Behavioral economics (BE)
Develops and applies psychological insights to economic decision-making.
The findings of BE challenge traditional economic views, which assume that individuals are self-interested, cost-benefit-calculating creatures with stable preferences.
BE holds that:
Our thinking is subject to uncertainty and insufficient knowledge and there are limits to our thinking capacity.
Many of our choices are influenced by emotions and intuition as opposed to reason.
Our behavior is affected by the context in which we make decisions, including the way choices are presented to us.
Our judgments are unconsciously influenced by readily available information in memory, automatically generated feelings, and salient information in the environment.
We live in the moment: we tend to resist change and prefer immediate benefits over future payoffs.
We are social animals with social preferences, such as those expressed in trust, reciprocity, and fairness.
Behavioral finance (BF)
Applies ideas from behavioral economics and psychology to understand financial decisions, and seeks to analyze individual and household behavior, as well as collective outcomes in financial markets.
BF addresses questions such as:
Why do investors tend to sell shares that have increased in price while holding on to those that have lost value?
Why do people assume a stock’s past performance as an indication of future performance?
How and why do price bubbles in financial markets form?