Thursday, January 20, 2011

Behavioural Finance and Bounded Rationality

Whether fortunately or unfortunately, human beings do not behave in perfectly economically rational ways which makes them very difficult to predict. Even with our most complex models accounting for a variety of different factors, there is a high degree of volatility not explained by our multifactor regressions and the models they produce.

Behavioural finance (along with it's fraternal twin, behavioural economics) aims to better understand how humans make decisions that are non-optimal in the strict finance / economics definition and don't comply with what academics would have us anticipate as expected behaviour.

While this course is particularly interesting, what did strike me as noteworthy was that a lot of the foundation material for this course is based on the same principals as integrative thinking taught in our FIT class. In fact, it seems as if we've been doing a review of FIT, focusing on how humans make errors in judgment and build sub-optimal mental models based on well documented shortcomings in how we think.

In fact, some of the examples used in the class are lifted from the exact same material presented to us in Q1 of our first year highlighting anchoring effects, neglecting regression to the mean, availability heuristic, rational probabilty assessments, hot hand and gamblers fallacy etc.


Dilip said...

Josh, Behavioural Economics and Behavioural Finance are NOT based on the principles of Integrative Thinking. It's the opposite.

Joshua Wong said...

Perhaps I should have been more precise in my language. It seems that these disciplines are common at least as it relates to trying to understand flawed model construction?

I'd really appreciate your thoughts on this.