2. The Rise and Rise of Behavioural Finance

Behavioural finance discards the assumptions of rationality and fair pricing, seeking to explain observed behaviour in financial markets by using the principles of psychology. Irrationality can be attributed to behavioural biases, which are either cognitive or emotional, both of which can lead to poor and irrational financial decisions. Kahneman and Tversky provided the early psychological theories that constitute the foundation of behavioural finance, and they also developed prospect theory that explains loss aversion. Irrationality is readily observable when, for example, people gamble against the odds or accept higher risk for lower return. Behavioural finance seeks to explain irrationality and the presence of market anomalies such as the calendar effects and profitable trading.