According to Investopedia, behavioral finance is a relatively new field that seeks to combine behavioral and cognitive psychological theory with economics and finance to provide explanations as to why people make irrational financial decisions. Basically, it’s a fairly new field of study that’s been developed to help us understand some age-old human conditions.
Why is behavioral finance a new field of study when, from time to time, all of us have the propensity to “follow the herd” and make emotional investment and purchasing decisions?
For a while, theoretical and empirical evidence suggested that “rational financial theories” did a respectable job of predicting and explaining certain behaviors (such as buying in when the market for anything [cars, homes, technology]) is overvalued, and then selling when it has bottomed out and will likely go no lower.
However, as time went on, academics in both finance and economics started to find anomalies and behaviors that couldn't be explained by the established fields of study that were available at the time. According to acclaimed financial writer Albert Phung, while these theories could explain certain "idealized" events, the real world proved to be a very messy place in which market participants often behaved erratically. Enter cognitive psychologist Daniel Kahneman, considered the father of behavioral economics/finance. Phung wrote that Kahneman’s research found that, when it comes to markets and economic bubbles, the “fear of missing out” is so powerful it can make otherwise fiscally-conservative people do financially irrational things.Was Kahneman correct? While he has some detractors, the Nobel Committee isn’t one of them. In 2002 it awarded him its highest honor for his work in economics.