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Like I always found the appeal to the market gods a bit odd. Why would the market fix mistakes instead of aggravating them? When the Chicago economists sometimes (reluctantly) admit that people make mistakes, they claim that people make different types of mistakes that will eventually cancel each other out in the market. Behavioral economics argues that, instead, people will often make the same mistake, and the individual mistakes can aggregate in the market. Let’s take the subprime mortgage crisis, which I think is a great example (but a very sad reality) of the market working to make the aggregation of mistakes worse. It is not as if some people made one kind of mistake and others made another kind. It was the fact that so many people made the same mistakes, and the market for these mistakes is what got us to where we are now.
How would a behavioral economist look at the sub-prime mortgage crisis in any way that is different from a rational economist?
Here is my perspective on the sub-prime mortgage crisis: When the housing market was hot, all the bankers that gave out loans assumed that their customers didn’t want their house to go into foreclosure, and that they would act accordingly. (more…)
Last Friday I was honored with the Ig Nobel award in Medicine for a paper that Rebecca Waber, Ziv Carmon, Baba Shiv and I wrote on the effects of discounts on the efficacy of placebo pain medications. We basically showed that when drugs are discounted they just don’t work as well. We also tried to make the point that this basic effect of expectations might also be the reason that people just don’t experience generic drugs to be as effective as brand name medications. (more…)
“In theory, there is no difference between theory and practice, but in practice there is a great deal of difference.”
This is in my mind the basic lesson we learned this week from the negative reactions of the markets to the bailout.
Given this, do you think we should revisit the bailout and maybe give the money directly to people who are struggling with their mortgages (maybe buying 1/2 of their mortgages and homes) instead of using the money to buy the financial instruments that represent these mortgages?
Sadly yours
Dan
Dear Irrational,
I am a finance professor at one of the top business schools in the U.S., and I am starting to doubt the assumptions of irrationality based on what I see in my students.
Here is the story: Every year when I teach the basic finance class to either the MBAs or the executive MBAs we get to the point where we talk at length about the benefit of diversification, including how to think about risk and return. (more…)
The WSJ recently reviewed a book called “Billion Dollar Lessons”
Here is one of the stories from the book (and the review): (more…)
I would like to propose that one reason people oppose the government bailout is because they want revenge on the companies that helped lead us into this disaster. Even though they know they will lose money and it doesn’t help them at all, at a very basic level a part of them want to see the companies suffer. (more…)