This paper was prepared for John B. Taylor and Michael Woodford, Editors

27

markets of the world show greater tendency to move together after the stock market crash

of 1987?  (See von Furstenberg and Jeon, 1989 and King, Sentana and Wadhwani, 1994.)

If we recognize the global nature of culture, there is no reason to assume that these events

have anything to do with genuine information about economic fundamentals.

Concluding Remarks

Since this paper was written in response to an invitation to summarize literature on

behavioral theory in finance, it has focussed exclusively on this topic, neglecting the bulk

of finance literature.  Because of its focus on anomalies and departures from conventional

notions of rationality, I worry that the reader of this paper can get a mistaken impression

about the place of behavioral theory in finance, and of the importance of conventional

theory.

The lesson from the literature surveyed here, and the list of varied behavioral

phenomena, is not that “anything can happen” in financial markets.  Indeed, while the

behavioral theories have much latitude for interpretation, when they are combined with

observations about behavior in financial markets, they allow us to develop theories that do

have some restrictive implications.  Moreover, conventional efficient markets theory is not

completely out the window.  I could have, had that been the goal of this paper, found very

many papers that suggest that markets are impressively efficient in certain respects.

Financial anomalies that intuitive assessments of human nature might lead one to expect

to find, or anomalies one hears casually about, often turn out to be tiny, ephemeral, or

nonexistent.  There is, for example, virtually no Friday the thirteenth effect (Chamberlain

et al., 1991; Dyl and Maberly, 1988).  Investors apparently aren’t that foolish.

Heeding the lessons of the behavioral research surveyed here is not going to be simple

and easy for financial researchers.  Doing research that is sensitive to lessons from

behavioral research does not mean entirely abandoning research in the conventional

expected utility framework.  The expected utility framework can be a workhorse for some

sensible research, if it is used appropriately.  It can also be a starting point, a point of

comparison from which to frame other theories.

It is critically important for research to maintain an appropriate perspective about human

behavior and an awareness of its complexity.  When one does produce a model, in whatever

tradition, one should do so with a sense of the limits of the model, the reasonableness of its

approximations, and the sensibility of its proposed applications.

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