Chapter 8: Behavioral law and economics
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The rational investor, as we encounter him in most traditional economics textbooks, is a rather prudent fellow. He knows the financial markets inside out, dispassionately pursuing his well-understood self-interest by weighing the potential and risk of each product he buys or sells. Most observers of the latest financial crisis, however, will find it hard to square this image with the revelations following the great meltdown. What they were confronted with in the daily newscasts of that time were reckless types driven by excessive greed, exuberance and sometimes fear, who frantically traded complex financial products they often barely understood. It has been said that the crisis of 2007–08 not only shook the worldwide financial system; it also rattled the science of economics. Reality suddenly seemed to fly in the face of some of its most fundamental assumptions, leading to an outright crisis of the discipline itself. Yet every crisis generates some profiteers. Accordingly, the slump for conventional economic wisdom created a ‘bull market’ for a group of economists who had long doubted some tenets of their discipline – most importantly, the theory of rational choice. The critique focused primarily on the behavioral model underlying conventional economics. Such critique is, in particular, voiced by a relatively new movement in legal studies, most often referred to as behavioral law and economics.