The Role of Behavioral Finance in Explaining Market Anomalies and Investor Biases

Abstract

Behavioral finance is crucial to understanding financial markets and investor behaviour. Traditional finance models, which assume rational and utility-maximizing investors, fail to explain real-world market oddities and departures from rationality. examines how behavioural finance helps explain these events. Market anomalies, unexplainable return patterns, challenge the Efficient Market Hypothesis and market players' rationality. Using psychology and sociology, behavioural finance examines cognitive biases, heuristics, and emotional aspects that influence financial decision-making. This abstract shows how behavioural finance explains market anomalies including the momentum effect, value premium, and equity home bias. Investor biases, caused by human cognition, frequently lead to poor investing decisions. Cognitive biases including prospect theory, mental accounting, and overconfidence affect asset price and allocation. analyses how social interactions and informational cascades cause market bubbles and collapses via herding behaviour. Behavioral finance extends beyond market abnormalities and biases. This abstract shows how behavioural finance research improves investing strategies and risk management. Behavioral finance has also shaped financial stability policies to mitigate investor biases.