Reforming Investor Protection Regulation: The Impact of Cognitive Biases

Abstract

A large body of empirical and experimental literature provides convincing evidence of the complexity of individual and institutional investor behavior in market environments. This complexity raises serious questions regarding the effectiveness of current systems of investor protection regulation, which are largely based on the rational investor model. This chapter considers the whole spectrum of cognitive biases that affect investor decision-making and the impact of investor behavior on market welfare. It also highlights the failure of current systems of investor protection regulation to devise techniques capable to counter the distorting impact of cognitive biases. In order to enhance the credibility of the behavioral critique, the chapter proposes a realistic and workable framework for reform, which, if implemented, would lead to effective debasing.

Keywords: Behavioral Law and Economics, Financial Markets, Behavioral Finance, Investor Protection Regulation

JEL Classification: G18, G28, K22