IDEAS home Printed from https://ideas.repec.org/p/pra/mprapa/40280.html
   My bibliography  Save this paper

Bounded rationality: psychology, economics and the financial crisis

Author

Listed:
  • Schilirò, Daniele

Abstract

Classical mathematical algorithms often fail to identify in time when the international financial crises occur although, as the classical theory of choice would suggest, the economic agents are rational and the markets are or should be efficient and behave also rationally. This contribution does not pretend to give a complete answer to these questions, but it will highlight some well-known limits of the classical theory of rational choice. In particular, the present paper will focus on the concept of bounded rationality. The work also makes some references to behavioral economics and to the literature of behavioral finance which has given important contributions in explaining the behavior and the anomalies of financial markets. Finally, following the approch of Simon, the paper proposes an analytical model to describe the behaviour of agents which are rationally bounded, risk averse and loss averse, emphasizing the relationship between psychology and economics which helps to explain the crisis in financial markets.

Suggested Citation

  • Schilirò, Daniele, 2012. "Bounded rationality: psychology, economics and the financial crisis," MPRA Paper 40280, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:40280
    as

    Download full text from publisher

    File URL: https://mpra.ub.uni-muenchen.de/40280/1/MPRA_paper_40280.pdf
    File Function: original version
    Download Restriction: no

    Other versions of this item:

    References listed on IDEAS

    as
    1. Rabin, Matthew, 2002. "A perspective on psychology and economics," European Economic Review, Elsevier, vol. 46(4-5), pages 657-685, May.
    2. Shlomo Benartzi & Richard H. Thaler, 1995. "Myopic Loss Aversion and the Equity Premium Puzzle," The Quarterly Journal of Economics, Oxford University Press, vol. 110(1), pages 73-92.
    3. Thaler, Richard H & Shefrin, H M, 1981. "An Economic Theory of Self-Control," Journal of Political Economy, University of Chicago Press, vol. 89(2), pages 392-406, April.
    4. repec:srs:jtpref:v:2:y:2011:i:2:p:182-195 is not listed on IDEAS
    5. Avanidhar Subrahmanyam, 2008. "Behavioural Finance: A Review and Synthesis," European Financial Management, European Financial Management Association, vol. 14(1), pages 12-29, January.
    6. David Genesove & Christopher Mayer, 2001. "Loss Aversion and Seller Behavior: Evidence from the Housing Market," The Quarterly Journal of Economics, Oxford University Press, vol. 116(4), pages 1233-1260.
    7. Daniel Ellsberg, 2000. "Risk, Ambiguity and the Savage Axioms," Levine's Working Paper Archive 7605, David K. Levine.
    8. Nicola Gennaioli & Andrei Shleifer, 2010. "What Comes to Mind," The Quarterly Journal of Economics, Oxford University Press, vol. 125(4), pages 1399-1433.
    9. Thaler, Richard, 1981. "Some empirical evidence on dynamic inconsistency," Economics Letters, Elsevier, vol. 8(3), pages 201-207.
    10. Robert J. Shiller, 2005. "Behavioral Economics and Institutional Innovation," Southern Economic Journal, Southern Economic Association, vol. 72(2), pages 269-283, October.
    11. Mario GRAZIANO & Daniele SCHILIRÒ, 2011. "Rationality And Choices In Economics Behavioral And Evolutionary Approaches," Theoretical and Practical Research in the Economic Fields, ASERS Publishing, vol. 2(2), pages 182-195.
    12. Matthew Rabin, 2002. "Inference by Believers in the Law of Small Numbers," The Quarterly Journal of Economics, Oxford University Press, vol. 117(3), pages 775-816.
    13. Shefrin, Hersh M & Thaler, Richard H, 1988. "The Behavioral Life-Cycle Hypothesis," Economic Inquiry, Western Economic Association International, vol. 26(4), pages 609-643, October.
    14. Terrance Odean, 1998. "Are Investors Reluctant to Realize Their Losses?," Journal of Finance, American Finance Association, vol. 53(5), pages 1775-1798, October.
    15. Matthew Rabin, 1998. "Psychology and Economics," Journal of Economic Literature, American Economic Association, vol. 36(1), pages 11-46, March.
    16. Burton G. Malkiel, 2003. "The Efficient Market Hypothesis and Its Critics," Journal of Economic Perspectives, American Economic Association, vol. 17(1), pages 59-82, Winter.
    17. Barberis, Nicholas & Shleifer, Andrei & Vishny, Robert, 1998. "A model of investor sentiment," Journal of Financial Economics, Elsevier, vol. 49(3), pages 307-343, September.
    18. Todd, Peter M. & Gigerenzer, Gerd, 2003. "Bounding rationality to the world," Journal of Economic Psychology, Elsevier, vol. 24(2), pages 143-165, April.
    19. Fama, Eugene F, 1991. " Efficient Capital Markets: II," Journal of Finance, American Finance Association, vol. 46(5), pages 1575-1617, December.
    20. Daniel Ellsberg, 1961. "Risk, Ambiguity, and the Savage Axioms," The Quarterly Journal of Economics, Oxford University Press, vol. 75(4), pages 643-669.
    21. Herbert A. Simon, 1955. "A Behavioral Model of Rational Choice," The Quarterly Journal of Economics, Oxford University Press, vol. 69(1), pages 99-118.
    22. Burton G. Malkiel, 2003. "The Efficient Market Hypothesis and Its Critics," Working Papers 111, Princeton University, Department of Economics, Center for Economic Policy Studies..
    23. repec:hrv:faseco:30747159 is not listed on IDEAS
    24. Kahneman, Daniel & Tversky, Amos, 1979. "Prospect Theory: An Analysis of Decision under Risk," Econometrica, Econometric Society, vol. 47(2), pages 263-291, March.
    25. Schilirò, Daniele, 2011. "Decisioni e razionalità in economia
      [Decisions and rationality in economics]
      ," MPRA Paper 29477, University Library of Munich, Germany.
    26. repec:pri:cepsud:91malkiel is not listed on IDEAS
    27. John Conlisk, 1996. "Why Bounded Rationality?," Journal of Economic Literature, American Economic Association, vol. 34(2), pages 669-700, June.
    28. Daniel Kahneman & Jack L. Knetsch & Richard H. Thaler, 1991. "Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias," Journal of Economic Perspectives, American Economic Association, vol. 5(1), pages 193-206, Winter.
    29. Nicholas Barberis & Ming Huang, 2006. "The Loss Aversion / Narrow Framing Approach to the Equity Premium Puzzle," NBER Working Papers 12378, National Bureau of Economic Research, Inc.
    30. Castellani, Marco & Di Giovinazzo, Viviana & Novarese, Marco, 2010. "Procedural rationality and happiness," Journal of Behavioral and Experimental Economics (formerly The Journal of Socio-Economics), Elsevier, vol. 39(3), pages 376-383, June.
    31. Fama, Eugene F, 1970. "Efficient Capital Markets: A Review of Theory and Empirical Work," Journal of Finance, American Finance Association, vol. 25(2), pages 383-417, May.
    32. Milton Friedman & L. J. Savage, 1948. "The Utility Analysis of Choices Involving Risk," Journal of Political Economy, University of Chicago Press, vol. 56, pages 279-279.
    33. Simon, Herbert A, 1979. "Rational Decision Making in Business Organizations," American Economic Review, American Economic Association, vol. 69(4), pages 493-513, September.
    34. Daniel Kahneman & Richard H. Thaler, 2006. "Anomalies: Utility Maximization and Experienced Utility," Journal of Economic Perspectives, American Economic Association, vol. 20(1), pages 221-234, Winter.
    35. Terrance Odean, 1999. "Do Investors Trade Too Much?," American Economic Review, American Economic Association, vol. 89(5), pages 1279-1298, December.
    36. Tversky, Amos & Kahneman, Daniel, 1986. "Rational Choice and the Framing of Decisions," The Journal of Business, University of Chicago Press, vol. 59(4), pages 251-278, October.
    Full references (including those not matched with items on IDEAS)

    Citations

    Citations are extracted by the CitEc Project, subscribe to its RSS feed for this item.
    as


    Cited by:

    1. Daniele Schilir, 2012. "Bounded Rationality And Perfect Rationality Psychology Into Economics," Theoretical and Practical Research in the Economic Fields, ASERS Publishing, vol. 3(2), pages 99-108.
    2. Schilirò, Daniele, 2017. "Economics versus psychology.Risk, uncertainty and the expected utility theory," MPRA Paper 83366, University Library of Munich, Germany.

    More about this item

    Keywords

    Bounded rationality; rational choice; cognitive economics; behavioral finance; risk aversion;

    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • B52 - Schools of Economic Thought and Methodology - - Current Heterodox Approaches - - - Historical; Institutional; Evolutionary
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • C60 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - General

    NEP fields

    This paper has been announced in the following NEP Reports:

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:pra:mprapa:40280. See general information about how to correct material in RePEc.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Joachim Winter). General contact details of provider: http://edirc.repec.org/data/vfmunde.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.