Rational Finance Theory
Also called Expected Utility Theory, Neoclassical Economic Theory, or Traditional/Modern Finance Theory
The assumptions underlying traditional finance theory have been said to makeHomo sapiens into Homo economicus. Let’s discuss these assumptions.
What are they?
How did it happen that they were adopted by traditional finance theory?
Why are they too limited/limiting?
Solution Preview
Behavioral finance developed under reactions to the limitations of rational and traditional finance theory even though many people assumed that it was developed through isolation. For this reason, this was one of the main assumptions which had rooted in people minds for the last decades until the researchers came up with the main idea concerning the development of rational finance theory. Additionally, many economist assumed that financial markets were not proper markets because they dwelled their knowledge on analogous to casinos (Baker & Nofsinger, 2010). The main reason for this is because many assets were strong-minded by speculative activity. This assumption made many people to ignore financial markets as proper markets in their lives.
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