BOUNDED RATIONALITY: PSYCHOLOGY, ECONOMICS AND THE FINANCIAL CRISES
Abstract
This contribution focuses on the concept of bounded rationality, highlighting the role of psychology in the economic decisions. The work analyzes Simon’s approach and his notion of bounded rationality as procedural rationality. Moreover, it examines some major contributions of behavioral economics concerning cognitive biases, stressing the importance of the institutional structure in the decision process. The paper also surveys the literature of behavioral finance which has become fashionable in explaining the anomalies of financial markets, pointing out also its limits.
References
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[10] De Bondt, Werner F.M. and Thaler, R.H. (1985). Does the stock market overreact? The Journal of Finance, 40(3): 793-805.
[11] De Bondt, Werner F.M. and Thaler, R. H. (1987). Further evidence on investor overreaction and stock market seasonality, The Journal of Finance, 42(3): 557-581.
[12] Ellsberg, D. (1961). Risk, ambiguity, and the Savage axioms, Quarterly Journal of Economics, 75(4): 643–669.
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[14] Fama, E. F. (1991). Efficient capital markets: II. Journal of Finance, 46(5): 1575-1617.
[15] Friedman, M. and Savage, L.J. (1948). Utility analysis of choices involving risk, Journal of Political Economy, 56(4): 279-304.
[16] Genesove, D. and Mayer, C. (2001). Loss aversion and seller behavior: evidence from the housing market, Quarterly Journal of Economics, 116(4): 1233-1260.
[17] Gennaioli, N. and Shleifer, A. (2010). What comes to mind, Quarterly Journal of Economics, 125(4): 1399-1433.
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[20] Gigerenzer, G. and Brighton, H. (2009). Homo heuristicus: why biased minds make better inferences, Topics in Cognitive Science, (1): 107–143.
[21] Gigerenzer, G., Hertwig, R., and Pachur, T. eds. (2011). Heuristics: The Foundations of Adaptive Behavior. New York: Oxford University Press.
[22] Goldstein, D.G. and Gigerenzer, G. (2002). Models of ecological rationality: The recognition heuristic. Psychological Review, 109: 75-90.
[23] Graziano, M. and Schiliro, D. (2011). Rationality and choices in economics: behavioral and evolutionary approaches, Theoretical and Practical Research in Economic Fields, II(2): 183-196.
[24] Hogarth, R.M. and Reder M.W. (1986). Editor’s comment: perspectives from economics and psychology, Journal of Business, 59(4): S185-S207.
[25] Kahneman, D. (2002). Maps of bounded rationality: a perspective on intuitive judgment and choice. Prize Lecture, December 8, 2002, Princeton University: 449-489.
[26] Kahneman, D. (2003). A psychological perspective on economics, AEA Papers and Proceedings, 93(2): 162-168.
[27[ Kahneman, D., Knetsch, J. L. and Thaler, R. H. (1991). The endowment effect, loss aversion, and status quo bias, Journal of Economic Perspectives, 5(1): 193-206.
[28] Kahneman, D. and Thaler, R.H. (2006). Anomalies: utility maximization and experienced utility, Journal of Economic Perspectives, 20(1): 221-234.
[29] Kahneman, D. and Tversky, A. (1972). Subjective probability: a judgment of representativeness, Cognitive Psychology, 3(3): 430–454.
[30] Kahneman, D., Tversky, A. (1973). On the psychology of prediction, Psychological Review, 80: 237-252.
[31] Kahneman, D., Tversky, A. (1979). Prospect theory. An analysis of decision under risk, Econometrica, 47(2): 263-292.
[32] Kahneman, D., Tversky, A. (1984). Choices, values and frames, American Psychologist, 39: 341-350.
[33] Malkiel, Burton G. (2003). The efficient market hypothesis and its critics, Journal of Economic Perspectives, 17(1): 59 – 82.
[34] Novarese, M., Castellani, M. and Di Giovinazzo, V. (2009). Procedural rationality and happiness, MPRA Paper 18290, University Library of Munich, Germany.
[35] Odean, T. (1998). Are investors reluctant to realize their losses? Journal of Finance, 53(5): 1775-1798.
[36] Odean, Terrance. (1999). Do investors trade too much? American Economic Review, 89 (5): 1279-1298.
[37] Rabin, M. (1998). Psychology and economics, Journal of Economic Literature, 36(1):11-46.
[38] Rabin, M. (2002). Inference by believers in the law of small numbers, Quarterly Journal of Economics, 117: 775–816.
[39] Rabin, M. (2002a). A perspective on psychology and economics, European Economic Review, 46(4-5): 657-685.
[40] Schilirò, D. (2012), Bounded rationality and perfect rationality: psychology into economics, Theoretical and Practical Research in Economic Fields, III(2): 101-111.
[41] Shefrin, H. and Thaler, R.H. (1988). The behavioral life-cycle hypothesis, Economic Inquiry, 26(4): 609 - 643.
[42] Shiller, R. J. (2005). Behavioral economics and institutional innovation, Cowles Foundation Discussion Paper No. 1499.
[43] Simon, H. A. (1955). A behavioral model of rational choice, Quarterly Journal of Economics, 69 (1): 99-118.
[44] Simon, H.A. (1956). Rational choice and the structure of the environment, Psychological Review, 63(2): 129-138.
[45] Simon, H.A. (1957). Models of man, social and rational: mathematical essays on rational human behavior in a social setting, New York: John Wiley and Sons.
[46] Simon, H.A. (1959). Theories of decision making in economics and behavioral science, American Economic Review, 49(3): 253-283.
[47] Simon, H.A. (1972). Theories of bounded rationality, in McGuire C.B. and Roy Radner, eds., Decision and organization, Amsterdam, North Holland Pub.Co.
[48] Simon, H.A. (1976). From substantive to procedural rationality, in Latsis Spiru J., ed., Method and appraisal in economics, Cambridge: Cambridge University Press: 129-148.
[49] Simon, H.A. (1979). Rational decision making in business organizations [Nobel Memorial Lecture], American Economic Review, 69(4): 493-513.
[50] Simon, H.A. (1982). Models of bounded rationality, Volume 2. Behavioral economics and business organization, Cambridge (MA): The MIT Press.
[51] Simon, H.A. (1997). Models of bounded rationality, Volume 3. Empirically grounded economic reason, Cambridge (MA): The MIT Press.
[52] Subrahmanyam, A. (2008). Behavioural finance: a review and synthesis, European Financial Management, 14(1): 12-29.
[53] Thaler, R.H. (1980). Toward a positive theory of consumer choice, Journal of Economic Behavior and Organization, 1(1): 36-60.
[54] Thaler, R.H. (1981). Some empirical evidence on dynamic inconsistency, Economics Letters, 8: 201-207.
[55] Thaler, R.H. (1999). Mental accounting matters, Journal of Behavioral Decision Making, 12:183-206.
[56] Thaler, R.H. (2003). Advances in Behavioral Finance II, New York, Russel Sage.
[57] Thaler, R.H. and Shefrin, H. (1981). An economic theory of self-control. Journal of Political Economy, 8(2): 392-406.
[58] Todd, P.M. and Gigerenzer, G. (2003). Bounding rationality to the world, Journal of Economic Psychology, 24: 143-165.
[59] Tversky, A. and Kahneman, D. (1973). Availability: A heuristic for judging frequency and probability, Cognitive Psychology, 5(2): 207-232.
[60] Tversky, A. and Kahneman, D. (1974). Judgment under uncertainty: heuristics and biases, Science, 185: 1124-31, September.
[61] Tversky, A. and Kahneman, D. (1981). The Framing of decisions and the psychology of choice, Science, 211: 453–458.
[62] Tversky, A. and Kahneman, D. (1983). Extensional vs. intuitive reasoning: the conjunction fallacy in probability judgment, Psychological Review, 90(4): 293–315.
[63] Tversky, A. and Kahneman, D. (1986). Rational choice and the framing of decisions, Journal of Business, 59(4): S251-S278, October.
[64] Von Neumann, J. and Morgenstern, O. (1944). Theory of games and economic behaviour, Princeton, Princeton University Press.
[2] Arrow, K.J. (1971). Essay in the theory of risk-bearing, Amsterdam, North Holland Pub.Co.
[3] Barberis, N., Shleifer, A. and Vishny, R. (1998). A Model of investor sentiment, Journal of Financial Economics, 49(3): 307-343.
[4] Barberis, N. and Thaler, R H. (2002). A survey of behavioral finance, NBER working paper 9222.
[5] Barberis, N. and Huang, M. (2006). The loss aversion/narrow framing approach to the equity premium puzzle. NBER working paper No 12378.
[6] Barros, G. (2010). Herbert A. Simon and the concept of rationality: boundaries and procedures, Brazilian Journal of Political Economy, 30(3): 445-472.
[7] Benartzi, S. and Thaler, R.H. (1995). Myopic loss aversion and the equity premium puzzle, Quarterly Journal of Economics, 110(1): 73-92.
[8] Camerer, C. and Loewenstein, G. (2003. Behavioral economics: past, present, and future. In Camerer, Colin, George Loewenstein, and Matthew Rabin, eds., Advances in Behavioral Economics, Princeton, Princeton University Press, Chapter 1.
[9] Conlisk, J. (1996). Why bounded rationality? Journal of Economic Literature, 34: 669-700.
[10] De Bondt, Werner F.M. and Thaler, R.H. (1985). Does the stock market overreact? The Journal of Finance, 40(3): 793-805.
[11] De Bondt, Werner F.M. and Thaler, R. H. (1987). Further evidence on investor overreaction and stock market seasonality, The Journal of Finance, 42(3): 557-581.
[12] Ellsberg, D. (1961). Risk, ambiguity, and the Savage axioms, Quarterly Journal of Economics, 75(4): 643–669.
[13] Fama, Eugene F. (1970). Efficient capital markets: a review of theory and empirical work. Journal of Finance, 35: 383-417.
[14] Fama, E. F. (1991). Efficient capital markets: II. Journal of Finance, 46(5): 1575-1617.
[15] Friedman, M. and Savage, L.J. (1948). Utility analysis of choices involving risk, Journal of Political Economy, 56(4): 279-304.
[16] Genesove, D. and Mayer, C. (2001). Loss aversion and seller behavior: evidence from the housing market, Quarterly Journal of Economics, 116(4): 1233-1260.
[17] Gennaioli, N. and Shleifer, A. (2010). What comes to mind, Quarterly Journal of Economics, 125(4): 1399-1433.
[18] Gigerenzer, G. and Goldstein, D.G. (1996). Reasoning the fast and frugal way: models of bounded rationality, Psychological Review, 103(4): 650–669.
[19] Gigerenzer, G. and Selten, R. (2001). Rethinking rationality. In Gigerenzer, Gerd and Reinhard Selten, eds., Bounded rationality: The adaptive toolbox, Cambridge (MA): MIT Press: 1-12.
[20] Gigerenzer, G. and Brighton, H. (2009). Homo heuristicus: why biased minds make better inferences, Topics in Cognitive Science, (1): 107–143.
[21] Gigerenzer, G., Hertwig, R., and Pachur, T. eds. (2011). Heuristics: The Foundations of Adaptive Behavior. New York: Oxford University Press.
[22] Goldstein, D.G. and Gigerenzer, G. (2002). Models of ecological rationality: The recognition heuristic. Psychological Review, 109: 75-90.
[23] Graziano, M. and Schiliro, D. (2011). Rationality and choices in economics: behavioral and evolutionary approaches, Theoretical and Practical Research in Economic Fields, II(2): 183-196.
[24] Hogarth, R.M. and Reder M.W. (1986). Editor’s comment: perspectives from economics and psychology, Journal of Business, 59(4): S185-S207.
[25] Kahneman, D. (2002). Maps of bounded rationality: a perspective on intuitive judgment and choice. Prize Lecture, December 8, 2002, Princeton University: 449-489.
[26] Kahneman, D. (2003). A psychological perspective on economics, AEA Papers and Proceedings, 93(2): 162-168.
[27[ Kahneman, D., Knetsch, J. L. and Thaler, R. H. (1991). The endowment effect, loss aversion, and status quo bias, Journal of Economic Perspectives, 5(1): 193-206.
[28] Kahneman, D. and Thaler, R.H. (2006). Anomalies: utility maximization and experienced utility, Journal of Economic Perspectives, 20(1): 221-234.
[29] Kahneman, D. and Tversky, A. (1972). Subjective probability: a judgment of representativeness, Cognitive Psychology, 3(3): 430–454.
[30] Kahneman, D., Tversky, A. (1973). On the psychology of prediction, Psychological Review, 80: 237-252.
[31] Kahneman, D., Tversky, A. (1979). Prospect theory. An analysis of decision under risk, Econometrica, 47(2): 263-292.
[32] Kahneman, D., Tversky, A. (1984). Choices, values and frames, American Psychologist, 39: 341-350.
[33] Malkiel, Burton G. (2003). The efficient market hypothesis and its critics, Journal of Economic Perspectives, 17(1): 59 – 82.
[34] Novarese, M., Castellani, M. and Di Giovinazzo, V. (2009). Procedural rationality and happiness, MPRA Paper 18290, University Library of Munich, Germany.
[35] Odean, T. (1998). Are investors reluctant to realize their losses? Journal of Finance, 53(5): 1775-1798.
[36] Odean, Terrance. (1999). Do investors trade too much? American Economic Review, 89 (5): 1279-1298.
[37] Rabin, M. (1998). Psychology and economics, Journal of Economic Literature, 36(1):11-46.
[38] Rabin, M. (2002). Inference by believers in the law of small numbers, Quarterly Journal of Economics, 117: 775–816.
[39] Rabin, M. (2002a). A perspective on psychology and economics, European Economic Review, 46(4-5): 657-685.
[40] Schilirò, D. (2012), Bounded rationality and perfect rationality: psychology into economics, Theoretical and Practical Research in Economic Fields, III(2): 101-111.
[41] Shefrin, H. and Thaler, R.H. (1988). The behavioral life-cycle hypothesis, Economic Inquiry, 26(4): 609 - 643.
[42] Shiller, R. J. (2005). Behavioral economics and institutional innovation, Cowles Foundation Discussion Paper No. 1499.
[43] Simon, H. A. (1955). A behavioral model of rational choice, Quarterly Journal of Economics, 69 (1): 99-118.
[44] Simon, H.A. (1956). Rational choice and the structure of the environment, Psychological Review, 63(2): 129-138.
[45] Simon, H.A. (1957). Models of man, social and rational: mathematical essays on rational human behavior in a social setting, New York: John Wiley and Sons.
[46] Simon, H.A. (1959). Theories of decision making in economics and behavioral science, American Economic Review, 49(3): 253-283.
[47] Simon, H.A. (1972). Theories of bounded rationality, in McGuire C.B. and Roy Radner, eds., Decision and organization, Amsterdam, North Holland Pub.Co.
[48] Simon, H.A. (1976). From substantive to procedural rationality, in Latsis Spiru J., ed., Method and appraisal in economics, Cambridge: Cambridge University Press: 129-148.
[49] Simon, H.A. (1979). Rational decision making in business organizations [Nobel Memorial Lecture], American Economic Review, 69(4): 493-513.
[50] Simon, H.A. (1982). Models of bounded rationality, Volume 2. Behavioral economics and business organization, Cambridge (MA): The MIT Press.
[51] Simon, H.A. (1997). Models of bounded rationality, Volume 3. Empirically grounded economic reason, Cambridge (MA): The MIT Press.
[52] Subrahmanyam, A. (2008). Behavioural finance: a review and synthesis, European Financial Management, 14(1): 12-29.
[53] Thaler, R.H. (1980). Toward a positive theory of consumer choice, Journal of Economic Behavior and Organization, 1(1): 36-60.
[54] Thaler, R.H. (1981). Some empirical evidence on dynamic inconsistency, Economics Letters, 8: 201-207.
[55] Thaler, R.H. (1999). Mental accounting matters, Journal of Behavioral Decision Making, 12:183-206.
[56] Thaler, R.H. (2003). Advances in Behavioral Finance II, New York, Russel Sage.
[57] Thaler, R.H. and Shefrin, H. (1981). An economic theory of self-control. Journal of Political Economy, 8(2): 392-406.
[58] Todd, P.M. and Gigerenzer, G. (2003). Bounding rationality to the world, Journal of Economic Psychology, 24: 143-165.
[59] Tversky, A. and Kahneman, D. (1973). Availability: A heuristic for judging frequency and probability, Cognitive Psychology, 5(2): 207-232.
[60] Tversky, A. and Kahneman, D. (1974). Judgment under uncertainty: heuristics and biases, Science, 185: 1124-31, September.
[61] Tversky, A. and Kahneman, D. (1981). The Framing of decisions and the psychology of choice, Science, 211: 453–458.
[62] Tversky, A. and Kahneman, D. (1983). Extensional vs. intuitive reasoning: the conjunction fallacy in probability judgment, Psychological Review, 90(4): 293–315.
[63] Tversky, A. and Kahneman, D. (1986). Rational choice and the framing of decisions, Journal of Business, 59(4): S251-S278, October.
[64] Von Neumann, J. and Morgenstern, O. (1944). Theory of games and economic behaviour, Princeton, Princeton University Press.
Published
2013-06-30
How to Cite
SCHILIRÒ, Daniele.
BOUNDED RATIONALITY: PSYCHOLOGY, ECONOMICS AND THE FINANCIAL CRISES.
Theoretical and Practical Research in Economic Fields, [S.l.], v. 4, n. 1, p. 97-108, june 2013.
ISSN 2068-7710.
Available at: <https://journals.aserspublishing.eu/tpref/article/view/1179>. Date accessed: 24 apr. 2024.
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