Conventional finance has long rested on the premise of fully rational agents operating in efficient and frictionless markets, where all available information is instantly reflected in asset prices and investment decisions are made to maximize expected utility. However, a substantial body of empirical evidence has challenged these assumptions, revealing that investors frequently deviate from rational behaviour due to cognitive limitations, emotions, and psychological biases. Behavioural finance emerged as an alternative framework that integrates insights from psychology and economics to better explain real-world financial decision-making. Rooted in the pioneering work of Kahneman and Tversky (1979) and further developed by scholars such as Thaler, Shiller, and Shefrin, the discipline examines how systematic biases influence individual and market outcomes. This paper presents a critical review of the theoretical foundations of behavioural finance, including Prospect Theory and its departure from traditional financial models. It explores major cognitive and emotional biases such as overconfidence, anchoring, representativeness, loss aversion, herding, mental accounting, and confirmation bias, highlighting their implications for investment behaviour and market efficiency. The study further employs India as a sustained case study, demonstrating how behavioural factors shape household asset allocation, securities market participation, and retail derivatives trading. Owing to its rapid financialisation, demographic diversity, and extensive regulatory datasets, India provides a valuable setting for observing behavioural phenomena at scale. Finally, the paper discusses emerging methodological developments, including neurofinance, quantitative behavioural finance, and experimental finance, which continue to expand the explanatory and predictive scope of the field.
