A Technical Approach

Behavioral Finance shares the same basic focus as the Keynesian idea of Castles in the Air.

Behavioral Finance seeks to understand the volatility of the Stock Market from several psychological and sociological standpoints.

The Efficient Markets Theory, which had its greatest dominance around the 1970s, focussed heavily on rational expectations, similar to the Fundamental Approach discussed earlier. This model assumed that "speculative asset prices such as stock prices always incorporate the best information about fundamental values and that prices change only because of good, sensible information meshed very well with theoretical trends of the time." (Shiller, October 2002)

This, idea, of course, gave a sense of forecastability in the stock market and in consumption. (If everyone made completely rational decisions with the best information available, this would give economists a much clearer view of how the financial world works). However, there have been quite a number of anomalies in the model when compared to actual data. In Shiller's work on stock markets, the anomalies found gave rise to a notion of excess volatility in the stock market which placed the efficient market theory on rather shaky ground.