Edited by Riccardo Viale, Shabnam Mousavi, Barbara Alemanni and Umberto Filotto
The chapter introduces some relevant neurocognitive topics on financial behaviour: the biases in financial predictions; the role of emotions in changing the weight of probability in financial risk assessment; the pragmatic aspect of communication in the financial market; the new neural discoveries about the phenomena of economic mirroring, imitation and free will; the emerging topic of organizational financial heuristics. Most of these data represent important knowledge to improve financial policy making and in particular to strengthen the new approach of behavioural policy making and regulation.
Behavioral policymaking views both policymakers and policytakers as boundedly rational agents who use heuristics. Therefore, understanding heuristic decision-making provides behavioral insights for the design and implementation of policies. Literature on bounded rationality in politics is closely connected to the study of heuristics in psychology, studied either in association with cognitive biases that limit the ability to fully account for information, or alternatively as simple but effective strategies in the absence of or without considering complete information. I argue that economists are now equal partners with psychologists in behavioral policymaking, provide a review of select work on the relationships between bounded rationality and political decision-making, and sketch some requirements for a theory of bounded rationality that can incorporate real-world irreducible uncertainty and the heuristic nature of decision-making. The future of macroeconomics – one that could effectively partner behavioral policymaking – emerges from platforms, such as BEFAIRLY, where academia interacts with government and industry.
Conventional economic theory has been the traditional base for public policymaking for many years; however, over the last decade a new behavioural movement has inspired interventions in several countries. In practice, policymakers have so far agreed on an array of policies often labelled as ‘behavioural policies’. The behavioural suffix in policy application is used to describe quite heterogeneous and diverse interventions. It is often unclear to which aspect of a policy formulation the term ‘behavioural’ refers, where practitioners, policy-makers and researchers often use or assume quite different definitions of the term ‘behavioural’. This chapter tries to put order on the different uses separating methods, insights and proper rules in particular in financial policymaking. The behavioural approach is not in antithesis with the conventional, rational approach but it represents a natural progression. Nudges and boosts, while distinct and somehow in contrast, are policy approaches ranging at the further end of this progression.
Behavioral regulation is on the agenda of politicians and authorities of most countries as coercive legislation has financial and political costs that are becoming difficult to afford. However, not all measures are equivalent, and not all of them are effective and appropriate in any situation: some issues have thus to be discussed to develop an effective and balanced approach. The preliminary step is the development of a shared vision of objectives of the regulation; once this is reached there are some issues specific to the behavioral approach. The first one is answering the question of the preferability of the gentle push over mandatory rules; then, if we accept the fact that regulators have the right and the duty to regulate, we should be confident that they are competent enough; finally there is the issue of responsibility: what happens, who is responsible and what are the consequences if things go wrong?
Benoit Mojon, Adrian Penalver and Adriana Lojschova
Non-conventional monetary policy works in part because of what people believe. And these beliefs are not always fully rational in a textbook sense. This chapter describes two examples in which beliefs can affect outcomes. In the first example we explain how the effectiveness of forward guidance depends on whether people perceive it as an unconditional commitment that policy interest rates will stay low or as an adverse signal about economic prospects. Forward guidance can become counterproductive if more people perceive it as the latter than the former. In the second example we show that large-scale bond purchases by central banks can raise bond prices just because people believe they should. Both these examples show that behavioural finance has insights for monetary policy making.
Massimo Egidi and Giacomo Sillari
In this chapter we address theoretical developments of choice models in the financial field, starting with the famous efficient market hypothesis (EMH) in financial markets and its implications, then moving on to a review of the theoretical and empirical challenges posed by psychological and behavioral studies to the EMH, paying particular attention, once again, to these arguments’ implications on the activity of financial operators. Finally, we look at the most recent studies aimed at identifying the neurophysiological links of financial choices.
Enrico Maria Cervellati
This chapter presents a personal (thus biased) view of the evolution of behavioral economics, which the author believes constitutes a revolution in economics or, better, a re-evolution of economics, since economics is behavioral in nature, it was behavioral at its outset, and finally returned to being behavioral. The chapter claims that most classical economists were behavioral economists since they considered psychology and sociology in their studies. While Simon’s idea of limited rationality anticipated behavioral economics, the work of Kahneman and Tversky and of the first modern behavioral economists such as Thaler, Shiller, Shefrin and Statman, among others, can be considered the first generation of behavioral studies. In recent years, behavioral economists went ‘in action’, suggesting solutions to biases or how to exploit them to the benefit of people. It is now time for a third generation of ‘personalized’ behavioral economics that accounts for individual personalities.
Research and studies concerning bank regulation and supervision have rarely crossed paths with behavioral finance. Regulators set rules and supervisors apply them, after interpreting the factual situation and according to their judgment. Therefore regulators and supervisors modify economic agents’ incentives, orient their expectations, and influence their beliefs. Bank customers’ behaviors are very much related to supposed bank liquidity and solvency and, basically, to bank reputation. Regulators and supervisors are major contributors to bank reputation. Bank deposits are believed to be liquid on creditors’ call. Regulators and supervisors bear great responsibility in this since they provide a rationale for trust, because banks’ balance-sheets are inherently opaque. Given that economic agents have a varying degree of financial education, the accountability of regulators and supervisors involves obvious problems of disclosure and communication.