Behavioral finance

Behavioral finance studies how psychological biases, emotions, and social behavior shape financial decisions and market outcomes.

Prospect theory: A theory of decision-making under risk in which people evaluate gains and losses relative to a reference point. It explains how loss aversion and framing alter choices involving money.
Disposition effect: The tendency of investors to sell winning assets too early and hold losing assets too long. It is a trading pattern linked to loss aversion and mental accounting.
Efficient-market hypothesis: The hypothesis that asset prices reflect available information, making persistent abnormal returns difficult to earn. Behavioral finance examines how biased beliefs and trading can produce departures from this benchmark.
Behavioral economics: The study of how psychological, social, and cognitive factors shape economic decisions. Behavioral finance applies this broader approach specifically to financial choices and markets.
Loss aversion: The tendency to experience losses more strongly than equivalent gains. It helps explain reluctance to sell losing investments or accept financial losses.
Representativeness heuristic: A judgment shortcut that estimates likelihood by resemblance to a familiar category or pattern. Investors may mistake a short run of returns for evidence of a durable trend.
Expected utility theory: A framework in which people rank uncertain prospects by the probability-weighted utility of their outcomes. Prospect theory arose partly to explain choices that expected utility theory does not describe well.
Nudge theory: An approach that changes choice environments to influence behavior without banning options or substantially changing incentives. Financial defaults can use predictable biases to increase saving or improve enrollment.
Heuristic: A mental shortcut that simplifies judgment, often at the cost of accuracy. Investors use shortcuts when evaluating uncertain, complex financial choices.
Availability heuristic: A judgment shortcut that estimates likelihood by how easily examples come to mind. Recent crashes or striking market stories can distort perceived investment risk.

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