The differences and connections between traditional financial theory and behavioral finance theory

The main contents of behavioral finance:

(1) Decision-making characteristics. Before behavioral finance was proposed, financial research almost never involved individual decision-making behavior. Behavioral finance believes that the decision-making process of behavioral finance entities changes with the nature of the problem and the environment in which the problem occurs. Decision-making characteristics of behavioral finance: ① The preferences of decision-makers are diversified and they seek satisfactory rather than optimal decisions. The preferences of decision makers are changeable and are only formed during the decision-making process; ② Decision makers tend to make decisions based on experience or subjective intuition rather than objective standards and preference information, and their decision-making procedures are personalized and specific , and with emotions; ③ People generally deal with problems not through probability, but through heuristic empirical decision-making rules.

Experience shows that the above decision-making characteristics help explain the behavioral characteristics of investors in the financial market and the changes in the capital market caused by their behavior, such as changes in stock market trading volume and noisy stock prices. , the behavior of investors following leaders and following the herd, etc.

(2) Expectation theory. The famous theoretical model in modern economics on risky decision-making is the "expected utility model". It was formed through strict axiomatic elaboration by Von Neumann and others. Its basic connotation is that decision makers seek to maximize the expected utility formed after weighted valuation. However, this theory has been challenged in a series of gambling choice experiments in experimental economics. The earliest gambling choice experiment was designed by Nobel Prize winner Allais. This gambling choice experiment produced the famous "Allais Paradox" (also known as the "same-outcome effect"), which challenged the expected utility theory. An experimental finding similar to the same-outcome effect is the "same-ratio effect," which means that if the payoff probabilities in a set of gambles are transformed by the same ratio, inconsistent choices will also occur. Like the same-outcome effect, the same-rate effect is also a challenge to expected utility theory. Research shows that many of people's decisions under uncertainty diverge from the predictions of the expectancy effect theory. To provide an explanation, through experimental observations and model design, Kahneman and Tversly proposed the expectancy theory. Expectancy theory is similar to expected utility theory, except that in the weighted sum of individuals maximizing utility, the weight is not equal to probability, and utility is obtained by the so-called "value function" rather than the utility function. The weight is derived from the true probability function. In the true probability, the weight under the minimum probability is 0, and the weight under the maximum probability is 1. That is, people regard extremely unlikely events as impossible, and highly possible events as certain. Between very small and very large probabilities, the slope of the weight function (the weight of the true probability function) is less than 1.

(3) Abnormal changes in stock prices. Behavioral finance believes that modern financial models cannot clearly explain anomalies in the capital market, such as underreaction or overreaction. Therefore, behavioral finance scholars build models to explain inefficient behavior in the market. For example, the BSV model of Barberis, Shleifer, and Vishny explains how the prices of financial assets deviate from EMH when investors believe that the change in returns is a temporary phenomenon. , he failed to adjust his expectations for future earnings in a timely manner, that is, he underreacted; when investors believe that the recent changes in stock prices in the same direction reflect changes in the company's earnings as a trend, and extrapolate this trend, it will lead to Overreaction. The DHS model of Daniel, Hirshleifer, and Subrahmanyam explains the short-term continuity and long-term correction of stock returns. The model believes that investors in the market are divided into two types: uninformation and information. The former does not have judgment bias, and the latter shows overconfidence and ego. There are two biases in judgment: overconfidence leads investors to exaggerate the accuracy of private information in stock value judgments, and self-preference leads to overreaction to private information and underreaction to public information; Hong and Stein's HS model, Explaining underreaction and overreaction, the HS model divides investors in the market into two categories: news observers and momentum traders. When predicting stock prices, news observers do not consider current or past prices at all, but based on Momentum traders base their predictions on a simple function of past historical prices.

Evaluation of behavioral finance theory:

(1) The emergence of behavioral finance has expanded a new perspective and opened up a new field for the study of financial theory. Using the theoretical framework of behavioral finance, you can deepen your understanding of traditional financial theory and further develop related content.

(2) Behavioral finance focuses on the impact of the capital market and product market conditions faced by the enterprise on the financial behavior of the enterprise, that is, the game between the enterprise and the capital market and the product market, making the research on the financial behavior of the enterprise more reality. For example, the common equity financing preference problem among listed companies in my country is attributed by traditional theory to the fact that the actual cost of equity financing is lower than the cost of debt. According to behavioral finance theory, at least some companies choose equity financing because of restrictions on capital market financing conditions.

(3) According to behavioral finance theory, correct investment strategies must take into account the imperfect rationality of investors and the frequent occurrence of abnormal phenomena such as underreaction and overreaction in the capital market.