Introduction to Behavioral Economics

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Topics: Economics, Utility
Behavioral economics

Behavioral economics
Behavioral economics and the related field, behavioral finance, study the effects of social, cognitive, and emotional factors on the economic decisions of individuals and institutions and the consequences for market prices, returns, and the resource allocation. The fields are primarily concerned with the bounds of rationality of economic agents. Behavioral models typically integrate insights from psychology with neo-classical economic theory. In so doing they cover a range of concepts, methods, and fields.[1]
Behavioral analysts are not only concerned with the effects of market decisions but also with public choice, which describes another source of economic decisions with related biases towards promoting self-interest.
There are three prevalent themes in behavioral finances:[2]
• Heuristics: People often make decisions based on approximate rules of thumb and not strict logic.
• Framing: The collection of anecdotes and stereotypes that make up the mental emotional filters individuals rely on to understand and respond to events.
• Market inefficiencies: These include mis-pricings and non-rational decision making.

Issues in behavioral economics
Behavioral finance
The central issue in behavioral finance is explaining why market participants make systematic errors. Such errors affect prices and returns, creating market inefficiencies. It also investigates how other participants take advantage
(arbitrage) of such market inefficiencies.
Behavioral finance highlights inefficiencies such as under- or over-reactions to information as causes of market trends (and in extreme cases of bubbles and crashes). Such reactions have been attributed to limited investor attention, overconfidence, overoptimism, mimicry (herding instinct) and noise trading. Technical analysts consider behavioral finance, behavioral economics ' academic cousin, to be the theoretical basis for technical analysis.[3]
Other key observations



References: • Ainslie, G. (1975). "Specious Reward: A Behavioral /Theory of Impulsiveness and Impulse Control". • Barberis, N.; Shleifer, A.;; Vishny, R. (1998). "A Model of Investor Sentiment" (http://jfe.rochester.edu/). • Becker, Gary S. (1968). "Crime and Punishment: An Economic Approach". The Journal of Political Economy 76 (2): 169–217 • Benartzi, Shlomo; Thaler, Richard H. (1995). "Myopic Loss Aversion and the Equity Premium Puzzle". The Quarterly Journal of Economics (The MIT Press) 110 (1): 73–92 • Cunningham, Lawrence A. (2002). "Behavioral Finance and Investor Governance". Washington & Lee Law Review 59: 767 • Diamond, Peter A., and Hannu Vartiainen, ed. (2007). Behavioral Economics and its Applications. Description (http://books.google.com/books?id=1-SVhlC9mVoC&dq=&source=gbs_navlinks_s) and preview (http:// • Daniel, K.; Hirshleifer, D.; Subrahmanyam, A. (1998). "Investor Psychology and Security Market Under- and Overreactions" • Garai Laszlo. Identity Economics – An Alternative Economic Psychology. 1990–2006. • Hens, Thorsten; Bachmann, Kremena (2008). Behavioural Finance for Private Banking (http://www.bfpb.ch). • Hogarth, R. M.; Reder, M. W. (1987). Rational Choice: The Contrast between Economics and Psychology. • Kahneman, Daniel; Tversky, Amos (1979). "Prospect Theory: An Analysis of Decision under Risk". 10 • Kahneman, Daniel; Ed Diener (2003) • Kirkpatrick, Charles D.; Dahlquist, Julie R. (2007). Technical Analysis: The Complete Resource for Financial Market Technicians • Kuran, Timur (1995). Private Truths, Public Lies: The Social Consequences of Preference Falsification, Harvard University Press • Luce, R Duncan (2000). Utility of Gains and Losses: Measurement-theoretical and Experimental Approaches. • The New Palgrave Dictionary of Economics (2008), 2nd Edition. Abstract links: Augier, Mie • Mullainathan, S.; Thaler, R. H. (2001). "Behavioral Economics". International Encyclopedia of the Social & Behavioral Sciences • Rabin, Matthew (1998). "Psychology and Economics". Journal of Economic Literature 36 (1): 11–46 (http:// pages.towson.edu/jpomy/behavioralecon/PsychologyandEconomicsRabin98JEL.pdf) • Schelling, Thomas C. (2006 [1978]). Micromotives and Macrobehavior, Norton. Description (http://books. • Shleifer, Andrei (1999). Inefficient Markets: An Introduction to Behavioral Finance. New York: Oxford University Press • Simon, Herbert A. (1987). "Behavioral Economics". The New Palgrave: A Dictionary of Economics. 1. • Thaler, Richard H., and Sendhil Mullainathan (2008). "Behavioral Economics," (http://www.econlib.org/ library/Enc/BehavioralEconomics.html) The Concise Encyclopedia of Economics, 2nd Edition • Overview of Behavioral Finance (http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1488110) • Geary Behavioural Economics Blog (http://gearybehaviourcenter.blogspot.com/), of the Geary Institute at com/pg/blog/Admin/read/50567/a-history-of-behavioural-finance-in-published-research-1944-1988) 11

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