Richard H. Thaler, “Behavioral Economics: Past, Present, and Future.”
American Economic Review 106(7): 1577–1600, 2016 (working paper pdf available here).
• Economics provides an approach to optimal decision making -- and that is well and good. But we should not let that model distract us from how people actually make decisions.
• When people make decisions, they make them as fallible Humans, not as textbook Econs. They remain fallible Humans irrespective of how often we are told that: (1) their decisions will look "as if" they are Econs; (2) their departures from the full Econ will be unsystematic; (3) when the stakes are high they will convert into Econs; (4) with time they will learn to be Econ; and, (5) the special magic of market settings will see to it that only Econs survive.
• Does the market "get prices right"? Consider the closed-end mutual fund with ticket symbol CUBA. Typically, CUBA is priced at about a 10-to-15 percent discount relative to its underlying assets. But after December 18, 2014, CUBA started to trade at a 70% premium over the value of its underlying securities, and premium pricing continued for about a year.
• Why? On December 18, 2014, President Obama announced that the US would normalize diplomatic relations with Cuba. The CUBA mutual fund has nothing to do with the country of Cuba.
• When Humans make decisions under uncertainty, the sort of preferences they display are not those of expected utility theory. Rather, many decisions seem to involve "prospect theory"-style preferences: (1) utility is based on changes in wealth from some reference point; (2) people are loss averse; and (3) people do not weight potential outcomes according to the objective probabilities.
• For intertemporal preferences, people often display a present bias, a taste for instantaneous gratification, and in many ways, do not exhibit exponential discounting.
• As with preferences, people also do not seem to hold fully rational beliefs. In particular, people display excessive optimism and excessive confidence in their beliefs.
• Actual choices are influenced by "supposedly irrelevant factors [p. 1595]," where the supposition of irrelevance is made within standard economic models. For instance, default settings tend to influence ultimate choices, even in high-stakes situations (such as retirement planning) where the defaults are less-than-optimal and easy to override.
• In the future, economic models will incorporate those behavioral features that best improve their predictive accuracy without imposing high costs in terms of complexity; "behavioral" will disappear as an adjective for a subset of economics, as all economics will be as behavioral as necessary.
• Economics provides an approach to optimal decision making -- and that is well and good. But we should not let that model distract us from how people actually make decisions.
• When people make decisions, they make them as fallible Humans, not as textbook Econs. They remain fallible Humans irrespective of how often we are told that: (1) their decisions will look "as if" they are Econs; (2) their departures from the full Econ will be unsystematic; (3) when the stakes are high they will convert into Econs; (4) with time they will learn to be Econ; and, (5) the special magic of market settings will see to it that only Econs survive.
• Why? On December 18, 2014, President Obama announced that the US would normalize diplomatic relations with Cuba. The CUBA mutual fund has nothing to do with the country of Cuba.
• When Humans make decisions under uncertainty, the sort of preferences they display are not those of expected utility theory. Rather, many decisions seem to involve "prospect theory"-style preferences: (1) utility is based on changes in wealth from some reference point; (2) people are loss averse; and (3) people do not weight potential outcomes according to the objective probabilities.
• For intertemporal preferences, people often display a present bias, a taste for instantaneous gratification, and in many ways, do not exhibit exponential discounting.
• As with preferences, people also do not seem to hold fully rational beliefs. In particular, people display excessive optimism and excessive confidence in their beliefs.
• Actual choices are influenced by "supposedly irrelevant factors [p. 1595]," where the supposition of irrelevance is made within standard economic models. For instance, default settings tend to influence ultimate choices, even in high-stakes situations (such as retirement planning) where the defaults are less-than-optimal and easy to override.
• In the future, economic models will incorporate those behavioral features that best improve their predictive accuracy without imposing high costs in terms of complexity; "behavioral" will disappear as an adjective for a subset of economics, as all economics will be as behavioral as necessary.
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