Wednesday, November 9, 2011

Behavioral economics - Daniel Kahneman

In my two years at Cornell the Professors that stood out were Harold Bierman who taught finance and Richard Thaler who taught economics.  From the latter the course of note was on behavioral economics of which he was a leading light.  The field drew heavily on the research of Daniel Kahneman and Amos Tversky. 

Behavioral economics essentially contends with the assumption of economics that people are rational actors, and through experiments finds how people consistently contradict what they would do if they were truly rational. 

Examples that I readily recall is that the people’s cost/benefit functions aren’t linear but rather curve so it is steeper to start and then tails off.  In time for the Christmas holidays this suggests an optimal strategy of wrap your gifts separately and pay in one bill (or in the lingo segregate your gains, consolidate your losses).

The other was the market anomaly—at least at the time—that markets tended to go down first thing on Monday, and go up towards the conclusion of trading on Friday.  This was a blow to efficient markets theories that always amused me (when are you in a better mood, at the start of the work week or its conclusion?).

What prompts the above is an article in Vanity Fair by Michael Lewis on Daniel Kahneman
As I’ve remarked on occasion MBAs are far from knowing everything, but that shouldn’t lead you to believe that they don’t know anything.  Behavioral economics was one of things I took away from Cornell’s Business School and have carried with me since the late 80’s.

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