History of Behavioral Economics
History of Behavior Finance/Economics
The Beginnings
Economics and psychology were closely linked dating back to Adam Smith, considered a founding father of modern economics. Economists considered utility, the relative happiness from certain economic purchases of goods and services, to be a psychological influence on people’s financial decisions. Entering what is known as the neo-classical era of economic thought; economists began to separate themselves from psychology. They felt that economics was a natural science, one which rational thought governed decisions. In neo-classical economics, the theory of Homo Economicus, or the Economic Man, became popular. Simply put, this theory asserts that an individual acts according to rational self-interest, seeking wealth through efficient laboring.
The Middle
Half a century ago psychology began to creep back into the realm of economics as behavioral finance was born. In the 1960’s Amos Tversky and Daniel Kahneman (psychologists) started examining the relationship between cognitive decision making in situations of risk and uncertainty and rational behavior models of economics. In 1979 they published Prospect Theory: Decision Making Under Risk, which has turned out to be one of the most influential works in behavioral finance. This work explains the psychological reasoning behind certain non rational economic decisions. Tversky had already passed away, but in 2002 Kahneman won the Nobel Prize for his work. According to the committee, Kahneman was awarded for, “having integrated insights from psychological research into economic science, especially concerning human judgment and decision-making under uncertainty."
Today
Today, behavioral finance is a hot-button issue in the economic field. Supporters feel it is necessary to continue the co-study of psychology and economics. Critics, on the other hand, are weary of experimental bias and feel that ‘classroom’ results do not necessarily transfer to the real world market place.
