A Review on “A Perspective on Psychology and Economics” of Matthew Rabin

During Behavioural Accounting Workshop in Kuala Lumpur, Prof Tan from NTU addressed shocking information: “Most of accounting, economics, and management scholars have wrong conclusion in behavioural research because most of them never take any formal education of psychology”. Indeed, I do agree with that. Most papers in behavioural economics hanged the conclusion up to addressing the results. No further elaboration with psychology perspective. For example is the Role of full moon on investor behaviour. Rarely found a paper elaborate the findings with Forgas Affect Infusion Model or the Somatic Marker or other psychology literature. It just reported there is an effect of full moon on investor behaviour. That’s all. No robust discussion.

Interestingly, I found a working paper of Matthew Rabin entitled “A Perspective on Psychology and Economics”. The flow is very interesting. It starts with the potential of behavioural economics in the future, then the unrealistic assumption in mainstream economics where behavioural economics tries to fill in, and how we can use psychology to fill in the unrealistic economics assumption. Here is the review.

“A Perspective on Psychology and Economics” by Matthew Rabin

Over the years, the main stream economics has been believed pyschologically unrealistic. There are three groups of behavioural finance have addressed their own perspective on the conventional economics. Daniel Kahneman, Amos Tversky, Richard Thaler, Colin Camerer and George Loewenstein, have criticized the basic tenet of conventional finance which is rational behaviour. Second group (such as Tom Schelling and George Akerlof) propose the alternative of the conventional economics approach. Lastly, prominent economists such as Ken Arrow, Peter Diamond, Dan McFadden, and Robert Solow advocated broadening the scope of conventional finance by gauging behaviour of agents.

This recent explosion of interest raises the worry that it is just a fad. However, the appreciation from the world to this “minor” course has rejected that “fad issue”. Moreover, while there is still a lot of controversy, behavioural economics is on the verge of “going mainstream”. Researchers such as David Laibson in macroeconomics and Ernst Fehr in labour economics have established themselves within mainstream economic fields. In several of the top U.S. economics departments, graduate students are being offered field courses in behavioral economics, and students in such departments are writing dissertations in the area. It shows the important of behavioural economics.

The wave of proving the basic tenet of conventional economics was already passed. The Anomalies, hedonic utility, prospect theory, and other dossiers of the argument on conventional economics assumption were so past years. Nowadays, it is an era of second wave which moves beyond pointing out problems with current economic assumptions, and even beyond articulating alternatives, and on to the task of systematically and formally exploring the alternatives with much the same sensibility and mostly the same methods that economists are familiar with.

There are many assumptions that conventional economics often make about human nature that behavioral and psychological research suggests are often importantly wrong. These

assumptions are that people: (1) are Bayesian information processors; (2) have well-defined and stable preferences; (3) maximize their expected utility; (4) apply exponential discounting weighting current and future well-being; (5) are self-interested, narrowly defined; (6) have preferences over final outcomes, not changes; and (6) have only “instrumental”/functional taste for beliefs and information.

The goal of psychological economics is to investigate behaviourally grounded departures from these assumptions that seem economically relevant. For a more concrete frame of reference, consider the following formulation of the classical economic model of individual choice, where uncertainty is integrated as probabilistic states of the world, with a utility function that may depend on these states of the world, and the assumption that the person maximizes expected value. There are 4 psychology aspects that can fit in on the “leak” of conventional finance which are: (1) Caring About Changes, (2) Caring About Others, (3) Self Interest and Economics, and (4) Caring About Now.


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