Archive for July 5th, 2007

Behavioral Economics: 2 different streams of thought

July 5, 2007

Studying Behavior economics/finance is really interesting.  Unlike economics, which looks at rational behavior and builds models, BE/BF looks at irrationality and builds models around it.

I came across this superb paper by Floris Heukelom (University of Amsterdam, and Tinbergen Institute), which summarises the works of the leading economists in the field and also neatly seperates the two mainstream thinking in BE/BF.

The paper tells me that Russell Sage Foundation has been funding most of the research in BE. There are 7 leading thinkers:

  1. Daniel Kahneman (Princeton, Nobel Laureate 2002)

  2. Amos Tversky, (Stanford, died in 1996)

  3. Richard Thaler, (Univ of Chicago)

  4. Colin Camerer, (California Institute of Tech)

  5. David Laibson, (Harvard)

  6. George Loewenstein, (Carnegie Mellon) and

  7. Matthew Rabin (Univ of California, Berkeley, Clark Medal Winner 2001)

(Kindly note: All seven are from different Universities in US  a hallmark of excellence of US higher education system.)

Read their work in the paper. However, what interested me was that at the end, the author explains that there are 2 disitinct streams of thought emerging in BE/BF: 

  • The first theoretical branch is organized around the work of Tversky, Kahneman and Thaler. It argues that the uncertainty the individual is faced with is of a fixed, or exogenous nature. This uncertainty can be found in the flipping of a coin, the weather broadcast for tomorrow and disposable income five years hence. The theory to analyze this decision behavior under uncertainty is decision theory. Behavioral economics of the first branch favors Kahneman and Tversky’s normative-descriptive distinction. Normative here is best understood as the objective, psychophysical benchmark with which the researcher compares human behavior. Following Kahneman and Tversky, the first branch of behavioral economics strives to build a descriptive theory of individual human decision behavior under exogenous uncertainty.

  • The second branch of behavioral economics is organized around Camerer, Loewenstein, and Laibson. It considers the uncertainty of the decision behavior to be of an endogenous or strategic nature. That is, the uncertainty depends upon the fact that, like the individual, also the rest of the world tries to make the best decision. The most important theory to investigate individual decision behavior under endogenous uncertainty is game theory.The second branch of behavioral economics draws less on Kahneman and Tversky. What it takes from them is the idea the traditional Samuelson economics is plainly false. It argues, however, that traditional economics is both positively/descriptively and normatively wrong. Except for a few special cases, it neither tells how the individuals behave, nor how they should behave. The main project of the second branch is hence to build new positive theories of rational individual economic behavior under endogenous uncertainty. And here the race is basically still open.

Hmm, I didn;t know this at all. Just glancing over work by Rabin, Lowenstein tells me there are exciting times ahead for economists. But much will depend on how the leading researchers in the field shape future perspectives. I agree a lot to with what the author ends the paper with:

As far as the rest of the economic community is concerned, it may be guessed that as long as behavioral economics does not have a theory for market behavior and macroeconomic phenomena, it will at most be integrated with existing theories.

Nice read.

What is common between US independence day and Economics?

July 5, 2007

Most US based economist bloggers are off today because of American independence day. Hence the assorted links I posted today are few. Anyways a thought just struck me and let me share it with all of you in form of a question:

What is common between US independence day and Economics?  

Answer: The father of economics, Adam Smith’s epic book Wealth of Nations came out in 1776, the year when US got its independence as well.  Adam Smith’s famous book came out on March 9, 1776 and US got its independence on 4 July, 1776. So in a way American independence and economics as a subject both happened in 1776 (Economics as a thought has been there since ages)

So, in a way, all America based economists have 2 reasons to celebrate 🙂

Assorted Links

July 5, 2007

1. Financial Rounds points out to some slangs used in finance.

2. Most of the roads in India are poised to be tolled (quite a few already have been). Here is an interesting article which says Electronic systems make tolls more expensive. Thanks to Marginal Revolution for the pointer.

3. BS has an excellent article on what ails Indian and Chinese economy. It is written by Jahangir Aziz And Kalpana Kochhar  who are both from IMF and country-heads of China and India respectively. Nice collaboration.

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