Friday, August 29, 2003

Behavioral Economics

The Economist has a good piece on how learning how to trade makes people better traders. It seems an obvious and unremarkable conclusion, but it turns out that people are naturally such appalling traders that it called the soundness of standard economic assumptions (and market efficiency) into question.

I've written about this many times in the past and I don't really think that behavioral econ is deeply contradictory to neoclassical econ (even Chicago-school econ). A common classical criticism of behavioral economics is that it looks at phenomenon that are either trivial to people, or rare. This means that people make suboptimal decisions because either the decisions are not important, or because they have no experience and are not expert. Chicago economist Dick Thaler's rebuttal to this is that common transactions are almost always trivial, while important transactions (such as buying a house) only come along occasionally, so these are exactly the types of circumstances that people make decisions under in the real world.

The Economist article discusses a paper where traders from one discipline avoided the usual behavioral biases in other areas -- they had learned to be good traders generally. Learning how to recognize and overcome innate cognitive biases seems to be a very worthwhile thing to learn, and it would be nice if it were taught in schools. As Clint said: "A man's got to know his limitations."


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