Behavioral finance as an answer to the limitations of standard finance

Abstract

Moving the standard finance theory further away from practice has led to an increased criticism of standard finance. Much evidence in favor of the absence of perfect investor rationality have called for the need of a new approach and a new point of view offered by behavioral finance. Behavioral finance relies on standard finance, supplements its theory and, according to behavioral economists, gradually substitutes it; however, behavioral finance also faces a number of limitations. The aim of this research is to find answers to the question of whether preference should be given to standard or behavioral finance, in terms of finance theory and investment practice. By applying the methods of qualitative economic analysis, it has been concluded that we should strive towards the integrated application of these theoretical frameworks in order to achieve their synergy, exploit the positive and concurrently eliminate the negative aspects. An example of a theoretical approach that reconciles the differences between standard and behavioral finance is Adaptive Markets Hypothesis (AMH), which is given particular attention in the paper and has not been discussed in the literature in the Republic of Serbia thus far.