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Traditional economics assumes that humans make rational decisions within optimally functioning markets, but real human behavior is only partially rational. Behavioral economics has emerged to address phenomena in financial markets that traditional economics cannot explain, such as the herd effect and the small firm effect. This shift challenges assumptions in traditional finance, prompting a reevaluation of human behavior as the cornerstone of economic and financial understanding. This paper delves into behavioral economics, focusing on the loss aversion theory and its emotional impact on economic decision-making. It analyzes market anomalies, including the momentum effect and long-term reversal, revealing how investor emotions can drive market volatility and asset prices deviating from their reasonable values. The framing effect is explored, demonstrating how scenario formulation changes can alter preferences in decision-making. The paper also discusses the endowment effect in the financial market, explaining its existence and its influence on investors' decisions and the overall market. By examining these aspects, the study finds that people's overreaction to market information can behaviorally impact investment decisions, leading to market anomalies and influencing price trends. The insights provided contribute to a more nuanced understanding of behavioral economics and its implications for financial systems.
Leyi Yang (Wed,) studied this question.