{"id":8756,"date":"2020-11-10T00:01:41","date_gmt":"2020-11-10T05:01:41","guid":{"rendered":"http:\/\/www.jasonapollovoss.local\/?p=8756"},"modified":"2020-12-14T12:44:23","modified_gmt":"2020-12-14T17:44:23","slug":"a-theory-of-behavioral-finance","status":"publish","type":"post","link":"https:\/\/jasonapollovoss.com\/web\/2020\/11\/10\/a-theory-of-behavioral-finance\/","title":{"rendered":"A THEORY OF BEHAVIORAL FINANCE"},"content":{"rendered":"

Over the summer I authored a series of articles that were deep dives into the major behavioral biases. I promised that these pieces would culminate in a theory of behavioral finance. Then business intervened. I was inordinately busy. My apologies. Without further adieu\u2026 A Theory of Behavioral Finance.<\/span><\/p>\n

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The Modern Paradigm<\/strong><\/span><\/p>\n

A criticism of behavioral finance is that it lacks an overarching theory.[i]<\/span><\/a> Namely, that it is just a long list of quirks and oddities logged by scientists about human behavior, but without an explanation for why they exist. Furthermore, a lack of a theory limits behavioral finance from making specific predictions about future outcomes. In turn, this means that behavioral finance is just short of being a science. This work seeks to rectify this situation and to have behavioral finance replace the failed investment paradigm of Modern Portfolio Theory (MPT).<\/span><\/p>\n

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What constitutes a theory?<\/strong><\/span><\/p>\n

Theories are analytical tools for understanding, explaining, and making predictions about a given subject matter.[ii]<\/span><\/a> In science a theory must have the following characteristics:[iii]<\/span><\/a><\/span><\/p>\n

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  1. It makes falsifiable predictions with consistent accuracy across a broad area of scientific inquiry.<\/span><\/li>\n
  2. It is well-supported by many independent strands of evidence, rather than a single foundation.<\/span><\/li>\n
  3. It is consistent with preexisting experimental results and at least as accurate in its predictions as are any preexisting theories.<\/span><\/li>\n<\/ol>\n

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    In the above list, note the importance of predictions to the necessary conditions for an analytical tool to be considered a theory. The dominant paradigm framing investing currently is Modern Portfolio Theory. But despite a deep search it is not clear what MPT is supposed to be predicting.<\/span><\/p>\n

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    Based on my experience I can posit that MPT\u2019s primary predictions are:<\/span><\/p>\n

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