The Behavioural Finance Revolution
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The Behavioural Finance Revolution

A New Approach to Financial Policies and Regulations

Edited by Riccardo Viale, Shabnam Mousavi, Barbara Alemanni and Umberto Filotto

Financial markets are complex. Regulators strive to predict ways in which they can malfunction and create rules to prevent this from happening, yet behavioural impacts are often overlooked. This book explores how behavioural finance can go hand-in-hand with traditional methods to help banks and regulators create better policies. It also demonstrates how the behavioural finance revolution has opened the way to a more integrated approach to the analysis of economic phenomena.
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Chapter 10: The heuristics revolution: rethinking the role of uncertainty in finance

Gerd Gigerenzer

Abstract

Modern finance has been shaped by the probabilistic revolution in physics. Following the portfolio-allocation framework of Markowitz and Merton, the assumption has been that all risks can be measured, priced and hedged, as in roulette. Yet banks do not play in a casino, but in the real, mostly uncertain world of finance. Under conditions of uncertainty (as opposed to risk), fine-tuned risk modeling is likely to fail, while robust heuristics are likely to succeed. This chapter uses insights from the study of heuristics to sketch the heuristics revolution in finance and behavioral finance: (1) to improve financial literacy of the general public by teaching useful heuristics, not just financial concepts; (2) to study systematically the heuristics that successful investors rely on; and (3) to investigate robust heuristics for banking regulation that make the financial world safer, as pioneered by the Bank of England.

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