Opinions
13 October 2017
171013-image-Richard_Thaler.jpg
llustration: Niklas Elmehed. Copyright: Nobel Media AB 2017

Awarding the Nobel Prize for economics to Richard Thaler is not only a recognition of his work but also of the way people think about markets: that it now incorporates psychological concepts, not just mathematical ones.

Thaler’s work touches – possibly unnoticed - many of the ways professionals in financial markets think and work. His theories of mental accounting, house money and the endowment effect can explain not just how individual investors make decisions, but the choices fund managers and traders make too.

Thaler even appeared in the movie The Big Short with Selena Gomez (an honour some might say rivals his Nobel Prize) explaining how Tversky, Gilovich and Vallone’s hot hand fallacy related to the 2007 collapse of the USA mortgage market.

And while it was his 2008 book Nudge, co-authored with Cass Sunstein, that brought him to the attention of the general public, his influence in finance and economics pre-dates this by decades.

Thaler is not the first person to receive the Nobel Prize for questioning the concept of rationality that underpins much of markets analysis

Thaler was one of the earliest traditionally trained economists who systematically questioned some of the fundamental thinking behind economic models, which he outlines in his 2015 memoir '' The making of behavioural economics: Misbehaving".

Arguably his earliest prominent interventions began in 1987 when the first of his “anomalies” columns was published in the American Economic Association’s Journal of Economic Perspectives. That column was on the January effect – the tendency for stock prices to rise in the first month of the year. He continued to write these columns for the next two decades.

Thaler is not the first person to receive the Nobel Prize for questioning the concept of rationality that underpins much of the markets analysis finance, and economic professionals make.

Winners Daniel Kahneman (2002), Robert Shiller (2013) and Herbert Simon (1978) each questioned it too. Arguably, Vernon Smith - who shared the prize with Kahneman in 2002 – also fits within this group.

And what was pioneering in 1987 is almost standard fare nowadays. Asset managers now incorporate behavioural approaches in considering portfolio construction and market valuation; regulators now have behavioural science units to apply lessons from the field to products and markets.

But Thaler himself, writing in the American Economic Journal in 2016 says in fact that the journey has only really begun. “Indeed, my sense is that we are at the beginning of a new wave of theoretical developments made possible simply by turning our attention to the study of Humans rather than Econs,” he writes.

And when the journey is complete, in a sense economics will only have come full circle.

In his own words

“I think it's time to stop thinking about behavioural economics as some kind of revolution. Rather, behavioural economics should be considered simply a return to the kind of open-minded, intuitively motivated discipline that was invented by Adam Smith and augmented by increasingly powerful statistical tools and datasets.

“This evidence-based discipline will still be theoretically grounded, but not in such a way that restricts our attention to only those factors that can be derived from our traditional normative traditions.”

If economics does develop along these lines, the term “behavioural economics” will eventually disappear from our lexicon.


Disclaimer

"THINK Outside" is a collection of specially commissioned content from third-party sources, such as economic think-tanks and academic institutions, that ING deems reliable and from non-research departments within ING. ING Bank N.V. ("ING") uses these sources to expand the range of opinions you can find on the THINK website. Some of these sources are not the property of or managed by ING, and therefore ING cannot always guarantee the correctness, completeness, actuality and quality of such sources, nor the availability at any given time of the data and information provided, and ING cannot accept any liability in this respect, insofar as this is permissible pursuant to the applicable laws and regulations.

This publication does not necessarily reflect the ING house view. This publication has been prepared solely for information purposes without regard to any particular user's investment objectives, financial situation, or means. The information in the publication is not an investment recommendation and it is not investment, legal or tax advice or an offer or solicitation to purchase or sell any financial instrument. Reasonable care has been taken to ensure that this publication is not untrue or misleading when published, but ING does not represent that it is accurate or complete. ING does not accept any liability for any direct, indirect or consequential loss arising from any use of this publication. Unless otherwise stated, any views, forecasts, or estimates are solely those of the author(s), as of the date of the publication and are subject to change without notice.

The distribution of this publication may be restricted by law or regulation in different jurisdictions and persons into whose possession this publication comes should inform themselves about, and observe, such restrictions.

Copyright and database rights protection exists in this report and it may not be reproduced, distributed or published by any person for any purpose without the prior express consent of ING. All rights are reserved.

ING Bank N.V. is authorised by the Dutch Central Bank and supervised by the European Central Bank (ECB), the Dutch Central Bank (DNB) and the Dutch Authority for the Financial Markets (AFM). ING Bank N.V. is incorporated in the Netherlands (Trade Register no. 33031431 Amsterdam).