Thaler: We’re more Homer Simpson than Spock

On September 7th at the Morningstar ETF Conference in Chicago, I had the good fortune to sit down with professor Richard Thaler of University of Chicago’s Booth School of Business; a month later, he won the Nobel Memorial Prize in Economic Sciences (I am not suggestion any causation here, but . . . )

His books include The Winner’s Curse: Paradoxes and Anomalies of Economic Life; Nudge: Improving Decisions About Health, Wealth, and Happiness (co-written by Cass Sunstein); and most recently Misbehaving: The Making of Behavioral Economics. Thaler also is a principal at Fuller & Thaler, an asset-management firm with $8 billion in assets.

Here is an excerpt; you can read the entire conversation at Morningstar:

Barry Ritholtz: Let’s start with an idea of yours from one of your more recent books that I found fascinating. It’s what you call “econs versus people.” Conventional economics assumes that people are highly rational and unemotional. They can calculate like a computer and have no self-control problems. That leads to two obvious questions. The first is how does this manifest itself in everyday economic choices?

 Richard Thaler: Well, the main point is that we’re not econs. We have a theory based on fictional characters. Think of Spock in the old Star Trek series. He’s an econ.

Ritholtz: Or at least tries to be.

Thaler: Pretty much succeeds.

Ritholtz: Pon farr?1 If you really want to get wonky….

Thaler: No, no, no, I don’t want to go there. But he’s close—closer than you or me—versus, say, Homer Simpson. If you were building a model of economic agents, what would be better— a model of Spock or a model of Homer Simpson?

Ritholtz: Certainly, Spock would be desirable, but Homer Simpson is the reality.

Thaler: Yes. So, economics is supposed to be about reality. Economics is not a theory of experts. That’s a mistake that lots of people make— that it’s built as if everyone knew as much about a subject as the economists studying it.

Ritholtz: So, the second question: How is a social science, such as economics, built on such a fundamentally flawed assumption?

Thaler: It didn’t used to be. I would say economics through World War II was behavioral economics. Starting with Adam Smith—especially The Theory of Moral Sentiments, the book before The Wealth of Nations—through Keynes, economics was behavioral.

Then, there was a period of the great mathematization of economics that started with people like Paul Samuelson. If you’re going to write down mathematical models, the easiest models to write are the ones where people are rational, because you just write max and solve, and if you can take a derivative and set it equal to zero, then you’re an economic theorist.

If people are doing something more complicated than that, like buying a stock or a fund because of its ticker symbol, good luck writing that down in a mathematical model.

Ritholtz: Yet the history shows that more memorable ticker names outperform random letters and random names.

Thaler: Right. So, behavioral economics is messy. Traditional economics is precisely wrong.

Continues at: Morningstar


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