Investor Psychology in Capital Markets: Evidence and Policy Implications

We review evidence that investors make systematic errors, and that psychological biases a ect market prices. We argue that it is likely that mispricing causes substantial misallocation of resources and ineÆcient risk sharing. However, imperfect rationality of asset markets is not a free license for government to try to correct market mispricing ex post. There is no reason to think that regulators, politicians or courts are less subject to bias than are market prices. Detecting and responding to market pricing errors is not the government's relative advantage. There is a case for private and public measures to help investors make better choices and to help investors make the market more informationally eÆcient, such as certain kinds of disclosure and reporting regulations. Especially, the government should avoid actions, such as in ationary or volatile monetary policy, which make investor biases worse.