I provide a synthesis of the Behavioural finance literature over the past two decades. I review the literature in three parts, namely, (i) empirical and theoretical analyses of patterns in the cross-section of average stock returns, (ii) studies on trading activity, and (iii) research in corporate finance. Behavioural finance is an exciting new field because it presents a number of normative implications for both individual investors and CEOs. The papers reviewed here allow us to learn more about these specific implications.

Executive Compensation and Investor Clientele Executive compensation has increased dramatically in recent times, but so has trading volume and individual investor access to financial markets. We provide a model where due toalackofsophisticationortonaïveté, possibly arising from high opportunity costs of learning about accounting conventions and financial markets, small investors are unable to decipher true executive compensation accurately. Expected compensation is therefore higher when small investors form a more significant clientele in the market for a firm’s stock. Our model further suggests that increased information asymmetry between large and small traders may deter the entry of small investors and keep executive compensation in check. Technologies that lower the cost of trading facilitate entry of small investors and raise expected compensation. In general, such compensation can be reduced through requirements that increase disclosure transparency. Empirical tests provide support to the key implication of the model that indirect executive compensation is higher in stocks Issues surrounding executive compensation have taken on increased prominence in recent

When agents first become active investors in financial markets, they are relatively inexperienced. We focus on the incentives of economic agents to educate these individuals. A feature of the financial market arena is that the agents best positioned to educate the inexperienced themselves stand to earn trading profits at the expense of inexperienced agents. Owing to this phenomenon, we show that the equilibrium amount of financial education may not fully correct the biases of the inexperienced agents. Thus, biased agents may not be fully educated by those with the best financial knowledge. This result complements hindrances to learning due to the self-attribution bias. With monopolistic delivery of financial education, the equilibrium proportion of educated agents tends to decrease with the profit potential of the information possessed by sophisticated agents, suggesting a policy need to reduce the informational advantage of agents with privileged access to information. On the other hand, in a competitive setting, increasing the variance of information tends to increase the rents from trading The notion that irrational investors may be prevalent in financial markets has taken on increased impetus in recent years. For example, while early empirical studies by Black,

This paper compares the extent to which different irrational behavior patterns explain the momentum effect. I find that price and earnings momentum increase in the average correlation of analysts ’ forecast errors. I argue that these results provide evidence that for my sample of large firms, the momentum effect may be better understood within a framework built on overconfidence about correlated signals than one built on limited attention and gradual information flow. JEL Classification: G12, G14

A behavioral competitive equilibrium restricts households ability to tailor their consumption to the state of the economy. Compared to standard competitive equilibrium, a behavioral competitive equilibrium yields more consumption risk and extreme price volatility when the realized output is near its maximum or minimum.