What are the fundamental principles of behavioral finance?

Behavioral finance is fundamentally centered on understanding the psychological factors that influence investor behavior and how these behaviors can subsequently affect market outcomes. This discipline combines insights from psychology and finance to explore why and how people make financial decisions, often deviating from what traditional financial theory might predict.

The significance of choice C lies in its focus on the cognitive biases and emotional responses that can lead investors to make irrational decisions, such as herd behavior, overconfidence, and loss aversion. This insight helps in comprehending market phenomena, especially during periods of volatility or irrational exuberance, which are not adequately explained by purely mathematical or economic models.

In contrast, other choices either misrepresent the scope of behavioral finance or focus on aspects outside its core principles. For instance, the emphasis solely on mathematical models neglects the psychological nuances that drive actual market behavior, while analyzing historical stock price movements does not address the underlying reasons for price changes. Similarly, while economic policies may indeed influence markets, the direct exploration of psychological impacts is what distinctly characterizes behavioral finance. This understanding of human behavior ultimately aids in creating more effective investment strategies and market predictions.