Daniel Kahneman: Psychology for Behavioral Finance

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Nobel Prize winner Daniel Kahneman is one of the founding fathers of behavioral finance. Although he holds a doctorate in psychology, not economics, he has had a profound effect on the dismal science. These days economic actors — that’s you and me — are not seen as rational, but rather human and prone to cognitive biases. This simple observation holds significant implications for the theory and practice of finance, ranging from the reliability of the Efficient Market Hypothesis and the Capital Asset Pricing Model to listening to a company presentation at a sell-side conference, speaking with investor relations professionals, building financial models, determining when to buy or sell securities, and even how to optimally organize an investment firm.

So wouldn’t it be nice to know what the good doctor knows? At the recent 65th CFA Institute Annual Conference, Kahneman distilled much of his research findings into bite-sized portions. What follows is a summary of his talk.

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Disorder, Social Capital, and Norm Violation: Three Field Experiments on the Broken Windows Thesis – Munich Personal RePEc Archive

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Abstract: Adding to the debate about the “broken windows” thesis we discuss an explanation of minor norm violation based on the assumption that individuals infer expected sanctioning probabilities from contextual cues. We modify the classical framework of rational crime by signals of disorder, local social control, and their interaction. Testing our implications we present results from three field experiments showing that violations of norms, which prevent physical as well as social disorder, foster further violations of the same and of different norms. Varying the net gains from deviance it shows that disorder effects are limited to low cost situations. Moreover, we provide suggestive evidence that disorder effects are significantly stronger in neighborhoods with high social capital.

 
See on mpra.ub.uni-muenchen.de

Do leaders affect ethical conduct?

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Abstract: We study whether leaders influence the unethical conduct of followers. To avoid selection issues present in natural environments, we use a laboratory experiment in which we form groups and assign leadership roles at random. We study an environment in which groups compete, with dishonest behavior enhancing group earnings to the detriment of social welfare. We vary, by treatment, two instruments through which leaders can influence follower conduct—prominent statements to the group and the allocation of monetary incentives. In general, the presence of active group leaders gives rise to significantly more dishonest behavior. Moreover, appointing leaders who are likely to have acted dishonestly in a preliminary stage of the experiment yields groups with significantly more unethical conduct. The analysis of leaders’ strategies reveals that leaders’ statements have a stronger effect on follower behavior than the ability to distribute financial rewards, and that leaders’ propensity to act dishonestly correlates with their use of statements or incentives as a means for encouraging dishonest follower conduct.

See on econpapers.repec.org

The Business Of Behavioral Economics

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You’ve done everything—endured diets, purged your freezer of Ben & Jerry’s, and educated yourself on fat, sugar, and calories. Yet, you can’t manage to lose weight.

What’s wrong with you? According to standard economic theory, which gives humans (perhaps too much) credit for making rational choices, those efforts should be enough to change your behavior. If you know the consequences but still get fat, you must want to be overweight.

Of course not, say Leslie John and Michael Norton, professors at Harvard Business School specializing in the burgeoning field of behavioral economics. “Standard economic theory suggests that as long as people understand the full consequences of their actions, they tend to act in their self interest,” says John. “If they want to be healthy, and you tell them how many calories are in a burger, then they’ll eat better.” But behavioral economics suggests that people make mistakes in their thinking. For example, we have self-control problems that can lead us to knowingly “misbehave.”

See on forbes.com