A Case for Theory-Driven Experimental Enquiry

Abstract

We argue that finance theorists and practitioners need to examine the reasons behind a seeming anomaly. The behavioral anomalies in the finance literature can be classified as price and return effects, volume and volatility effects, time-series patterns, and miscellaneous effects. For each category, the empirical literature offers a multitude of explanations. Our main thesis is that theory-driven experimental analysis will allow clarification among competing explanations and should complement existing empirical paradigms. We present a theoretical information-processing framework for examining the psychology of financial decision making. The framework comprises both cognitive and motivational antecedents of bias in financial decision making and provides a grounding for many behavioral anomalies noted in the literature. To illustrate use of the model, we examine financial decision-making biases in the choice between underpriced (value) and overpriced (glamour) stocks.

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