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SYSTEMATIC ANALYSIS OF DEPARTURES FROM THE HOMO OECONOMICUS PARADIGM ARE ESSENTIAL FOR REALISTIC FINANCIAL RESEARCH AND ANALYSIS.
Hubert Fromlet is a senior vice president and chief economist at Swedbank in Stockholm, Sweden. He is also a professor of international economics at the Blekinge Institute of Technology. He holds a Ph.D. from the University of Wurzburg, Germany. He formerly worked at SAAB-Scania and Swedish Co-operative Banks.
Behavioral finance has the potential to be a valuable supplement to classical and neoclassical financial theory, which currently dominates financial analysis. It considers psychological factors as important input to financial analysis and decisions and is gaining increasing momentum in academic research and practical application in the U.S. and Europe. Behavioral finance explains many reactions on financial markets that appear to be contrary to conventional theory and can thus make an important contribution to avoidance of serious mistakes and to finding investment strategies. It also can make a contribution to improved asset performance-but it can hardly pick single winners on the market, despite some interesting approaches.
Anomalies in financial markets are of interest and importance to economists in finance and other sectors. They affect fundamental decisions and make decisions that appear to be sound turn out badly and vice versa. For example, for several years there has been intense media interest in technology stocks. Most of that time, as we know in retrospect, there was a positive bias in media assessments.
Also, in Swedish newspapers and among economists there is an on-going debate concerning the weakness of the Swedish currency, the crown. In early 2001, as this paper was being written, the crown was weaker than it had been for years--despite large surpluses in the government budget, a positive balance on current account, plus higher Swedish growth and lower inflation rates than in the twelve European Monetary Union countries. Thus, weakness of the crown does not look rational for a fundamentally oriented analyst.
Is there a change of economic rules under way that has not yet been incorporated into the analysis of financial markets? Is there a need of a supplementary economic and financial theory? This article explores some of the issues in financial markets that can be addressed by "behavioral finance," an emerging field that takes explicit...