Behavioral Finance Vs Traditional Finance and Bayes' Formula

[pianok]

“Behavioral finance doesnt assume that investors are risk averse, that they adhere to Bayes’ formula, that they act in their own self interest or that they have perfect informtion”.
I was wondering why Bayes’ forumla adheres to traditional finance? And why is it considered not adhering to the behavioral finance? Is it because BF is not based on statistics as is traditional finance?

 

[cpk123]

in traditional finance - you make an adjustment - recalculate probabilities - condtional vs. effective probabilities.
In behavioral finance - the adjustments are made based on behavioral considerations - Emotional and cognitive biases play their part in the adjustments made - but definitely probabilities do not come into the mix.

 

[S2000magician]

pianok wrote:”Behavioral finance doesnt assume that investors are risk averse, that they adhere to Bayes’ formula, that they act in their own self interest or that they have perfect informtion”.
I was wondering why Bayes’ forumla adheres to traditional finance? And why is it considered not adhering to the behavioral finance? Is it because BF is not based on statistics as is traditional finance?

You may be misreading the statement. It says that behavioral finance doesn’t assume that people adhere to Bayes’ formula.
Bayes’ formula is used to update probabilities based on new information. Behavioral finance doesn’t assume that people update probabilities when they get new information.

 

[daharmattan1]

I’d say it also doesn’t not assume that though. But as cpk123 states, it incorporates other factors other than a strict mathematical/rational recalculation of those probabilities

 

[DaRook1e]

Just to add to the previous comments: taking decision based on the Bayes’ Formula assumes that people are not only able to perform complex (yet not for everyone) mathematical calculations but also to have a full access to all relevant information and to act rationally. In fact, people have limited intellectual and calculating abilities which coupled with time constraints on processing information is in line with the assumtptions of the behavioral finance.