Financial Economics

DEFINITION of 'Financial Economics'

A branch of economics that analyzes the use and distribution of resources in markets in which decisions are made under uncertainty. Financial decisions must often take into account future events, whether those be related to individual stocks, portfolios or the market as a whole. Financial economics employs economic theory to evaluate how time, risk (uncertainty), opportunity costs and information can create incentives or disincentives for a particular decision.

BREAKING DOWN 'Financial Economics'

Financial economics often involves the creation of sophisticated models to test the variables affecting a particular decision. Often, these models assume that individuals or institutions making decisions act rationally, though this is not necessarily the case. Irrational behavior of parties has to be taken into account in financial economics as a potential risk factor.

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