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.
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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