Much of modern financial economics works with models in which agents are fully rational, in that they maximize expected utility and use Bayes' law to update their beliefs. Behavioral finance is a large and active field that develops and studies models in which some agents are less than fully rational. Such models have two building blocks: limits to arbitrage, which makes it difficult for rational traders to undo the dislocations caused by less rational traders; and psychology, which provides guidance for the kinds of deviations from full rationality we might expect to see. We discuss these two topics and consider a number of applications: asset pricing; individual trading behavior; the origin of bubbles; and financial crises. Not offered 2022-23.
The online version of the Caltech Catalog is provided as a convenience; however, the printed version is the only authoritative source of information about course offerings, option requirements, graduation requirements, and other important topics.