The term “behavioural finance” generally refers to a branch of economics that studies the behaviour of financial markets, and its models include psychological principles linked to both individual and social behaviour.

According to some studies, when a numerous group of individuals (or small but influential groups) show patterns of behaviour (prejudices or preconceptions) that diverge from rational expectation, such behaviour may affect the entire market. As already said, behavioural finance bases itself on both social and individual psychology. In fact, cognitive prejudices only have real anomalous effects if there is social contamination with a strong emotional content (eg. collective fear or greed), leading subsequently to behaviour known as “flock behaviour”. If it’s true that feelings like fear and greed have often played a major role in the “hot” moments on the market, it’s equally true that there are other causes of irrational behaviour. One of these is poor judgement of information, ie. cognitive (and therefore perfectly rational) errors that influence investors and their decisions.

Behavioural finance revolves around three cardinal points.

The first is heuristics, whereby all decisions are based on empirical, approximate rules that don’t follow rational analysis but are made instinctively on the basis of past experience.

The second point is context, whereby decisions are influenced by the mode of decision making adopted or, for example, the way a question is asked. The third is the inefficiency of the market, which explains all those situations that would seem contrary to rational explanation and an efficient market, such as mistaken assessments of prices, non-rational decision making processes.

Over the years, experts critical of behavioural finance have tried to show that it is more a study of the market’s anomalies than a real branch of finance. According to them, the market is efficient and in the end every behavioural anomaly is destined to be priced out of the market.