11. Behavioral Finance and the Role of Psychology



Financial Markets (2011) (ECON 252)

Deviating from an absolute belief in the principle of rationality, Professor Shiller elaborates on human failings and foibles. Acknowledging impulses to exploit these weaknesses, he emphasizes the role of factors that keep these impulses in check, specifically the desire for praise-worthiness from Adam Smith’s The Theory of Moral Sentiments. After a discourse on Personality Psychology, Professor Shiller starts a list of important topics in Behavioral Finance with Daniel Kahneman’s and Amos’s Tversky’s Prospect Theory. The value function and the probability weighting function, as two key components of this theory, help explain certain patterns in people’s everyday decision making, e.g. the existence of diamond ring insurance and airline flight insurance. An in-class experiment underscores the prevalence and importance of the concept of overconfidence. Further topics include Regret Theory, gambling behavior, cognitive dissonance, anchoring, the representativeness heuristic, and social contagion. Professor Shiller concludes the lecture with some perspectives on moral judgment in the business world, addressing shared values and integrity.

00:00 – Chapter 1: Human Failings & People’s Desire for Praise-Worthiness
11:37 – Chapter 2. Personality Psychology
20:14 – Chapter 3. Prospect Theory and Its Implications for Everyday Decision Making
35:53 – Chapter 4. Regret Theory and Gambling Behavior
40:40 – Chapter 5. Overconfidence, and Related Anomalies, Opportunities for Manipulation
57:16 – Chapter 6. Cognitive Dissonance, Anchoring, Representativeness Heuristic, and Social Contagion
01:12:38 – Chapter 7. Moral Judgment in the Business World

Complete course materials are available at the Yale Online website: online.yale.edu

This course was recorded in Spring 2011.

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