Behavioral Finance and the Psychology of Investment Decisions

Abstract

Behavioral finance challenges the traditional assumption of rational decision-making in financial markets by integrating insights from psychology to understand how investors make financial decisions. This review explores the foundational principles of behavioral finance, key psychological biases, and the role of emotions in investment choices. It also examines how behavioral finance influences market dynamics, investment strategies, and policy interventions designed to improve financial decision-making. By analyzing concepts such as loss aversion, overconfidence, herd behavior, and mental accounting, the study highlights how cognitive and emotional factors contribute to market inefficiencies, speculative bubbles, and financial crises. Furthermore, emerging trends such as neurofinance, AI-driven behavioral insights, and digital nudging are shaping the future of investment behavior. Understanding behavioral finance is crucial for investors, financial advisors, and policymakers aiming to develop strategies that mitigate biases and enhance long-term financial stability.