The rational-behavioral debate in financial economics

The contest between rational and behavioral finance is poorly understood as a contest overtestability' 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.

Duke Scholars

Author Alon Brav Fuqua School of Business

Author Alexander Rosenberg Philosophy