The Journal of Behavioral Finance & Economics- JBF&E

Members of the Academy of Behavioral Finance & Economics (ABF&E)

Advances in Financial Decision Making: In Search of a New Paradigm

James Howard
University of Maryland University College

Abstract

         This paper will employ a model comprised of five components (Rules of Thumb/Heuristics, Rational Being/Theory, Cognitive Psychology/Behavioral Finance, Neuroscience, and the Unconscious Mind) for conducting a qualitative meta-analysis of the current state of financial decision making behavior. Early financial decision making was not supported by any formal theory until Irving Fisher's Theory of Interest in 1907. While the field of management was making strides early in the 20th century, finance remained primarily an experiential field dominated by rules of thumb until the late 1940s. The development of expected utility theory ushered in the golden age of theoretical finance as academics borrowed concepts from economics and the physical sciences to support Modern Portfolio Theory, the Capital Asset Pricing Model, Option Pricing Theory, and so forth. The failure of theory to explain why individuals do not behave as theory predicts they should has stimulated interest in developing progressively better paradigms. From the early 1970s, this search has focused on contributions from cognitive psychology and neuroscience in making significant strides in understanding financial decision making behavior and why observed behavior deviates from theory. The resulting time series analysis will clarify the overlaps and the ascendency and decline of the relative influence of each paradigm over time. A major goal is to better understand how we arrived at our current state of knowledge and to provide an assessment of the sources of future contributions and strategies likely to be major contributors to our growing knowledge of financial decision making in the future.

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