The Rational-Behavioral Debate in Financial Economics
Journal of Economic Methodology, 11:4, 393–409 December 2004
17 Pages Posted: 14 Jul 2004 Last revised: 18 Feb 2019
The contest between rational and behavioral finance is poorly understood as a contest over "testability" and "predictive success." In fact, neither rational nor behavioral finance offer much in the way of testable predictions of improving precision. Researchers in the rational paradigm seem to have abandoned testability and prediction in favor of a scheme of ex post "rationalizations" of observed price behavior. These rationalizations, however, have an unemphasized relevance for behavioral finance. While behavioral finance advocates may justly criticize rationalizations as unlikely to lead to a science of financial economics with improving predictive power, rational finance's explanatory power plays a key role supporting the limits of arbitrage arguments that make behavioral finance possible.
Keywords: Raional Finance, Behavioral Finance, Economic Methodolology
JEL Classification: B41, G12, G14
Suggested Citation: Suggested Citation