Why are irrational decisions made? : Distortions, heuristics and neurofinance

Abstract

The objective of this study is to analyse how emotions, cognitive distortions and social impacts shape financial decisions questioning the traditional view suggesting people act rationally. While classical theories emphasise logics and expected outcome, behavioural economics and neurofinance have demonstrated that decisions are also impacted by mental shortcuts, emotional distortion or even evolutional aspects. The study discusses concepts such as bounded rationality, the prospect theory, as well as a wide range of cognitive distortions due to information overload, emotional reasons or afterthought. In the analysis, the distortions are classified into four main categories: distortions caused by limitations of cognitive capacity, distortions originating from emotions and psychological inclinations, distortions changing past events and distortions shaped by social dynamics. Distortions are not ad hoc; they are conscious and find their origins in how information is processed. To understand them may help both individuals and organisations to make better financial decisions. Improved awareness may lead to better judgement and more stable long-term financial results.

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