Behavioral Finance - Asset Prices Predictability, Equity Premium Puzzle, Volatility Puzzle: The Rational Finance Approach

Abstract

In this paper we address three main objections of behavioral finance to the theory of rational finance, considered as “anomalies” the theory of rational finance cannot explain: (i) Predictability of asset returns; (ii) The Equity Premium; (iii) The Volatility Puzzle. We offer resolutions of those objections within the rational finance. We do not claim that those are the only possible explanations of the “anomalies”, but offer statistical models within the rational theory of finance which can be used without relying on behavioral finance assumptions when searching for explanations of those “anomalies”.

Keywords: Behavioral Finance, Rational Finance

JEL Classification: C10, C58, G02, G12, G14