Explaining Stock Market Crashes: A Behavioral Finance Approach

Abstract

This chapter is devoted to behavioral finance. It sketches the historical development of this field of research which focuses on the impact of behavioral biases on investment decisions. Key bi ases which are relevant for stock market crashes are introduced: availability bias, representativeness bias, herding bias, overoptimism bias, overconfidence bias, anchoring bias and prospect theory. The chapter ends with using these biases for explaining the October 1987 crash.