Incorporation of behavioural sciences into financial regulation - a better way to protect investors

Current financial regulation is based on neoclassical economics. Its core assumption is that well-informed investors make rational and wealth-maximisation decisions. This approach is strongly reflected in EU financial legislation, which focuses on information disclosure. However, evidence provided by behavioural sciences reveals that investors fail to make optimal decisions because they are prone to biases and framing effects. Studies show that people may be subject to bounded rationality and bounded self-control. Despite growing interest in behavioural sciences, its explicit applications in financial regulation are still rare and the use of measures countering the negative impact of the biases is rather exceptional. This article provides a number of examples of the incorporation of behavioural economics into different legal areas and considers what lessons can be drawn therefrom. The objective is to provide a review, which will help to see whether behavioural sciences could be used to fine-tune policy design in financial regulation and/or enhance its enforcement in order to better protect investors. This paper further discusses what could be the best way to incorporate psychological aspects into financial regulation.