Keynes and Macroeconomics After 70 Years
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Keynes and Macroeconomics After 70 Years

Critical Assessments of The General Theory

Edited by L. Randall Wray and Matthew Forstater

In this substantial new collection, esteemed Post-Keynesian scholars reassess the relevance of Keynes’s The General Theory to a broad array of topic areas, ranging from the environment, investment finance, exchange rates, and socialism, as well as inquiries into general Post-Keynesian theory.
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Chapter 14: Keynes’s Theory of Probability, Investment Behavior, and

Behavioral Finance and Edwin Dickens


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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