Chapter 20: Ambiguity Aversion and Illusion of Control in an Emerging Market: Are Individuals Subject to Behavioral Biases?
Benjamin Miranda Tabak and Dimas Mateus Fazio INTRODUCTION The traditional financial theory considers individuals as rational, in the sense that they identify and use relevant information and are also able to make optimal decisions. As maintained by Benartzi and Thaler (2002), the definition of rationality is related to the following facts: first, when they receive new information, individuals update their beliefs accordingly; second, considering their beliefs, individuals make decisions that are considered acceptable (consistent with Savage’s expected utility theory; Savage, 1953). Behavioral finance theory proposes that we must consider models in which the agents are not completely rational in order to better understand some financial phenomena. In other words, this theory analyzes what happens when we relax one or both premises of the classical financial theory. With this in mind, Tomer (2007) illustrates behavioral economics by asserting that it is less narrow, rigid, intolerant, mechanical, separate and individualistic than mainstream economics. Besides, Thaler (1994) also recognizes the influence of behavioral effects on decision making. The author affirms that the completely rational and the almost-rational are only two possible profiles for investors in the financial market. Even though the latter attempt to make good investment decisions, in fact they make predictable mistakes owing to the imperfection in the rational process. According to Thaler and Mullainathan (2001), behavioral finance studies in which way economic, sociological and psychological concepts combine so as to explain events in the real economy, where the actions of individuals are not fully rational. In traditional financial theory, on...
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