by Simon Bond

Investors always say they are going to buy the "dips”, that is until the dips come, then they consider selling. It has to do investor psychology.

Behavioural economics is, in a way, at the intersection of economics and psychology. On one hand, traditional economic theory assumes that people are perfectly rational, patient, computationally proficient little economic robots that know objectively what makes them happy and make choices that maximise this happiness. (Even if traditional economists acknowledge that people aren’t perfect utility-maximisers, they usually argue that the deviations are random rather than showing evidence of consistent biases.)

Behavioural economists, on the other hand, know better, they aim to develop models which account for the facts that people procrastinate, are impatient, aren’t always good decision-makers when decisions are hard (and sometimes even avoid making decisions altogether), go out of their way to avoid what feels like a loss, care about things like fairness in addition to economic gain, are subject to psychological biases which make them interpret information in biased ways, and so on.

These deviations from traditional theory are necessary if economists are to understand empirically how people make decisions about what to consume, how much to save, how hard to work, how much schooling to get, etc. Furthermore, if economists understand the biases that people exhibit that lower their objective happiness, they can put on a bit of a presciptive, or normative, hat in either a policy or a general life advice sense.

Technically speaking, behavioural economics was first acknowledged by Adam Smith back in the eighteenth century, when he noted that human psychology is imperfect and that these imperfections could have an impact on economic decisions. This idea was mostly forgotten, however, until the Great Depression, when economists such as Irving Fisher and Vilfredo Pareto started thinking about the "human" factor in economic decision-making as a potential explanation for the stock market crash of 1929 and the events that transpired after.

Economist Herbert Simon officially took up the behavioural economics cause in 1955 when he coined the term "bounded rationality" as a way to acknowledge that humans don't possess infinite decision-making capabilities. Unfortunately, Simon's ideas weren't initially given a lot of attention (though Simon did win a Nobel Prize in 1978) until a couple of decades later.

Behavioural economics as a significant field of economic research is often thought to have started with the work of psychologists Daniel Kahneman and Amos Tversky. In 1979, Kahneman and Tversky published a paper entitled "Prospect Theory" that offers a framework for how people frame economic outcomes as gains and losses and how this framing affects people's economic decisions and choices.

Prospect theory, or the idea that people dislike losses more than they like equivalent gains, is still one of the main pillars of behavioural economics, and it is consistent with a number of observed biases that traditional models of utility and risk aversion cannot explain.

That said, behavioural economics is still a very new field, so there is a lot more left to learn.