# Keynes and Macroeconomics After 70 Years

## Critical Assessments of The General Theory

## Edited by L. Randall Wray and Matthew Forstater

# Chapter 14: Keynes’s Theory of Probability, Investment Behavior, and

## Behavioral Finance and Edwin Dickens

## Extract

behavioral ﬁnance Edwin Dickens INTRODUCTION This chapter is a contribution to the Post Keynesian literature (for example, Carabelli, 1988; O’Donnell, 1989; and Gerrard, 1992 (on the link between Keynes’s theory of probability (that is, Keynes, 1921 [1973]: Part I) and his theory of investment behavior (that is, Keynes, 1936 [1964]: Book IV). My interpretation of this link is as follows: for any given investment project, Keynes shows that the probability of the payoﬀ, and thus the expected proﬁt, is less than the estimates of orthodox economists. To substantiate my interpretation, I make reference to the behavioral-ﬁnance literature on the winner’s curse, betting quotients, preference reversals and loss aversion.1 For Keynes, the major problem with orthodox probability theory is the concept of risk that it implies. The orthodox concept of risk is derived from the deﬁnition of probability in terms of the principle of non-suﬃcient reason. However, orthodox economists assume, often implicitly, that it is also implied by the deﬁnition of probability in terms of the law of large numbers.2 In contrast, Keynes derives his concept of risk from the deﬁnition of probability in terms of the logical relationship between propositions, which opens the way for him to introduce the concept of the weight of arguments. Consequently, this chapter is structured as follows. In the next section, I derive the orthodox concept of risk from the deﬁnition of probability in terms of the principle of non-suﬃcient reason. I then explain why the winner’s...

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