Many concepts in finance and economics are predicated on markets behaving rationally. Unfortunately for economists blogeverywhere, humans can often behave irrationally, thus ruining many predictive models. In response to this apparent failing in what is called the “efficient market hypothesis,” a segment of economics called behavioral finance has emerged in order to explain why irrational behavior happens. Behavioral finance is an intersection of psychology and economics that studies why people behave the way they do when it comes to finances, risk, and other topics.

One aspect of behavioral finance is the exploration of cognitive biases. At its core, cognitive biases are thought patterns that cause people to make poor choices, even when evidence to the contrary is clear. They are thought to be mental leftovers from an earlier part of humanity’s evolution. Continue reading