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Why Rational Markets Still Produce Irrational Investors: A Behavioral Finance Study of India's Retail Investing Boom
Subject area: Management and Commerce · Area of research: Finance
DOI: https://doi.org/10.64388/IREV10I2-1720312
Abstract
Financial theory has long rested on the premise that markets are efficient — that prices absorb available information quickly and fully, leaving little room for investors to profit from anything other than genuine risk-taking. Yet the same markets built on this premise regularly produce bubbles, panics, herd-driven rallies and stubborn mispricings that persist far longer than rational expectations would predict. This article examines why the Efficient Market Hypothesis and the observed behaviour of real investors so often diverge. It surveys the theoretical foundations of market efficiency alongside the behavioural finance literature that has emerged to explain its recurring failures, drawing on cognitive biases such as overconfidence, loss aversion, anchoring, herd behaviour and confirmation bias. The article argues that markets can be informationally efficient in aggregate while still being populated by individually irrational participants, since price-level efficiency depends on the errors of many investors cancelling out rather than on each investor behaving rationally. Where errors are correlated rather than random — as they are during herding episodes, speculative manias or panic-driven sell-offs — this cancellation breaks down and prices depart from fundamental value for extended periods. The discussion concludes that reconciling rational-market theory with investor psychology requires treating efficiency as a contested, self-correcting process rather than a fixed state, and that recognising predictable behavioural patterns offers both a caution to individual investors and a tool for those designing markets and regulation.
Keywords
Efficient Market Hypothesis, Behavioural Finance, Investor Psychology, Cognitive Bias, Herd Behaviour, Prospect Theory, Market Anomalies
How to cite this paper
@article{1720312,
author = {Varun Gouda T H, Soumya Chikkagoudra},
title = {Why Rational Markets Still Produce Irrational Investors: A Behavioral Finance Study of India's Retail Investing Boom},
journal = {Iconic Research And Engineering Journals},
year = {2026},
volume = {10},
number = {2},
pages = {460-464},
issn = {2456-8880},
url = {https://www.irejournals.com/formatedpaper/1720312.pdf},
abstract = {Financial theory has long rested on the premise that markets are efficient — that prices absorb available information quickly and fully, leaving little room for investors to profit from anything other than genuine risk-taking. Yet the same markets built on this premise regularly produce bubbles, panics, herd-driven rallies and stubborn mispricings that persist far longer than rational expectations would predict. This article examines why the Efficient Market Hypothesis and the observed behaviour of real investors so often diverge. It surveys the theoretical foundations of market efficiency alongside the behavioural finance literature that has emerged to explain its recurring failures, drawing on cognitive biases such as overconfidence, loss aversion, anchoring, herd behaviour and confirmation bias. The article argues that markets can be informationally efficient in aggregate while still being populated by individually irrational participants, since price-level efficiency depends on the errors of many investors cancelling out rather than on each investor behaving rationally. Where errors are correlated rather than random — as they are during herding episodes, speculative manias or panic-driven sell-offs — this cancellation breaks down and prices depart from fundamental value for extended periods. The discussion concludes that reconciling rational-market theory with investor psychology requires treating efficiency as a contested, self-correcting process rather than a fixed state, and that recognising predictable behavioural patterns offers both a caution to individual investors and a tool for those designing markets and regulation.},
keywords = {Efficient Market Hypothesis, Behavioural Finance, Investor Psychology, Cognitive Bias, Herd Behaviour, Prospect Theory, Market Anomalies},
month = {August},
doi = {https://doi.org/10.64388/IREV10I2-1720312}
}