BEHAVIORAL FINANCE AS A WAY OF EXPLAINING MARKET ANOMALIES: TEACHINGS FROM THE GAMESTOP SAGA.

By allowing people and legal entities to invest in companies on the stock market, financial markets facilitate the allocation of capital and have the power to improve or worsen a country’s as well as the world’s economy. Investment decisions made on one side of the world can have a significant effect on people and businesses living elsewhere, even in other continents, as the devastating global financial crisis of 2008 has demonstrated. It has thus become crucial - especially for regulatory purposes – to comprehend the factors that influence investment decisions, a field in which behavioral studies serve as an effective tool. Behavioral finance is a unique and fast growing field of finance that uses psychology and sociology studies of individuals and their underlying motivations to <<understand the observable, systemic and human departures from rationality>>. One of the key aspects of this approach is the identification of cognitive and emotional biases that can lead investors in making irrational decisions. These decisions are ultimately the cause of anomalies in the stock market. Contrary to the assumptions of traditional finance, which assume that investors are rational and make decisions based on all available information, behavioral finance recognizes that investors are subject to certain behaviors and biases that affect investment decision-making for the worse. This thesis will indeed provide an opposite perspective to the disproportionate rationality and efficiency hypothesized by neoclassical economic theories. On one hand these theories have managed to accurately describe trends of the stock market and economy, but on the other they failed at explaining the causes of certain phenomena, namely market bubbles and crashes. In fact, evidence shows that many assumptions and findings of traditional finance are invalid. An example of this is the efficient market hypothesis, according to which stock prices reflect all available information. But what if the information itself is humanly difficult to collect and is not available to all, but only to a selected few? In the real world, investors do not have equal access to all available information, as some of it, at least for a while, always remains private or almost impossible to obtain. Even though it is illegal for executives and directors to buy and sell stock of their firm based on proprietary information not available to the investing public, studies have shown that identifying and prosecuting insider trading is challenging due to the subtle distinctions between what is and isn’t legal. Although behavioral finance certainly has the potential to explain why market anomalies exist, the objective of this thesis is not to present it as a replacement for conventional finance. The qualitative analysis that will be presented in the form of social and psychological studies is to be used as a support to the analytical tools of quantitative finance. Therefore the objective of this research is to provide additional evidence and help in giving a rational explanation as to why these irrational capital market events happen. In doing so a specific case study will be presented, the 2021 GameStop bubble.