Economics is a social science, dealing with the behavior of individuals and the results of interactions where money is concerned.
Understanding how human psychology impacts behavior in financial matters and how that behavior affects the markets is a daunting task, but much progress has already been made. Dan Ariely sums up investor behavior quite nicely in his book Predictably Irrational when he says,
Standard economics assumes that we are rational—that we know all the pertinent information about our decisions, that we can calculate the value of the different options we face, that we are cognitively unhindered in weighing the ramifications of each potential choice. We are presumed to be making logical and sensible decisions. If we make a mistake, the supposition is that we will learn from those mistakes and behave differently in the future. However, we are far less rational in our decision making than standard economic theory assumes. Our irrational behaviors are neither random nor senseless—they are systematic and predictable. We make the same types of mistakes repeatedly because of how our brains are wired.
Harvard economics professor Andrei Shleifer, author of Inefficient Markets, states
In short, investors hardly pursue the passive strategies expected of uninformed market participants by the efficient markets theory. . . . Investors' deviations from the maxims of economic rationality turn out to be highly ...