Nobel Laureate Richard H. Thaler on the End of Behavioral Finance

Richard H. Thaler, the US economist who elevated the word “nudge” from transitive verb to political catchphrase, can now add “Nobel laureate” to his impressive biography.

On Monday, the Royal Swedish Academy of Sciences in Stockholm announced that Thaler, who teaches at the Booth School of Business at the University of Chicago, had won the 2017 prize in economics “for his contributions to behavioral economics.”

BREAKING NEWS The 2017 Prize in Economic Sciences is awarded to Richard H. Thaler @R_Thaler @UChicago @ChicagoBooth #NobelPrize pic.twitter.com/mbQijTyE7t

— The Nobel Prize (@NobelPrize) October 9, 2017

In a statement, the Royal Swedish Academy said that Thaler “has incorporated psychologically realistic assumptions into analyses of economic decision-making. By exploring the consequences of limited rationality, social preferences, and lack of self-control, he has shown how these human traits systematically affect individual decisions as well as market outcomes.”

Thaler is perhaps best-known for his popular book about choices: Nudge: Improving Decisions about Health, Wealth, and Happiness — how we make them and what we can do to improve how we make them. His “nudge” theory is also credited with inspiring former UK prime minister David Cameron’s Behavioural Insights Team (BIT) — or “Nudge Unit.” Thaler reportedly “visited Britain in 2008 to promote his theory, met Cameron, and made such an impression that for a time he acted as unpaid adviser to the Tory leader.”

Former US president Barack Obama also officially adopted the “nudge” approach when he created the Social and Behavioral Science Team (SBST), which sought to integrate behavioral science research into policy making.

Shortly after the announcement from Sweden, fellow economist Tyler Cowen wrote:

“This is a prize that is easy to understand. It is a prize for behavioral economics, for the ongoing importance of psychology in economic decision-making, and for ‘Nudge,’ his famous and also bestselling book co-authored with Cass Sunstein.”

Cowen also noted that “perhaps unknown to many, Thaler’s most heavily cited piece is on whether the stock market overreacts for psychological reasons.”

Perhaps also unknown to many is that Thaler spoke at the 70th CFA Institute Annual Conference in Philadelphia this past May.

My colleague, Shreenivas Kunte, CFA, wrote a recap of the session, entitled “Richard Thaler: To Intervene or Not to Intervene.” Another colleague, Ron Rimkus, CFA, conducted a 13-minute interview with Thaler.

Thaler has also contributed to the CFA Institute Financial Analysts Journal^®, among other CFA Institute publications over the years.

In his prescient conclusion to the 1999 piece, “The End of Behavioral Finance,” he wrote:

“Behavioral finance is no longer as controversial a subject as it once was. As financial economists become accustomed to thinking about the role of human behavior in driving stock prices, people will look back at the articles published in the past 15 years and wonder what the fuss was about. I predict that in the not-too-distant future, the term ‘behavioral finance’ will be correctly viewed as a redundant phrase. What other kind of finance is there? In their enlightenment, economists will routinely incorporate as much ‘behavior’ into their models as they observe in the real world. After all, to do otherwise would be irrational.”

Additional Thaler-Related Content:

• Thaler presented a compelling analysis of the “Architecture of Choice” in an audio podcast.
• In “Theoretical Foundations I,” published in June 2001, Thaler explored the equity risk premium. According to the article’s abstract:

“One of the puzzles about the equity risk premium is that in the U.S. market, the premium has historically been much greater than standard finance theory would predict. The cause may lie in the mismatch between the actual asset allocation decisions of investors and their forecasts for the equity risk premium. In this review of the theoretical explanations for this puzzle, two questions are paramount: (1) How well does the explanatory theory explain the data? (2) Are the behavioral assumptions consistent with experimental and other evidence about actual behavior? The answers to both questions support the theory of ‘myopic loss aversion’ — in which investors are excessively concerned about short-term losses and exhibit willingness to bear risk based on their most recent market experiences.”

• Back in 2003, CFA Magazine spoke with Thaler, among other pioneers of behavioral finance. Their combined stories document the genesis and development of the field.
• In “Risk: The Final Frontier,” my colleague Roger Mitchell quotes Thaler at length. Of particular interest for practitioners are his comments about the behavioral approach adopted by the firm he founded.
• And in “Missed Behavior,” Thaler discussed the possible connection between cognitive biases and unethical behavior.

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All posts are the opinion of the author. As such, they should not be construed as investment advice, nor do the opinions expressed necessarily reflect the views of CFA Institute or the author’s employer.

Image Credit: W Scott Mitchell 2016