Behavioral economics – Is an atheoretical approach harmful?

| | Economics

Behavioral economics research has been path breaking and has truly impacted the thinking of most investors. Psychology is fundamental to human decision-making and our knowledge and understanding of economic agents has been enhanced through the large body of research in this area. Through finding exceptions and breaking down conventional utility maximization theory and wisdom, behavioral economic has advanced science, yet this work is not completely fulfilling. Our knowledge is filled with behavioral exceptions and leaves us with the impression that our decision-making skills are psychological damaged, but there is no unifying framework for how the range of biases fits within utility maximization, consumer behavior, market efficiency, and general decision-making. 

 

My anxiousness is with the atheoretical nature of this work. Research based on exceptions or storytelling is effective at punching holes in existing theory but the broad list of biases has not replaced the current paradigm with a new framework. Perhaps we are still early in the process; nevertheless, the need for a theory/model/narrative construct is all the more important to support the foundation of economics; good theory with testable hypotheses. These points are well articulated by Ran Spiegler in the current issue of the American Economic Journal: Microeconomics, “Behavioral Economics and the Atheoretical Style”.


The author contrasts behavioral economics with game theory. Game theory has provided a rich set of theories to explain, test, and predict behavior. A collection of behavioral biases no matter how large cannot replace the existing paradigm of thinking about choice. Any paradigm shift needs a new theory to supplant the old. This is more than an interesting discussion on theory. Investors everywhere know about behavioral biases as lists of bad behavior, but to truly improve behavior, theory is needed to provide a scaffolding to bind our thinking.