From Perfection to Psychology: Reconciling Mathematical Financial Models with Investor Behaviour

This research examines how the notion of rationality has developed and been applied within the contrasting frameworks of traditional and behavioural finance. Traditional finance is grounded in the idea of fully rational agents who maximize utility in efficient markets, whereas behavioural finance challenges this view by asserting that actual decision-making is shaped by bounded rationality. The paper conducts an in-depth analysis of key theoretical foundations and empirical evidences to trace the transformation of the rational investor from a strictly logical, model-driven figure into a more realistic, psychologically influenced decision-maker. The research highlights that cognitive limitations, psychological biases, and emotional triggers often lead market participants to rely on heuristics, resulting in systematic errors and market anomalies that classical models fail to explain. Ultimately, the research concludes that rationality serves as a multidimensional bridge between human cognition and effective financial action. By synthesizing these opposing frameworks, the study provides a more holistic foundation for future financial modelling and offers practical insights for investors and advisors to enhance risk management and long-term wealth preservation.