress. I focus on three topics – beliefs about future earnings, beliefs about future returns, and prospect theory – and on their applications to understanding asset prices and investor behavior. I close by commenting on some new directions in the field – cognitive foundations, non-traditional decision processes, and artificial intelligence.