As an undergraduate, I was taught that people behave rationally and process information well. I recall being curious about these suppositions, having witnessed plenty of less-than-intelligent behavior (some of it my own). But these assumptions were used as the basis for models of how markets work.
As the years went by, evidence of irrationality accumulated. I felt as if the economic foundations I was taught were cracking. Fortunately, a group of psychologists invited themselves into our discipline to bind up our understandings.
Among them was Daniel Kahneman, who died last week. Kahneman was a godfather of behavioral economics, which proved that people are irrational…but in very predictable ways. His life’s work earned him the 2002 Nobel Prize in Economics, the first awarded to someone who had never taken an economics class.
Through easy-to-follow experiments, Kahneman and his collaborator Amos Tversky explored the boundaries of our rationality. They identified a series of flaws, or biases, that separate human beings from classical economic ideals:
These examples of our innate humanness are interesting, but usually harmless. In other situations, though, the boundaries of our rationality can be much more costly. Kahneman’s work has helped to steer people to make better decisions more often.
I encourage my colleagues to include books on behavioral economics on their reading lists. A good entry point is “The Undoing Project,” Michael Lewis’ profile of Kahneman and Tversky. “Misbehaving,” by Kahneman’s collaborator Richard Thaler, takes things to the next level. (My review of that book can be found here.) And for the harder core, Kahneman’s “Thinking Fast and Slow” goes deeper into the depths of the human mind.
Daniel Kahneman will be missed. But his ideas will forever be with us.
Information is not intended to be and should not be construed as an offer, solicitation or recommendation with respect to any transaction and should not be treated as legal advice, investment advice or tax advice. Under no circumstances should you rely upon this information as a substitute for obtaining specific legal or tax advice from your own professional legal or tax advisors. Information is subject to change based on market or other conditions and is not intended to influence your investment decisions.
© 2024 Northern Trust Corporation. Head Office: 50 South La Salle Street, Chicago, Illinois 60603 U.S.A. Incorporated with limited liability in the U.S. Products and services provided by subsidiaries of Northern Trust Corporation may vary in different markets and are offered in accordance with local regulation. For legal and regulatory information about individual market offices, visit northerntrust.com/terms-and-conditions.
A message from Advisor Perspectives and VettaFi: To learn more about this and other topics, check out our most recent market outlooks.
© Northern Trust
More Behavioral Finance Topics >
