How human behavior creates investment opportunities

Behavioral finance shines a spotlight on how psychology influences investor behavior which in turn has an impact on financial markets. This plays an important role in explaining factor premiums and assessing the extent to which they will be sustainable in the long run. This school of thought proposes that investors are not fully rational in their actions, but instead allow their decisions to be influenced by emotions that can be the source of behavioral biases. It is therefore important to gain an understanding of these cognitive tendencies as they help to explain why markets are inefficient, and why factor premiums such as low volatility, momentum, quality and value exist.