The contrast between traditional and behaviour finance is very important concept to understand in finance .

Traditional Finance

Traditional finance is built on the assumption that investors are rational and Markets are efficient .

Specifically Investors are :

1. Rational

2. Self interested and utility maximizing

3. Holds optimal portfolios . Optimal portfolios are mean variance efficient

4. Processes information without biases

5. Risk averse

Markets are :

1 . Efficient which means the prices reflect all available information.

Behavioural finance

Behavioural Finance is based on observed investor and market behaviour. It attempts to explain both .

One of the main concepts of Behaviour Finance is that investor biases affect financial decisions . Another is that markets are always not efficient!

Some behaviour finance concepts :

1. Bounded rationality vs perfect information and rationality

2. Prospect theory ( loss aversion ) vs Utility maximizing theory ( risk aversion) .

3 . Discount rate should include a sentiment risk premium

4. Portfolios are constructed in layers to satisfy investor goals vs optimal portfolios