Behavioral Finance is an empirical stream of academic research in finance that observes financial behaviors and tests whether they conform to the rationality hypothesis.

Indeed financial theory was built half a century ago on the assumption of rational decision-makers and its macroeconomic inference, market efficiency.

That framework made possible significant advances regarding the valuation of financial assets. But it also displayed strong limitations. Empirical data has so much been accumulating for thirty years that many researchers finally advocate to abandon those assumptions.

Researchers in behavioral finance conclude with no hesitation that professional and individual investors are not fully rational. Their behaviors display a series of biases of different types (cognitive, emotional and social) and reflect complex risk preferences.

After being overlooked by classic theorists, behavioral finance has then been progressively accepted thanks to a rigorous methodology and valuable insights that connect individual psychology with aggregate market behaviors. The recent development of behavioral valuation models for financial assets should make possible a merger with the classic stream of research in finance.

The usefulness of behavioral finance for market practitioners is straightforward. On the one hand, it helps to analyse one’s own behavior and try to debias it. On the other hand, it enables practitioners to understand the psychological dimension of market movements and cycles and apply adequate asset management strategies.