The most concise explanation of behavioral finance I’ve ever seen

The most concise explanation of behavioral finance I’ve ever seen

January 29, 2016 Behavioral Finance, Research Insights
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One of the most overused– and misunderstood — terms I’ve seen used by finance practitioners is “behavioral finance.” Many professionals consider themselves to be “behavioral finance experts” because they identify irrational investors.1

Newsflash: Identifying irrational investors is not behavioral finance.

But here is a great summary from a Baker, Bradley, and Wurgler paper we’ve covered in the past:

Behavioral models of security prices combine two ingredients. The first is that some market participants are irrational in some particular way…The second ingredient is limits on arbitrage, which explain why the “smart money” does not offset the price impact of any irrational demand.

Too many practitioners focus on irrational investors and too little attention on limits of arbitrage. We go in depth on the subject of behavioral finance here and explain why it is much more complicated to exploit irrational behavior than many want to believe.


1. It is a bit ironic that some research identifies that professionals ARE the irrational investors).

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About the Author

Wesley R. Gray, Ph.D.

After serving as a Captain in the United States Marine Corps, Dr. Gray received a PhD, and was a finance professor at Drexel University. Dr. Gray’s interest in entrepreneurship and behavioral finance led him to found Alpha Architect. Dr. Gray has published three books: EMBEDDED: A Marine Corps Adviser Inside the Iraqi Army, QUANTITATIVE VALUE: A Practitioner’s Guide to Automating Intelligent Investment and Eliminating Behavioral Errors, and DIY FINANCIAL ADVISOR: A Simple Solution to Build and Protect Your Wealth. His numerous published works has been highlighted on CBNC, CNN, NPR, Motley Fool, WSJ Market Watch, CFA Institute, Institutional Investor, and CBS News. Dr. Gray earned an MBA and a PhD in finance from the University of Chicago and graduated magna cum laude with a BS from The Wharton School of the University of Pennsylvania.