What is the main difference between behavioral finance and traditional finance?

First of all, their theoretical basis is different.

Investor's rationality and market efficiency hypothesis constitute the two theoretical cornerstones of traditional finance, while behavioral finance has different theoretical foundations.

(1) The traditional financial theory holds that investors are rational and profit-seeking, that is, they seek to maximize benefits in the capital market through arbitrage pricing theory, modern portfolio theory, capital asset pricing model and option pricing theory. Value perception refers to investors' mentality and emotions in the capital market. Behavioral finance believes that investors have four kinds of mentality and emotions in the investment process: overconfidence, pursuing advantages and avoiding disadvantages, pursuing fashion and conformity, reducing regret and shirking responsibility. It is precisely because these attitudes and emotions dominate the investment decision-making process of economic actors that their decision-making has the following characteristics: the behavior of decision-makers is diverse and changeable, and it is usually only formed in the decision-making process; Decision makers have strong adaptability, and the nature and environment of decision-making will have an impact on the procedures and methods of decision-making. Decision makers prefer the principle of satisfaction to the principle of optimization. People usually make decisions that do not follow the optimal model in the sense of mathematical finance, that is, the irrationality of investors' feelings based on value relative to traditional finance constitutes one of the theoretical foundations of behavioral finance.

(b) Whether the market competition is effective.

Traditional financial theory holds that in the process of market competition, rational investors can always seize the arbitrage opportunity created by irrational investment, which makes irrational investors lose their wealth in market competition and eventually be eliminated by the market. Behavioral finance believes that the insufficient disclosure and asymmetry of information held by rational investors and irrational investors make people dissatisfied with the above assumptions. Therefore, market competition is inefficient, which constitutes another theoretical basis of behavioral finance.

Second, the risk measurement methods of the two decisions are different.

The measurement of financial market risk is to measure the value loss of financial assets caused by adverse changes in market factors. The mainstream method is described by the probability distribution of financial assets' income, and the VAR (Value At Risk) method is usually used to measure the possible loss under a certain probability level (confidence level).

VAR, also known as value at risk, refers to the maximum potential loss of any financial instrument or portfolio in a certain period of time in the future under a given probability condition. Mathematically, the VAR method is expressed as the profit and loss distribution of investment tools or portfolios, and its expression is: prob (vPvt [-var] = a (1), where vPvt represents the market value change of portfolio p with confidence (1- A) during the holding period of vt. Equation (1) shows that under a, the loss value is greater than or equal to VAR.

Behavioral financiers believe that in practice, investors often regard the results greater than the initial capital as risks, while those less than the initial capital as real risks. Therefore, in the utility function of investors, the negative utility brought by losses is often given greater weight, while the positive utility brought by gains is given less weight. However, the traditional financial description method using standard deviation and covariance gives the same weight to the above-average investment results and the below-average investment results, which is not realistic and can not really explain the risks of investors. Furthermore, from the psychological feelings of investors, behavioral finance uses the probability that the actual value of a variable is less than the average value of a variable or the safe value considered by the subject of an objective function (or a value that can maintain its own utility as good as the current situation) to represent risks. The form of this risk measurement method is: prob (w [s] [a (2) where w stands for wealth, s is the level of wealth that can maintain the current utility (w and s can also be represented by x and E (X) respectively), and a is the predetermined probability of investors. It can be seen that this method is a risk measurement method that pays more attention to investment losses.

It should be noted that vPvt and VAR in equation (1) are relative quantities (differences), and w and s in equation (2) are absolute quantities. When the value of VAR is the difference between the asset value and the average value of variables or the wealth level that maintains the current utility, two different risk measurement methods of traditional finance and behavioral finance will get the same result.

Third, the difference between the two decision-making models.

The main theoretical models of traditional finance include option pricing model, capital asset pricing model (CAPM) and so on. Behavioral asset pricing model (BAPM) is an extension of modern capital asset pricing model. Unlike CAPM, in BAPM, investors are not all rational, but are divided into two categories: information traders and noise traders. Information traders are rational investors, and they strictly follow CAPM. They are not affected by cognitive bias, but only pay attention to the mean and variance of the portfolio. Noise traders who don't act according to CAPM will make all kinds of cognitive bias errors and have no strict preference for mean variance. These two types of traders interact with each other, and both * * * determine the asset price. When the current trader is a representative trader, the market is efficient; When the latter becomes a representative trader, the market is inefficient. In BAPM, the expected return of securities is determined by its/behavior β0, which is the tangent slope of/mean-variance efficient portfolio 0. Here, the effective combination of mean variance is not equal to the market portfolio in CAPM, because the current securities prices are affected by noise traders. In addition, BAPM also makes a comprehensive study on the return analysis, risk premium, term structure and option pricing of market portfolio in the presence of noise traders. In terms of market behavior model, there are two models with great influence in behavioral finance: DHS (Daniel, Hirschleifer and Subra-Manyam, 1997) model and BSV (Barberis, Shlerfer and Vishny, 1998) model. The former divides investors into those with information and those without information, and analyzes them from this perspective. The theoretical basis of the latter is that investors believe that there are two paradigms of income, namely, the return of average income and the continuous change of income. Although DHS model and BSV model are based on different behavioral premises, their conclusions are similar, and they all think that investors' behavior will lead to overreaction or lagging reaction of stock prices.