Oct 14, 2017

Behaving like a human

It seems behavioralists are finally winning minds. It's been a few decades they are struggling to persuade the neo-classical theorists, and are rejected, that there are more to the market than "individuals rationality" and "market efficiency". Richard Thaler is often called the "father of the behavioral economics". He has been awarded the Noble Memorial Prize 2017. (If you are not that much into economics, you may remember him in the movie "Big Short", who was explaining "synthetic CDO" in a Las Vegas casino, along with Selena Gomez!)

The basic assumption behind rationality of the market participants is in this that individuals are following Expected Utility Theory (EUT), based on a set of axioms initially established by von Neumann–Morgenstern ("VNM axioms") in their decision-making processes. Behavioralists, however, have been testing the actual behavior of individuals in the market and have found out that there are deviations from the EUT while the individuals are making economic decisions.

Among the pioneers of the behavioralist approach in economics were Daniel Kanheman (also a Noble Laureate 2002) and Amos Tversky (1979), who established the framework of the so-called "Prospect Theory", where "loss aversion" was among the most important factors that cause such deviations from rationality.

In addition, the Noble Memorial Prize in 2013 was awarded to Robert Shiller, who also had major contributions to our understanding of the behavioral aspects of the market.