A Unified Behavioral Finance

Abstract

We often hear that behavioral finance is nothing more than a collection of stories about irrational people—that it lacks the unified structure of standard finance. Yet today’s standard finance is no longer unified because wide cracks have opened between its theory and the evidence. The first generation of behavioral finance attempted to fill the cracks in standard finance largely by accepting its notions of investors as rational, yet describing investors as irrational and misled by cognitive and emotional errors. The second generation of behavioral finance described briefly here and in detail in the author’s book Finance for Normal People characterizes investors as normal. It depicts behavioral finance as a unified structure that incorporates parts of standard finance, replaces others, and bridges the gaps between theory, evidence, and practice.

TOPICS: Wealth management, portfolio management/multi-asset allocation