Modern Finance vs. Behavioural Finance: An Overview of Key Concepts and Major Arguments

Abstract

Modern Finance has dominated the area of financial economics for at least four decades. Based on a set of strong but highly unrealistic assumptions its advocates have produced a range of very influential theories and models. Nonetheless, in the last two decades a new academic school of thought has emerged that refutes the key assumption of a homo economicus; an assumption that represents the cornerstone for the development of the theory of efficient markets. The first empirical evidence against efficient markets in the mid-eighties signalled the beginning of a fierce debate between these two schools of thought. This paper gives an overview of the key arguments of these two distinctive academic doctrines.

Keywords: Behavioural Finance, Modern Finance, Efficient Market Hypothesis, Overreaction Hypothesis, Underreaction Hypothesis, Investors' Overconfidence

JEL Classification: B13, G14