Homo economicus – or more like Homer Simpson?

- "The final judgement has not yet been passed on what prompted the recent financial market crisis. The Fed‟s loose monetary policy, regulatory and supervisory shortcomings, the banks‟ unbridled pursuit of profit, and systemic complexity, not to mention non-rational behaviour by economic agents, have all been advanced as explanations. As a result, the homo economicus model still common in economic theory, which effectively forms the microeconomic basis for market efficiency, has once again come under hefty criticism."
- "In this paper the assumptions of the homo economicus model are compared with the results of psychological experiments. It clearly emerges that in real life people do not always make rational decisions based on established preferences and complete information. In many ways their behaviour thus contradicts the homo economicus model. Much of the behaviour observed is caused through people trying to cope with the complexity of the world around them by approximating, because collating and evaluating all the factors of relevance to a decision overtaxes their mental processing capacity. As a rule these approximation methods deliver serviceable results, but they often also lead to distorted perceptions and systematic flaws."
- "These psychologically driven inadequacies also occur with investment decisions. Distortions arise due to information availability, errors of judgement about how representative such information is, loss aversion, the search for confirmation, isolation and endowment effects, status quo bias and – particularly on the financial markets – the misinterpretation of patterns."
- "Investors and investment advisors should be aware of these effects when assessing financial products, when estimating future factors of relevance to the success of an investment decision and their own appetite for risk, and when considering their own investment behaviour – especially since they are dealing with typically non-linear processes in conjunction with long maturities for some financial investments."
- "Making allowance for these effects in investment decisions can help avoid wrong decisions – but it is still no guarantee of above-average performance."
DeutscheBank International Topics 20100629