Showing posts with label behavioral economics. Show all posts
Showing posts with label behavioral economics. Show all posts

Saturday, June 7, 2014

Wrong Behavior


There are numerous new studies on behavioral economics which seem to say that one’s usual instincts and hard wired mental models are incorrect. This results in mistaken behavior with outcomes that one had hoped to avoid. In other words, the mind is actually misleading you, even if you think that you have superior instincts and intellect. Someone had said that intelligent people are in fact the easiest to fool, being adept in abstract reasoning but ungrounded in reality, lacking street smarts or down to earth skills (i.e. repairing a lawn mower, etc.). The Chinese have a saying that knowledge not used is useless knowledge, hence, putting scorn on intellectuals who learn from books. There is a backlash on smart people but there is another problem in saying that down to earth folks have more wisdom. For example, the predilection for huge homes, despite the absence of need, or the practicality of large spaces that are unutilized, the urge for bigger and better whether housing or food portions, or indulgences in the scale of a Las Vegas production. Bigger is always better. One starts to doubt himself if one does not follow the crowd, or wallow in envy if one does not follow the Joneses, like in the hysteria after the terror attacks, to be unpatriotic even when profiling Muslims and Middle Eastern men as described in the book ‘Zeitoun.’

On the other hand, the recent book ‘Scarcity’ reflects the opposite reaction, where one is pound foolish but penny wise, striving to save dollars and cents but splurging on large purchases (i.e. Mac Mansions).  Hence the mind is a beast to be tamed, far from the logical computer like efficiency that people sometimes think it is, perhaps like Sherlock Holmes who solves difficult crimes but resorts to smoking opium as a way to relax.   Improving one’s mental skill while destroying his faculties in the long run by taking drugs, plus the risk of being addicted, a story never fully explored by Arthur Conan Doyle. Or someone like Bill Clinton, brilliant as a policy wonk and a superior politician, but self-destructive in his urges, resulting in disgrace in an otherwise brilliant career, though still popular despite his follies.  Similarly in investment behavior, despite the proven method of Warren Buffet, as most investors still buy during bull markets and sell in bear markets, buying flashy overvalued stocks and disdaining value stocks. Perhaps like buying a luxury car, expensive to maintain and not fuel efficient but with sexy styling. But one never knows, living in a materialist consumer society, when not shopping is considered a sin, not spending a sickness. What is the use of money when unused?

What does behavioral economics tell us? That man is a victim of his passions, succumbing to the desires of the body, forever looking for release and instant gratification. The rare individual who is self-controlled is viewed as an aberration; a savant or dyslexic or an idiot. It is an uncommon trait that a whole discipline in economics is devoted to disproving one’s instincts, one’s supposedly rational mental capacity. ‘To one’s own nature be true’ is a good saying, never to be swayed by fads or by media. An individual thinker is rare, for someone to make his own mind and stick to his own reasoning even against the common norm. Behavioral economics is about irrational behavior, the lack of financial literacy, or unwise thinking that maybe fueling the trend towards a data driven life. To get objective facts and be guided by data, not by the mind when following one’s instincts. Often times, the correct outcome is counterintuitive, not the expected behavior. For example, when a politician disdains war (Ron Paul or  Barack Obama), preferring diplomacy and negotiation, which conservatives consider incorrect, not bombing Iran, or toppling the Syrian government. Hence, not going to war is as a mistake, a sign of weakness when it may be the wisest thing to do.  But one never knows, considering the superior arsenal one possesses; what is the purpose of advance weaponry when unused?

Obesity is another example of irrational thinking. An article in Time says that counting calories is the incorrect way to lose weight. It is not the quantity that matters but quality. In other words, one should eat less complex carbohydrates and sugar, but instead eat lots of fruits and vegetables even healthy fats in foods like avocado, olive oil and nuts. The key is metabolism and one should focus on foods that will aid metabolism. In other words, eating less and exercising more will not help you achieve the goal of losing weight but choosing the type of foods that will improve metabolism. Experts now say that eating less and exercising more only works for a select group of people.  Hence, eating less carbohydrates and exercising in the gym is the wrong behavior when trying to lose weight. Who would have thought that was the case? But the data from the studies show otherwise. Data trumps everything.

Tuesday, March 30, 2010

Economics Rigor


There is a rich intellectual discourse on economics in the recent years. My classes in college got stuck on the basics: Paul Samuelson, price elasticity, supply and demand, micro and macro economics. The good stuff where never covered like behavioral economics and financial investments. Basically the stuff about capital markets like the stock market, central bank functions and so on. I guess it’s because the country back then has not reached the level of sophistication as the west. The whole concept of the efficient market was bypassed in relation to the capital markets.


The only significant treatise I remember from college was the critique on the School of Economics on the Marcos regime. It was basically a challenge on the form of cronyism that affected the free functioning of the market. These days these problems seemed to be quaint and simplified. Other Asian countries like Malaysia and Indonesia have even exceeded the Philippine in terms of cronyism. Now, government intervention and control seem to be the accepted response in the wake of the financial turmoil. It seems government will always play an important role in the economy. This role is something that is already in full bloom in countries like China, Japan, Korea and Singapore.



I guess my college years were more a reaction to the Marcos regime where the old oligarch is reacting against the new cronies raised by Marcos. It seems that this is a normal development in third-world economies where everyone wants to keep the pie for himself. The underdevelopment of the capital markets resulted in not being updated with the latest theories on stuff like modern portfolio theory, diversification, Black-Scholes model and so on. The recent crisis has resulted in an explosion of books that tries to explain the current problems. At the heart of the critique is the failure of the efficient market theory. This efficient market theory is now being replaced with the so called behavioral economics where irrational people subject the market boom and bust cycles.

The destruction of wealth plus the fall of institutions like Lehman Brothers and Bear Sterns have shown that tools like risk management is inadequate. Risk was not understood the wrong pricing models made the situation unmanageable. So we are back to square one although people like Warren Buffet and George Soros as usual prove everybody wrong. I guess these people do not rely on exotic theories but on common sense although Soros tried to create a philosophical framework for investment, coming close to behavioral economics with his theory of reflexive phenomenon. So its important to jump into the books again to understand the present predicament.

Books by Gillian Tett, Justin Fox, George Soros and Benoit Madelbrott, Nassim Taleb all try to explain the present situation. It now clear the Alan Greenspan is likely wrong. and efficient market is a fallacy although some parts of the model still work. So one should cultivate the following skills: understand one’s cognitive bias in investing, the herd of crows and behavioral economics and assessing risk. It does not hurt to learn as well from Warren Buffet and read books like ‘Fool’s Gold,’ ‘The Last Man Standing’, ‘Lords of Finance; and so on to understand the new normal in the financial systems. It’s a good way to understand tomorrow’s world today.

Friday, November 20, 2009

A New Religion


Two new branches in economics called behavioral economics and neuroeconomics attempt to explain the recent financial calamity. To explain briefly, the crisis is due to old thinking patterns that existed when man was living in the Stone Age. In other words, certain mental patterns or heuristics are hard wired in the brain and caused the bubbles and busts in the real estate and stock markets. These wrong patterns of though or inner bias are seen in overconfidence, herd mentality and knee jerk reactions to new information. These reside more in the intuitive process of making judgments than in rational thinking.


The burgeoning field of Neuroeconomics even uses brain scans to provide biological proof of these wrong thinking patters. One bias is called ‘money illusion’ where people underestimate inflation, for example or react against a financial loss rather than a gain even when the arrangement is similar. This field has provided undisputed evidence that man cannot be a true investor until he recognizes these erroneous mental patterns in his brain. Brain scans show areas in the brain that work when the so-called ‘money illusion’ occurs. But how does one explain the many successful stories of investors in the market? In one word: plain dumb LUCK.


A typical investment success is more attributable to luck than to inner ability. These ideas prove the point raised by the writer Nassim Taleb in his books like ‘The Black Swan’ wherein investment success is more due to luck rather than skill. Investing in the stock market or real estate for most people is actually like gambling in a casino due to this inner bias. But gambling may even provide better returns rather than investments. True financial geniuses like Warren Buffet or George Soros are those rare rational individuals who can logically assess an investment correctly. These people seem to possess characteristics of autistic individuals.


A lot of books write about the new economics. These books debunk the classic economic theories such as the efficient market theorem wherein people are rational investors rather than irrational fools which is the true reality. This irrationality impacts both the institutional lenders as well as the investing public. New theories abound such as the adaptive market hypotheses that try to bridge the new findings with the old. These new books are useful to read:

1. Your Money and Your Brain: How the New Science of Neuro-economics Can Help Make You Rich by Jason Zweig, 2007

2. The Mind of the Market by Michael Shermer, 2008

3. The Subprime Solution: How Today’s Global Financial Crisis Happened and What to do about it by Robert J. Shiller

4. Animal Spirits: How Human Psychology Drives the Economy and Why it Matters for Global Capitalism by George A. Akerlof and Robert J. Shiller

5. Nudge: Improving Decisions about Health, Wealth and Happiness by Richard H. Thaler and Cass R. Sunstein

Someday these new branch of economics may soon replace religion and spiritualism. After all, seekers of truth really try to find out more about themselves, to know who they really are, to find the truth and be free. Behavioral economics and neuro economics can soon provide the answers in the field of investing. Hence, you will know more about yourself by understanding these new theories rather than looking for a spiritual guru in India, for example. I guess this is as close as modern man can get to a new relevant religion. A religion for the moneyed class so to speak.

A new religion that is tied to the material life and how one can prosper in the affluent age. Where a true rational investor can be made after understanding the ‘hidden’ laws of neuro and behavioral economics. Of course, the spiritual founders or gurus of these new ways of thought are Warren Buffet or George Soros who have mastered themselves, surveyed the illiterate investor masses in the market and profited immensely. The annual meetings of Berkshire Hathaway can now be seen to be like a spiritual meeting, perhaps like Khumb Mela in India where masses of the investing public learn at the knee from an oracle or guru. Sometimes it takes a catastrophe like the recent financial mess to allow the truth to come out.