The Investment Advisor Body of Knowledge + Test Bank

CHAPTER 16 Behavioral Finance Theory

Many traditional investment theories and models make assumptions that investors act rationally and in a consistent manner. Behavioral finance argues that investors are subject to numerous conditions that in effect cause them to act irrationally much of the time. Research in this field can help investment professionals identify the more common biases and mental heuristics and when investors are more likely to make mistakes.

This chapter will take a quick look at the origins of the field and some of the more important concepts originally established in the field of behavioral finance. The focus then turns to the application of behavioral finance as it applies to investor behavior.

The reading reviews the basic descriptions of these mental and emotional traps and reviews practical applications and recommendations for how to deal more effectively with each. The author discusses numerous examples of common situations facing investors and the unhealthy choices that typically follow. Investment advisors and consultants should recognize most of these biases, having observed them in the behaviors of their clients and themselves as well.

Behavioral Finance and Wealth Management: Behavioral Finance

Learning Objectives

• Describe the concept of behavioral finance and how it supplements traditional financial and investment theory.
• Describe “prospect theory” and explain its importance as a pillar in behavioral finance.
• Describe and differentiate among ...