The Role of Behavioural Finance in Explaining Stock Price Volatility: A Theoretical Framework

Stock price volatility has long been a central focus in financial markets, traditionally explained through classical theories that assume rational investor behaviour.However, integrating behavioural finance provides a nuanced understanding of the underlying psychological factors contributing to market fluctuations.This paper presents a comprehensive theoretical framework that elucidates the role of behavioural finance in explaining stock price volatility.By incorporating key behavioural concepts such as overconfidence, herding behaviour, loss aversion, and prospect theory, the framework bridges the gap between investor psychology and market dynamics.The proposed model highlights how cognitive biases and emotional responses can lead to deviations from fundamental values, resulting in increased volatility.Additionally, the framework examines the interplay between institutional factors and individual investor behaviour, offering insights into how these elements collectively influence market stability.This theoretical exploration underscores the significance of behavioural factors in shaping financial markets and provides a foundation for future empirical research aimed at mitigating volatility through behavioural insights.