tag:blogger.com,1999:blog-17232051.post6015161657986595305..comments2024-03-28T03:16:14.104-04:00Comments on Noahpinion: Behavioral economics vs. behavioral financeNoah Smithhttp://www.blogger.com/profile/09093917601641588575noreply@blogger.comBlogger35125tag:blogger.com,1999:blog-17232051.post-63566263099216983812016-06-29T04:50:02.792-04:002016-06-29T04:50:02.792-04:00I think so too. Daniel Ellsberg?I think so too. Daniel Ellsberg?Alex Felixhttp://www.comarch.com/finance/noreply@blogger.comtag:blogger.com,1999:blog-17232051.post-63159039447083940572014-03-15T12:43:11.516-04:002014-03-15T12:43:11.516-04:00Hi Noah, from what I understand behavioural financ...Hi Noah, from what I understand behavioural finance is focused on biases in decision making while decisions controlled by non-biased emotions are considered utility controlled and therefore is in the general standard finance frame. Wouldn't you think that our emotional preferences vary to the extent that they should not just be in the utility group but maybe a area of its own withing behavioural finance?Ulf Lowenhavhttp://www.eqapital.senoreply@blogger.comtag:blogger.com,1999:blog-17232051.post-53879145935933631312014-03-12T17:46:54.062-04:002014-03-12T17:46:54.062-04:00Noah, thanks for the reference. And thanks for th...Noah, thanks for the reference. And thanks for the blogging too. To echo one of the earlier comments, blogs like yours are a treasure for us amateurs. I'm going to push my luck and inquire if you can recommend another introductory text aimed more at the "behavioral economics" end of things.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-17232051.post-79832973755942903622014-03-12T12:40:59.565-04:002014-03-12T12:40:59.565-04:00This covers a lot of it:
http://www.princeton.edu/...This covers a lot of it:<br />http://www.princeton.edu/~markus/research/papers/book.htmNoah Smithhttps://www.blogger.com/profile/09093917601641588575noreply@blogger.comtag:blogger.com,1999:blog-17232051.post-32817479150475772442014-03-12T12:18:39.929-04:002014-03-12T12:18:39.929-04:00Can anybody recommend an introductory book that wo...Can anybody recommend an introductory book that would cover the literature Noah reviews in his post?Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-17232051.post-86612758653902001822014-03-07T00:13:05.271-05:002014-03-07T00:13:05.271-05:00Um...why isn't Daniel Ellsberg mentioned?Um...why isn't Daniel Ellsberg mentioned?Blue Aurorahttps://www.blogger.com/profile/02044362251868221897noreply@blogger.comtag:blogger.com,1999:blog-17232051.post-16735795245421672362014-03-06T06:27:51.383-05:002014-03-06T06:27:51.383-05:00The US Federal Reserve was not able to predict the...The US Federal Reserve was not able to predict the Great Recessions nor most of the recessions before that. Do we need any more evidence that modern economics does not work? Behavioral economics and finance offer us some of the best ways out of this intellectual dead-end. See my post at http://www.perthleadership.org/index.php/easyblog/entry/modern-economics-doesn-t-work on this issuetedhttps://www.blogger.com/profile/09717524947379431048noreply@blogger.comtag:blogger.com,1999:blog-17232051.post-64703276588624951122014-03-05T11:29:15.544-05:002014-03-05T11:29:15.544-05:00this type of post -- discussion an problem...citat...this type of post -- discussion an problem...citation of key academic papers... drawing broad conclusions...is incredibly helpful to a practitioner...thank you ... also does not the whole development of behavioral econ/fin feel like the early stages (still) of a kuhnian scientific revolution...the small evidence keeps pilling in that the old general model does not work...the old guard just has to ignore evidence (and defend by arguing their own system's internal logic)...while the new guard doesn't yet have a unified global theory to replace the old one with ....james purnellhttps://www.blogger.com/profile/05036879461449020469noreply@blogger.comtag:blogger.com,1999:blog-17232051.post-4947545233223324682014-03-03T21:35:28.425-05:002014-03-03T21:35:28.425-05:00"Yes. But faced with a menu of things that do..."Yes. But faced with a menu of things that don't really offer much predictive power, of course macroeconomists are going to go with what suits their intuition/politics/desires. It's the derp we know vs. the derp we don't know."<br /><br />Sure, but that's not science.<br /><br />And the thing is, we DO have some models with actual predictive power. Most based on the study of historical data. Even a few based directly on experimental, behavioral economics studies.<br /><br />We can often predict when people will say "That's not a fair deal. No way," for example. This seems rather useful in the grand, centuries-spanning part of macroeconomics.<br /><br />Thanks to Keynes, we can predict changes in unemployment based on the changes in the liquid wealth supply among the general population. Excellent predictive value, and it comes from *behavioral* observations, frankly.<br /><br />I think Rosser is right -- the desire for a "perfect theory of everything" drives people to go beyond the predictive power which we have. But we do have a lot of predictive power, far more than the ancient Romans did!Nathanaelnoreply@blogger.comtag:blogger.com,1999:blog-17232051.post-49048040011158515312014-03-03T21:29:47.365-05:002014-03-03T21:29:47.365-05:00Regarding institutions, institutions are very impo...Regarding institutions, institutions are very important.<br /><br />Understanding the behavior of institutions.... is a behavioral question! Understanding why institutions are structured the way they are... is a behavioral question! Understanding why particular institutions induce particular behaviors among the people involved in them or dealing with them... is a behavioral question!<br /><br />Behavioral studies are at the *foundation* of the study of institutions. I don't think those are separate.<br /><br />Noah: the core of "behavioral" economics is saying "Let's see how people actually behave, rather than making shit up like the classical economists do." The core is behavioral experiments, nothing more. Anything which involves experimenting to see how people behave, and finding rules of thumb / models which model this *accurately*, can be called "behavioral" economics. <br /><br />As opposed to the religion-based "homo economicus" economics models which start with "Let's assume everyone behaves in this way in which we know empirically that they don't...."<br /><br />To some extent, people's behavior can be modeled by utility functions (though never by "standard" ones) and to some extent people's behavior can't. (Heuristics seem to provide better models.) But the model type isn't important for making something a "behavioral" theory, what's important is that the model is based in observed behavior, rather than "pure reason from first principles" nonsense.Nathanaelnoreply@blogger.comtag:blogger.com,1999:blog-17232051.post-11305031591734537582014-03-03T21:23:31.455-05:002014-03-03T21:23:31.455-05:00"rational choice" is a small, situation-..."rational choice" is a small, situation-specific application. Outside its limited area of application it gives blatantly false predictions.<br /><br />Get a clue, Mr. House. Science is like this -- there's a lot we don't know. The desire for grand generalizations while dismissing the complex, situation-specific empirical data as "unimportant" is known as religion. There's a reason most economists have been accused of doing religion.<br /><br />People forget that physics was in this position less than 150 years ago. Physics had one advantage: the cultists who believed in a grand universal religion-based model of physics had been roundly defeated and thrown out of the science departments.Nathanaelnoreply@blogger.comtag:blogger.com,1999:blog-17232051.post-53799327454084809462014-03-03T21:20:33.382-05:002014-03-03T21:20:33.382-05:00Physics appeared to be a bunch of disconnected, un...Physics appeared to be a bunch of disconnected, unrelated, "quirky" theories -- optics, electricity, magnetism, mechanics, etc. They weren't compatible with each other.<br /><br />The big, correct generalizations do not arrive until you have an enormous number of individual "tidbits" of knowledge. Trying to skip the "tidbits" stage gets you *false and useless* generalizations.<br /><br />Rational choice as a "big picture" is false and useless. (In fact, "rational behavior" happens only in a small minority of economic transactions -- it's another tidbit, empirically speaking.)<br /><br /> All you have is the tidbits. Deal with it. Do some more empirical research and eventually you may begin to see a bigger picture. That's science.Nathanaelnoreply@blogger.comtag:blogger.com,1999:blog-17232051.post-83563352728918838602014-03-03T12:38:22.950-05:002014-03-03T12:38:22.950-05:00"How could economics not be behavioral? If i..."How could economics not be behavioral? If it isn’t behavioral, what the hell is it? <br />And I think it’s fairly clear that all reality has to respect all other reality. If you come to inconsistencies, they have to be resolved, and so if there’s anything valid in psychology, economics has to recognize it, and vice versa. So I think the people that are working on this fringe between economics and psychology are absolutely right to be there, and I think there’s been plenty wrong over the years... Charlie Munger (Warren Buffet's partner ) from his 1995 speech "Twenty Four Standard Causes of Human Misjudgement" <br /><br /> As an interested outsider who reads tons of econ blogs, the most common complaint I have is that economists tend to minimize, be blind to or willfully ignore the "social" part of their social science. When I came across this speech days ago, I thought this guy gets it. I wish every economist would read this ( maybe they do? )...AND take it to heart. <br />Transcript here...http://www.rbcpa.com/Mungerspeech_june_95.pdf<br /><br />Anyway, you know it is worth a read because I got it via Cory Doctorow @ Boing Boing. You can watch the speech here...http://boingboing.net/2014/03/02/this-day-in-blogging-history-164.html<br /><br /><br />Bill Ellisnoreply@blogger.comtag:blogger.com,1999:blog-17232051.post-88197993955616708462014-03-03T11:14:44.433-05:002014-03-03T11:14:44.433-05:00There seems to be a need for a passwrod for the LS...There seems to be a need for a passwrod for the LSV paper link.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-17232051.post-80159622353948691182014-03-02T18:18:49.705-05:002014-03-02T18:18:49.705-05:00Rational expectations has been sneaking BE in via ...Rational expectations has been sneaking BE in via variables such as "propensity to [care about something irrational]". Rational expectations just means you have a reductionist equation that purports to explain decision-making.Anonymousnoreply@blogger.comtag:blogger.com,1999:blog-17232051.post-91046323162189712042014-03-02T11:43:18.714-05:002014-03-02T11:43:18.714-05:00Let me follow up with noting that the matter of wa...<i>Let me follow up with noting that the matter of wanting a "transcendent" unifying solution is what led macroeconomists into the pit of assuming rational expectations, which Chris House has not too long ago declared to be "here to stay," even though it is as empirically baseless as the Euler consumption equation.</i><br /><br />Yes. But faced with a menu of things that don't really offer much predictive power, of course macroeconomists are going to go with what suits their intuition/politics/desires. It's the derp we know vs. the derp we don't know.<br /><br /><i>Regarding behavioral econ/fin as operating out of the intersection of psychology and econ one interesting approach is to try to ground things at least partly in neuroeocnomics. Woodford, an old complexity guy who went conventional in his views of macro, has recently been pointing in this direction, and indeed many things in behavioral econ can be understood this way. I note that we now know that hyperbolic discounting is tied to which part of the brain is active when certain kinds of decisions are being made.</i><br /><br />I was pretty excited by that paper! Finance people are going to be very interested in that sort of thing, I predict. Macro people, maybe not.Noah Smithhttps://www.blogger.com/profile/09093917601641588575noreply@blogger.comtag:blogger.com,1999:blog-17232051.post-12250435266605240432014-03-02T11:37:07.058-05:002014-03-02T11:37:07.058-05:00I think that some of behavioral finance is related...I think that some of behavioral finance is related to behavioral econ, but some isn't, and some might or might not be (we just don't know yet). The term "behavioral" has been allowed to "creep" substantially in finance.<br /><br />I never understood how habit formation and hyperbolic discounting were behavioral. Aren't those just slightly non-standard utility functions??Noah Smithhttps://www.blogger.com/profile/09093917601641588575noreply@blogger.comtag:blogger.com,1999:blog-17232051.post-67356405184837675712014-03-02T04:47:57.022-05:002014-03-02T04:47:57.022-05:00A correction: Akerlof's paper is "Procras...A correction: Akerlof's paper is "Procrastination and Obedience," not the other way around. Sorry about that, but it is late; I need to go to sleep.<br /><br />Barkley Rosserrosserjb@jmu.eduhttps://www.blogger.com/profile/09300046915843554101noreply@blogger.comtag:blogger.com,1999:blog-17232051.post-44079688944347934312014-03-02T04:42:01.973-05:002014-03-02T04:42:01.973-05:00Let me follow up with noting that the matter of wa...Let me follow up with noting that the matter of wanting a "transcendent" unifying solution is what led macroeconomists into the pit of assuming rational expectations, which Chris House has not too long ago declared to be "here to stay," even though it is as empirically baseless as the Euler consumption equation. Assuming adaptive expectations, even though we know that this is what is really going on, is messy because there are so many versions of it out there. Which one to adopt? So much easier just to assume that agents on average assume what in fact happens. That certainly solves out problems, whew!<br /><br /> Regarding behavioral econ/fin as operating out of the intersection of psychology and econ one interesting approach is to try to ground things at least partly in neuroeocnomics. Woodford, an old complexity guy who went conventional in his views of macro, has recently been pointing in this direction, and indeed many things in behavioral econ can be understood this way. I note that we now know that hyperbolic discounting is tied to which part of the brain is active when certain kinds of decisions are being made.<br /><br /> Personally I view tying behavioral econ just to psychology as being limiting and not useful, unless one assumes a broad interpretation of psychology. Thus I cannot resist noting that I have been attacked (yes, much more than merely "criticized") on an anonymous site where Noah often gets attacked as well for appointing to the ed board of ROBE an econophysicist, an evolutionary anthropologist (who has publicly criticized "economics," shame on him), and a gadfly former trader who publishes on statistics and related matters and has also publicly criticized not just economics but economists (double shame on him), and even pubbed a paper by the latter in the first issue of ROBE (shocking and awful!). When anonymous whiners are not just ejaculating all over about what awful people these folks are, the argument is made that what they do is not behavioral economics, because the latter is only what happens at the intersection of econ and psych. Sorry, but I take a broader view and will take a broader view, and I did so when I edited JEBO, and in that I followed my predecessor, Richard Day. I think the broader approach has been more productive, and I expect it to continue to be so, even if we do not achieve a nice neat and simple "transcendent" theory of behavioral economics, or to put it more bluntly how to explain what people actually do, rather than maybe what they ought to do.rosserjb@jmu.eduhttps://www.blogger.com/profile/09300046915843554101noreply@blogger.comtag:blogger.com,1999:blog-17232051.post-32490559060466489902014-03-02T04:29:06.234-05:002014-03-02T04:29:06.234-05:00Very nice summary of current behavioral fin lit, N...Very nice summary of current behavioral fin lit, Noah. Not sure I would have made as many sub-categories as you have, but you have covered the ground well. A few points.<br /><br /> Maybe I am old-fashioned (heck, let's face it; I am old-fashioned), but I continue to consider behavioral fin to be a sub-part of behavioral econ. Heck, as Editori-in-Chief of the new Review of Behavioral Economics (ROBE, sorry for the ongoing adverts), I fully intend to pub papers on behavioral fin as well as behavioral econ that are not fin, just as I did when I edited JEBO. OTOH, the desire to sharply separate the two may be due to fin folks wanting to justify their higher salaries than the regular econ folks, :-).<br /><br /> Following up on that I would note at least one point in this that Chris House makes. He lists hyperbolic discounting as a success story, albeit supposedly now fully understood and presumably absorbed into macro. However, surely hyperbolic discounting has implications for behavioral fin, n'est ce pas?<br /><br /> While Chris emphasizes the role of Laibson in hyperbolic discounting, and with his position at Harvard he is safely respectable and thus to be imitated by aspiring grad students, it was George Akerlof who revived Strotz's initiation of the study of this from the 50s in his 1991 Ely lecture to the AEA, "Obedience and Procrastination," It is George Akerlof who has since been pushing a behavioral macro pretty publicly, although apparently to the disdain of most established macroeconomists who just cannot get back to tweaking DSGE models with the appropriate frictions.<br /><br /> On that I must admit that some such behavioral frictions may be importable into DSGE, notably the matter of momentum or habit in consumption, with the essentially complete failure of the Euler consumption equation key here, not unrelated to such matters as hyperbolic discounting, btw. It is also the case that all that New Keynesian focus on sticky wages and prices can be at least partly based on behavioral arguments, notably when we talk about downward stickiness of wages. Some of the arguments for that have been developed by Akerlof and Yellen, among others, with the downward stickiness of wages being central to the Akerlof-Dickens-Perry argument for a 2% inflation target that Janet Yellen convinced Alan Greenspan to adopt back in 1996 or so. Thus behavioral macro has been influencing policy for some time, given the widespread adoption of the 2% inflation target around the world.<br /><br /> On the matter of Chris's invocation of institutions, well, as somebody out of the University of Wisconsin-Madison where the likes of Ely and Commons used to roam, and people like Dan Bromley still push it at Land Economics, I think that is important. However, I think that to a substantial degree many institutions exist to channel behavior in a world where it is often much more fundamentally irrational than we might like. In this regard, returning to finance, note the ongoing flurry of papers about herding and fragility, and how at least some institutions and regulations in finance are attempts to deal with that, although not very effectively now.<br /><br /> Let me push this deeper. I am at base a complexity guy, and I and some others like David Colander have long argued that complexity is at the base of behavioral econ, a view I would say was shared by the founder of behavioral econ, my friend the late Herbert Simon. In the face of ineluctible complexity, he introduced the concept of bounded rationality. Maybe this fits Chris's story about billiard tables and all that, which sounds like Milton Friedman from his positive econ essay. <br /><br /><br /><br /> rosserjb@jmu.eduhttps://www.blogger.com/profile/09300046915843554101noreply@blogger.comtag:blogger.com,1999:blog-17232051.post-43764449392946619822014-03-01T19:54:31.148-05:002014-03-01T19:54:31.148-05:00I hear that interest in BE in Europe is still just...I hear that interest in BE in Europe is still just as strong as ever. And from what I've seen, interest in BE in micro theory in America is still quite strong. But in macro in America - i.e. what Chris House does - interest in BE indeed seems to have waned in recent years. And in finance, as I argue in this post, behavioral stuff is on the rise, and is not really considered out of the mainstream.Noah Smithhttps://www.blogger.com/profile/09093917601641588575noreply@blogger.comtag:blogger.com,1999:blog-17232051.post-21289954155956338562014-03-01T18:48:09.864-05:002014-03-01T18:48:09.864-05:00I took a leave at my job in a bank to make a PhD o...I took a leave at my job in a bank to make a PhD on 'Behavioral microfoundations of retail credit markets' that is about to end (research is done, I'm writing the final draft now). <br /><br />I did a theoretical model of banking competition (based on OC and yes, I agree it may be mostly an artifact for whatever-makes-bankers-take-more-risks) and an experimental research with pupils where I first they did some tests on PT (K&T'92) and OC (Moore&Healy'2008) and then they played a business simulation game where they played the role of a bank to see how much credit and at what price they would grant credit to a series of customers, given macro expectations provided to them. The strongest results of the experiment were that distortion of probabilities (PT) clearly affected the quality of credit granted (charging lower interest rates to riskier borrowers).<br /><br />Noah, please... don't tell me BE is over now!! (even though I am an European...)dpeonhttp://www.dpeon.comnoreply@blogger.comtag:blogger.com,1999:blog-17232051.post-90449567384968790052014-03-01T12:19:56.042-05:002014-03-01T12:19:56.042-05:00I see. But then why would that be curtains for beh...I see. But then why would that be curtains for behavioral econ? If various specific markets have behavioral corrections that can't be ignored, it seems like behavioral will always have to stick around, and there will always have to be some economists who work with it.Noah Smithhttps://www.blogger.com/profile/09093917601641588575noreply@blogger.comtag:blogger.com,1999:blog-17232051.post-87492927339497140962014-03-01T11:53:01.748-05:002014-03-01T11:53:01.748-05:00That’s actually a pretty good summary of what I’m ...That’s actually a pretty good summary of what I’m saying. I don’t think that behavioral econ was anticipating *replacing* rational choice but advocates were expecting that it could lead to substantial modifications of our understanding of how decisions are made. If behavioral remains, in your words, a bunch of small, situation-specific corrections then I would think that it will ultimately be of only limited use. Chris Househttp://orderstatistic.wordpress.comnoreply@blogger.comtag:blogger.com,1999:blog-17232051.post-89024878126992600202014-03-01T11:20:32.451-05:002014-03-01T11:20:32.451-05:00OK, I think I might get what you're saying. Be...OK, I think I might get what you're saying. Behavioral econ, when it was just getting started, seemed to promise to be able to *replace* rationality as the dominant paradigm for how to model human decision-making. But no behavioral paradigm has emerged - there hasn't been a huge success that shows us an example for how we can replace rationality across the board. So at best, behavioral econ is going to turn out to be a bunch of small, situation-specific corrections to rationality, instead of fulfilling its promise of replacing rationality as the basic fundamental principle. Is that what you're saying?Noah Smithhttps://www.blogger.com/profile/09093917601641588575noreply@blogger.com