THE RATIONAL-

BEHAVIORAL
DEBATE IN
FINANCIAL
ECONOMICS
P R E S E N T E D B Y:

AMBIKA SINGH
A A S H I H A L D I YA
SHAKTI SINGH TOMAR
P R A G YA G I G O O
TOPIC HIGHL IGHT S 01
OUTLINE
• Introduction
• The Nature of Rational Finance
• The Relevance of Rational Finance
• Conclusion
INTRODUCTION - EVALUATION OF
THE RATIONAL-BEHAVIORAL 02
DEBATE

In defending their “Ex-post explanatory

Despite its limited success
approach and in attacking power” refers to the
in terms of testability and
behavioral finance, ability of a model or
prediction, rational finance
researchers in the rational theory to provide
enjoys a hidden relevance to
finance paradigm argue explanations for events
behavioral finance.
that they hold the high or outcomes that have
ground of testability and already occurred.
predictive power
03 • P R E D IC T IO N S A N D T E S T S A R E
C E N T R A L IN R AT IO N A L F IN A N C E .
• M ILTO N F R IE D M A N ' S
IN S T R U M E N TA L IS M V IE W S T H E O R IE S
A S P R E D IC T IV E TO O L S .
• A T R A D E -O F F IS P R O P O S E D ,
S A C R IF IC IN G C A U S A L
U N D E R S TA N D IN G F O R P R E D IC T IO N .
• "P R IM E D IR E C T IV E " P R E F E R S
R AT IO N A L E X P L A N AT IO N S U N L E S S
IR R AT IO N A L IT Y FA IL S .
• A C H IE V E M E N T S L IK E "N O A R B IT R A G E "
FA C E S K E P T IC IS M IN R E A L -W O R L D
THE NATURE OF A P P L IC A B IL IT Y.
RATIONAL
FINANCE
04 • R AT IO N A L F IN A N C E V S . B E H AV IO R A L
F IN A N C E :
• IN T E R C O N N E C T E D N E S S O F R AT IO N A L
A N D B E H AV IO R A L F IN A N C E :
• A R B IT R A G E A N D M IS P R IC IN G :
• IN V E S TO R B E H AV IO R A N D A R B IT R A G E
C O N S T R A IN T S :
• IN A B IL IT Y TO C O N V IN C E R AT IO N A L
IN V E S TO R S :.
• R E L E VA N C E O F R AT IO N A L F IN A N C E IN
B E H AV IO R A L F IN A N C E :
• R E A L -W O R L D E X A M P L E S A N D IM PA C T:
THE RELEVANCE
OF RATIONAL
FINANCE
04
• S UP ERI ORI TY OF VALUE
S TRATEGI ES

• BEHAVI ORAL FINANCE PERSPECTIVE

• LI MI TS TO ARBITRAGE

• ROLE OF RATI ONALIZATION

• LI MI TS BEYOND RATIONALIZATION

THE RELEVANCE
OF RATIONAL
FINANCE
PHILOSOPH IC A L C O N TEST
CONCLUSION
Ongoing debate between rational and behavioural finance

R ATIO NA L PA R A D IG M C R ITIQ U E

Use of ambiguous irrationality assumptions without

rigorous mathematics.
These models lack novel, testable predictions in
financial market behaviour.
B EHAVIOR AL PAR ADIGM CRITIQUE

Lack of meaningful predictive successes.

CONCLUSION
Inability to identify measurable economic variables.

M ODELING FLE XIB IL ITY ACCUSATIONS

Mutual accusations of excessive modeling flexibility.

DEB ATE OVER TE STAB ILITY AND

PR EDICTION

Accusations of the other failing to commit to these goals, leading

to a complex and often obscured debate.
THANK YOU