European Financial Management, Vol. 14, No. 1, 2007, 12–29 doi: 10.1111/j.1468-036X.2007.00415.x

Behavioural Finance: A Review and Synthesis
Avanidhar Subrahmanyam
Anderson Graduate School of Management, University of California at Los Angeles, USA E-mail: subra@anderson.ucla.edu

Abstract

I provide a synthesis of the Behavioural finance literature over the past two decades. I review the literature in three parts, namely, (i) empirical and theoretical analyses of patterns in the cross-section of average stock returns, (ii) studies on trading activity, and (iii) research in corporate finance. Behavioural finance is an exciting new field because it presents a number of normative implications for both individual investors and CEOs. The papers reviewed here allow us to learn more about these specific implications.
Keywords: behavioural finance, market efficiency, cross-section of stock returns JEL classifications: G00, G10, G11, G14, G31, G32, G34
1. Introduction

The field of finance, until recently, had the following central paradigms: (i) portfolio allocation based on expected return and risk (ii) risk-based asset pricing models such as the CAPM and other similar frameworks, (iii) the pricing of contingent claims, and (iv) the Miller-Modigliani theorem and its augmentation by the theory of agency. These economic ideas were all derived from investor rationality. While these approaches revolutionised the study of finance and brought rigour into the field, many lacunae were left outstanding by the theories. For example, the traditional models have a limited role for volume, yet in actuality, annual volume on the NYSE amounts to somewhere in the region of 100% of shares outstanding. Second, while the benefits of diversification are emphasised by modern theories, individual investors often hold only a few stocks in their portfolios. Finally, expected returns