Behavioral Economics (eBook)

Fabrizio Ghisellini is a member of the Advisory Board of the Center for Monetary and Financial Studies of LUISS University, Rome, Italy, and was previously Director for Financial Operations at the Ministry of the Economy and Finance, Italy. He runs courses in behavioral economics in various Italian universities and is the author of many books, exploring areas such as behavioral factors affecting household investment choices.Beryl Y. Chang is Professor of Economics at New York University, USA, and served as an economist for risk performance of large credit and investment portfolios with major banks in the United States and as a consultant for international institutions. She has given a seminar course in behavioral economics and finance at Columbia University, USA, and is a published author and referee for numerous journals in areas of applied micro and macroeconomics, interdisciplinary/behavioral economics, international and financial economics, industrial organization, and risk management. Chang is also a concert violinist.

Preface 5
Contents 9
List of Figures 11
List of Tables 13
Part I: How did we get here? 14
1: Introduction to Part I 15
2: Does Conventional Economics Fit Reality? 17
2.1 The Rise of New Classical Economics 17
2.2 The First Pillar of Conventional Economics: Maximization of Utility 21
2.3 The Second Pillar of Conventional Economics: Rationality and Expectations 27
2.4 How the Homo Economicus Takes His Decisions 32
2.5 The Reality Test 38
References 47
3: The Behavioral Alternative 49
3.1 The Behavioral Revolution: From Normative to Positive Economics 49
3.2 The Behavioral Revolution: Is Utility Just a Function of Wealth? 55
3.3 The Behavioral Revolution and the Concept of Rationality 62
3.4 Human, All Too Human: The Global Crisis Case 89
3.4.1 Investors 90
Creating the Environment for the Bubble 90
Herding 91
Life Before and After the Bubble Burst 91
3.4.2 Banks, Borrowers, and Regulators 93
References 96
Part II: Moving Forward: Seven Businesses to Finish 99
4: Introduction to Part II 100
4.1 How Many Real Biases Are There? 101
4.2 How Do Real-World People Form Expectations? 101
4.3 Time Discounting and Preferences 102
4.4 Rationality: An Inferiority Complex? 102
4.5 The Problem with Behavioral Finance 103
4.6 Should Biased Nudgers Nudge Us? 103
4.7 What We Talk About When We Talk About Behavioral Economics 104
Reference 104
5: How Many Real Biases Are There? 105
5.1 200 and Counting? 106
5.2 Screening Biases 112
5.2.1 Affect 112
Screener 1: Is It Innate? 113
Screener 2: Used When Time/Information Scarce? 113
5.2.2 Disposition Effect 114
Screener 1: Is It Innate? 115
Screener 2: Used When Time/Information Scarce? 115
5.2.3 Illusion of Control 117
Screener 1: Is It Innate? 118
Screener 2: Used When Time/Information Scarce? 119
5.2.4 Loss Aversion 119
Screener 1: Is It Innate? 120
5.2.5 The Hindsight Bias 121
Screener 1: Is It Innate? 123
Screener 2: Used When Time/Information Scarce? 124
5.2.6 The Conjunction Effect/Fallacy 125
Screener 1: Is It Innate? 128
References 129
6: How Do People Form Expectations in the Real World? 133
6.1 Expectations Before Behavioral Economics 133
6.2 Expectations (or Their Absence) in Behavioral Research 136
6.3 Is There a Tractable Way to Model Expectations in a Behavioral Model? 147
References 159
7: Time and Preferences 161
References 180
8: Rationality: An Inferiority Complex? 182
8.1 The (Almost) Unchallenged Dominance of Conventional Rationality in Behavioral Economics 182
8.2 Unconventional Rationality and Unconventional Utility Functions 186
References 193
9: The Problem with Behavioral Finance 195
9.1 The Easy Victory of Behavioral Over Conventional Finance 195
9.2 Mean Variance Optimization Strikes Again? 200
9.3 Asset Allocation and Loss Indicator Issues: Problems and Research Perspectives 201
References 208
10: Should Biased Nudgers Nudge Us? 209
10.1 What Is Nudging? Flies and Toilets 209
10.1.1 Definition of the Perfect Nudge 211
10.2 Public and Private Nudges 214
10.3 Case Studies: Do Nudges Work? 217
10.4 Is Nudging Right? 219
References 226
11: What We Talk About When We Talk About Behavioral Economics 227
References 233
Index 234