Investor Irrationality and Self-Defeating Behavior: Insights from Behavioral Finance

The efficient markets hypothesis (EMH) has posited investment decision-makers as rational, utility-maximizing individuals. Cognitive psychology, on the other hand, suggests that human decision processes are susceptible to several illusions: those caused by heuristic decision-making processes, as well as those arising from the adoption of frames. Unfortunately, these heuristics may lead to cognitive illusions that include: representativeness, overconfidence, anchoring, gambler's fallacy, loss aversion, regret aversion, and mental accounting, among others. Behavioral finance proponents argue that heuristic-driven bias and framing effects cause market prices to deviate from fundamental values. This field amalgamates theories from financial economics, psychology, and sociology in an attempt to construct a more “complete” model that incorporates the idiosyncrasies of human behavior in financial markets. This paper argues that understanding of the findings of this research benefits individual investors the most as it seeks to create awareness of the various human biases and the high costs they impose on their portfolios.