Tuesday, November 04, 2008

The behavioral revolution in economics

In light of the work by Delgado et al. mentioned in today's other posting, I thought it appropriate to pass on this NY Times Op-Ed piece by David Brooks, on the decline of economic models that presume that people are mostly engaged in rationally calculating and maximizing their self-interest. Rather, people put great energy in perceiving things that aren't true. Brooks emphasizes the work of Taleb:
Taleb believes that our brains evolved to suit a world much simpler than the one we now face. His writing is idiosyncratic, but he does touch on many of the perceptual biases that distort our thinking: our tendency to see data that confirm our prejudices more vividly than data that contradict them; our tendency to overvalue recent events when anticipating future possibilities; our tendency to spin concurring facts into a single causal narrative; our tendency to applaud our own supposed skill in circumstances when we’ve actually benefited from dumb luck.

And looking at the financial crisis, it is easy to see dozens of errors of perception. Traders misperceived the possibility of rare events. They got caught in social contagions and reinforced each other’s risk assessments. They failed to perceive how tightly linked global networks can transform small events into big disasters.

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