Behavioral Finance  |  JAN 1999

Life Cycle Model Of Crowd Behavior by Henry O. Pruden, Ph.D.

Life Cycle Model Of Crowd Behavior by Henry O. Pruden, Ph.D. For a large part of the past 30 years, the discipline of finance has been under the aegis of the efficient market hypothesis. But in recent years, enough anomalies have piled up, cracking its dominance of the field. As a consequence, the arrival of new thinking to explain market behavior has warranted attention, and its name is behavioral finance. Behavioral finance proponents believe that markets reflect the thoughts, emotions, and actions of normal people as opposed to the idealized economic investor underlying the efficient market school as well as fundamental analysis. Behavioral man may intend to be rational, but that rationality tends to be hampered by cognitive biases, emotional quirks, and social influences. Behavioral finance uses psychology, sociology, and other behavioral theories to explain and predict financial markets. It also describes the behavior of investors and money managers. In addition, it recognizes the roles that varying attitudes play toward risk, framing of information, cognitive errors, self-control and lack thereof, regret in financial decision-making, and the influence of mass psychology. Assumptions about the frailty of human rationality and the acceptance of such drives as fear and greed have long been accepted by students of technical analysis. Indeed, in his Stock Market Behavior: The Technical Approach To Understanding Wall Street, Harvey Krow classified technical analysis in the behaviorist school of thought.

by Henry O. Pruden, Ph.D.