Based on the conventional financial theory, the participants and the economic agents around the world are considered to be rational wealth maximizer. However, there are several instances which would involve emotions and psychology in terms of decision making. The emotional and psychological engagement sometimes influences economic agents to behave unpredictably and irrationally. Behavioral finance is considered to be the new field which combines the aspect of behavior and cognitive psychological theory and associates this with the conventional economics and finance. The aim of the behavioral finance is to evaluate the reason behind the irrational financial decisions made by the people. The focal point of the behavioral finance is determining the irrational systematic errors of the market participants in comparison with the rational market participants (Andrikopoulos, 2005). These errors tend to affect the prices and returns within the market causing market inefficiencies. The study of behavioral finance takes into consideration of those participants that take advantage of market inefficiencies. The behavioral finance has been surpassing the aspects of modern and conventional finance. The modern finance generally focuses on the study of the investments and investigates into the dynamics of assets and liabilities. The focus of the conventional and modern finance had never been on the aspects of emotions and psychology. The modern finance, therefore, could never formulate and justify the reason behind the irrational behavior of the market participants. Over the last four decades, the modern finance has been dominating the area of financial economics. Although the conventional finance has produced different influential models and theories, the new academic school of thought has paved the path for behavioral finance. The trade-off between the two schools of thought has signaled the beginning of the fierce battle. However, theorists are of the view that the behavioral finance is at odds with the modern finance.
This is the efficient frontier in which the set of the efficient portfolio is considered to yield the highest return at the lowest possible risk. This is the phenomenon through which the portfolio managers are able to maximize the returns and thereby mitigate risks.
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