that large number of sophisticated investors offset the effects of behavior of the non - sophisticated investors, thereby making markets efficient. for instance, when irrational optimist investors buy stocks the sophisticated investor sells stocks and vice versa. however, this behavior of sophisticated investors need not always lead to efficient markets. it is possible that sophisticated investors increase the effects of the actions of irrational investors, for instance, by buying stock ahead of irrational investors in anticipation of price increases. this leads to prices of stock being away from their fundamental value, i. e., mispricing. arbitrage of asymmetric information 9. it is seen that mispricing happens in securities for which information is sparse or comes too slowly. stocks may be mispriced for long periods of time due to a number of reasons and investors trade on information which they believe is superior to information available with anyone else. these could be forecasts or stock specific news. however, it is possible that sometimes even the sophisticated investors interpret the information incorrectly. it is also possible that overconfident investors are able to take advantage of liquidity traders before rational investors, thereby earning higher returns than rational investors. mispricing can also persist for long periods of time due to other happenings. for instance, if an investor identifies a return pattern statistically, it is difficult for him to know whether other investors have identified and acted upon that pattern or not. therefore, uncertainty can lead the prices to be away from the true value for long periods of time. in a related point, it is also possible to see why there may be limits to arbitrage due to risks and costs associated with exploiting the arbitrage opportunity. 10. let us think of a situation in which irrational investors are bearish on a certain stock. this will cause the price of that stock to fall. standard theory will have us believe that rational investors will sense an opportunity and buy the stock at the lower price shorting a similar stock to hedge the position. thus, buying of the stock will take the price back to its fundamental value. this exposition of the dynamics of price change is based on the assumption that every mispricing creates an immediate opportunity to make riskless profits. this may, however, not be the case. there may be risks and costs that dissuade taking advantage of arbitrage opportunities. illustratively, even when the stock price is down due to unwarranted pessimism, rational investors may still

models of decision making under risk and uncertainty to economic models of rational behaviour and this led to resurgence of psychology in economics. 3. the recent global financial crisis caused severe damages to many economies across the globe. governments and central banks had to step in to bailout many financial institutions to protect the systemic stability. greed and fear played a big role in the way markets behaved much against the lines predicted by the mathematical models. the behavioural economics do succeed in explaining the recent market distortions driven by these two human traits. the greed for huge gains drove financial engineers to innovate and sell complex financial products to unsophisticated investors. as the crisis unfolded stock market reacted sharply and stopped rallying. fear then took over and accentuated the sell - off instead of encouraging investments at lower prices. i do not intend to dwell on these areas in detail but what i intend to highlight during my brief presentation is to focus on some of the facets of interconnectedness of psychology with economics and how human bis central bankers ’ speeches behaviour and emotions impact economic decisions. i would also attempt to put forth some of the findings of behavioral finance talking along the contours of mainstream and behavioural economics. sociology and psychology underpin economics 4. as we know, in the field of behavioural economics, insights are drawn from psychology and sociology to arrive at explanations for economic phenomena. the main departure of behavioral economics from its mainstream counterpart is that behavioral economics questions the basic tenets of mainstream economics, i. e., the assumption of fully rational agents with purely self - centered preferences. once these assumptions are relaxed, we are able to answer a lot many questions that do not have clear cut answers in mainstream economics. behavioral economics is a truly fascinating field and it has been increasingly incorporated within the mainstream framework. shifts in behaviour of economic agents 5. a large part of the thinking in finance during the 1970s was dominated by the efficient market hypothesis which stated that markets are always right, decisions of millions of rational investors make the markets the best judge of value of financial products and that price of financial products contains the best possible information about the fundamentals. in this connection, one can refer to justin fox, who, in his book titled the myth of the rational market : a history of risk, reward, and delusion on wall street has eloquently traced the origins of the irrationality of efficient market hypothesis and has explained the events leading to the crumbling of the myth of efficient markets. as we know,