Classical financial theory generally assumes investors are rational actors who weigh available evidence and price assets accordingly, which is part of why speculative bubbles are so awkward for that theory to explain — if everyone is rationally pricing in all available information, an asset shouldn't be able to inflate wildly past any defensible estimate of its worth and then collapse. Behavioural finance exists specifically to explain what classical theory struggles with: real markets are made of real people, and real people are systematically, predictably irrational in ways that can build bubbles even when most individuals involved are reasonably smart.
Herd behaviour turns individual judgement into collective momentum
One of behavioural finance's central findings is that investors don't evaluate assets in isolation — they're heavily influenced by what other investors around them appear to believe and do, a tendency known as herd behaviour. When an asset's price is already rising, that rise itself becomes evidence, in investors' minds, that buying is the right call, prompting more buying, which pushes the price up further, reinforcing the same belief in a self-feeding loop. Crucially, this can happen even among individually rational investors: if you believe other investors have private information you lack, following the herd can seem like a reasonable strategy, even though the aggregate effect — everyone following everyone else, with no one actually anchoring to underlying value — is a price divorced from anything the asset could plausibly be worth.
Overconfidence and loss aversion do the rest
Behavioural finance has also documented specific, replicable biases that distort judgement in predictable directions: overconfidence leads investors to overestimate their own ability to pick winners or time markets correctly; loss aversion means people feel the pain of a loss more intensely than the pleasure of an equivalent gain, which shapes decisions about when to sell in ways that don't track a rational expected-value calculation. During a bubble's inflation phase, overconfidence in ever-rising prices can suppress the caution that might otherwise limit speculative buying; when a bubble eventually bursts, loss aversion and panic can drive selling far more sharply and rapidly than the same rational-actor model would predict, turning a correction into a crash.
What we're still unsure about
That herd behaviour, overconfidence, and loss aversion are real, measurable phenomena affecting investor decisions is well supported by decades of behavioural finance research. What remains genuinely contested is how much weight these psychological factors deserve relative to other explanations for specific historical bubbles — some economists argue certain episodes are better explained by rational responses to genuine uncertainty, distorted incentives, or structural market features than by investor irrationality alone, and untangling exactly how much of any given bubble was "irrational" versus a rational response to a genuinely unusual situation remains an active area of disagreement.
This sits inside Behavioural Finance, one of eight topics in Finance, one of five domains in Economics, one of seventeen subjects the app can quiz you on.