Inclusion Of Psychological Factors In Financial Theories: Transformation From Traditional Finance To Behavioral Finance

Abstract

A rational investor and rationality are basic models to provide understanding of financial market in traditional financial theories. In the traditional finance theory, rationality means well known about the ideas and information of market and act according to the standardized act on the basis of this market information. Market crises, anomalies of the financial markets are some of those incidents which was not explained by traditional financial theories. Traditional finance foundation is mainly based on efficientmarket concept(EMH), investor rationality concept and the modern portfolio theory (MPT)developed by Markowitz. But till1990 the traditional finance theories were not so been challenged. Market anomalies discard the concept of rationality of investors and questioned the traditional financial theories since mid-1990s.this resulted in the emergence and development of a new paradigm that is behavioural finance. In this paper an attempt has beenmade to highlight the criticism of the traditional finance theories as pointed out by behavioural financesupportersandalsoadiscussiononthe significanceofbehaviouralfinance.