Behavioural Finance: Reflexive and Reflective

The traditional finance theory has been based on the assumption that an investor is a rational being who takes decisions based on full information to maximize his utility. This classical model assumes the market participants are perfectly and fully informed and can make objective decisions in a logical manner for the efficient functioning of financial markets. In practice, however, empirical studies find that investors make irrational investment decisions due to psychological biases, emotions, and cognitive limitation. This area is in the center of Behavioural finance because it deals with the issue of how psychological elements can influence investment decisions and their implications for market results.
Behavioural finance argues against the assumptions of perfect rationality and those of market efficiency. One more crucial conceptual distinction in this space is reflexive versus reflective thinking, two forms of cognition that describe investor behaviour. Reflexive thinking is automatic, fast, and frequently emotive; reflective thinking is slower, more deliberative, and analytical. A basic understanding of these two forms of thinking can prove useful in understanding how investors arrive at decisions, to what kinds of biases they are subject, and how markets perform in the real world.
This article covers the area of Behavioural finance, showing the interaction of reflexive and reflective processes that constitute investment choices. The article should therefore give an overview of the two modes of thinking, how they influence the psyche of an investor, and how these eventually drive market anomalies and inefficiency.