BEHAVIORAL FINANCE: INTEGRATION WITH CLASSICAL THEORIES FOR EFFECTIVE MANAGEMENT OF INVESTMENT DECISIONS

Abstract

This article explores the role of behavioral finance in modern financial science, highlighting its practical value, potential applications, advantages, and limitations. The study critically examines key behavioral theories, including prospect theory, investor behavior in stock markets, noise trading theory, and the influence of psychological traits on trader performance. These theories aim to explain the irrationality observed in financial decision-making and its implications for market dynamics, while challenging the fundamental assumptions of classical financial theories. The study emphasizes that behavioral finance, despite its achievements, should not be seen as an independent alternative to classical finance. Instead, it complements traditional financial models by incorporating psychological and behavioral factors into the analysis of market behavior. Behavioral finance provides tools for understanding the cognitive biases, emotional influences, and heuristics that often lead to deviations from rational decision-making. This perspective improves the ability to explain market anomalies such as bubbles, panic selling, and overconfidence, which classical theories struggle to address. In addition, the study highlights the challenges of applying behavioral finance theories in practice. Unlike classical finance theories that offer quantitative models and algorithms for decision-making, behavioral finance lacks universal methods for predicting market outcomes or developing optimal investment strategies. Its findings are largely descriptive in nature and focus on understanding investor behavior rather than prescribing actionable solutions. However, integrating behavioral finance with classical models can help investors develop more adaptive strategies that take into account their own biases and psychological traits. In summary, behavioral finance enriches classical finance theories by incorporating psychological and behavioral aspects into the financial decision-making process. While it does not replace traditional approaches, it serves as an additional basis for addressing the complex conditions of modern financial markets. Using knowledge from behavioral finance, investors and financial professionals can develop more reliable strategies that respond to both market realities and human tendencies.