How does behavioral finance differ from traditional finance?

Behavioral finance distinguishes itself from traditional finance primarily through its incorporation of psychological theories to better understand investor behavior. Traditional finance often relies on the assumption that all market participants are rational and make decisions solely based on available information to maximize utility. It typically emphasizes mathematical models and statistical analyses to predict market movements and optimize investment decisions.

On the other hand, behavioral finance recognizes that investors are influenced by cognitive biases, emotions, and social factors, which can lead to irrational decision-making and market anomalies that traditional models may not fully account for. By including these psychological aspects, behavioral finance provides a more comprehensive view of financial markets and investor behavior, allowing for insights into why markets may deviate from expected rational outcomes. This focus on the intersection between psychology and finance offers a richer understanding of how individuals actually behave in real-world scenarios.