behavioural economics

Behavioural EconomicsMasterclass by Rupesh Parikh

Game 1

Would you rather:a) Receive £450 in cash nowb) Have 50% chance of receiving

£1000, but also 50% chance of receiving nothing

Game 2

Would you rather:a) Lose £450 in cash nowb) Have 50% chance of losing £1000,

but also 50% chance of losing nothing

Are economists' assumptions good

approximations of real people's behaviour?

E.g.1 Bernie Madoff

Trader and Broker Reported

abnormally large returns of 5.6% in 2008

$36bn transferred into his fund

SCAM Collapse

E.g.2 LTCM Investment Firm Run by Merton and

Scholes Nobel Prize

winners for theory of market manoeuvres regarding US and Soviet bonds

Market did not act as empirical suggestions denoted

Bankruptcy

E.g.3 David Li

Actuary / Quant Mathematical

correlation theory (Gaussian Copula)

Assumed that market would function at all times

Aggregate changed – but the model didn’t

Collapse

Keynes – Animal Spirits

Decisions often made out of a spontaneous urge to react

Cornerstone of economic theory is consumer confidence

The key, therefore, is to revive confidence in markets.

This should not tip over to arrogance!

Confidence

Bubbles

Economic Froth driven by human behaviour acting irrationally

Bubbles are created – don’t match the law of demand!

Story of 2008...

Conclusions

Greed ? Is it an animal spirit? Was it rational to start selling sub-

prime? Was it a good idea invest in a bubble

based on other people’s investment?

http://www.youtube.com/watch?v=bx_LWm6_6tA