2025/05/24 by Tariq, Samiha
Decision Sciences · Social Sciences · #Decision-Making and Behavioral Economics #Experimental Behavioral Economics Studies #FOS: Economics and business #Theoretical Economics (econ.TH)
paper · pdf · doi:10.48550/arxiv.2505.18835
openalex publication_date 2025/05/24 · openalex created_date 2025/10/10 · openalex updated_date 2026/07/28
This paper examines the impact of cognitive biases on financial decision-making through a static Bayesian game framework. While traditional economic theory assumes fully rational investors, real-world choices are often shaped by loss aversion, overconfidence, and herd behavior. Integrating psychological insights with economic game theory, the model studies strategic interactions among investors who allocate wealth between risky and risk-free assets. Solving for the Bayesian Nash Equilibrium reveals that each bias distorts optimal portfolios and alters aggregate market dynamics. The results echo Herbert Simon's notion of bounded rationality, showing how biases can generate market inefficiencies, price bubbles, and crashes. The findings highlight the importance of incorporating psychological factors into economic models to guide policies that foster market stability and more informed financial decision-making.