A Conceptual Framework of Behavioral Biases in Finance

Abstract

The behavior of financial markets and decisions of individuals are many a time driven by various biases. This can be attributed to the tendency of humans to resort to shortcuts owing to the constraints on time and mental capacity to process unlimited information. Various researchers have made an attempt to classify these biases into various types. But these biases have been viewed in isolation, thereby ignoring the possibility of any interaction or relationship between them. This paper aims to provide a comprehensive view of the behavioral biases by taking into account such interactions and developing a conceptual framework that incorporates the antecedents or causes of the biases and their outcomes or consequences. It also explores the possibility of overcoming some of the biases. It is argued that certain biases reinforce each other. The strength of each bias is a function of several factors like the external environment and presence of other biases in the process. The paper concludes that behavioral biases have been and will continue to influence human judgement. Although it is possible to avoid some of the biases in specific situations, it is not possible to completely eliminate them.