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Nobel Prize in Economics – behavioural finance recognised

Professor Richard H. Thaler of the School of Business at the University of Chicago has been awarded the Nobel Prize in Economics for his work within behavioural finance. This is the second time a behavioural finance economist has won the prize since Daniel Kahneman in 2002.

Behavioural finance identifies cognitive biases that cause people to use faulty logic and consequently make irrational decisions, as opposed to traditional microeconomic theories that assume that individuals are always rational.

Professor Thaler is perhaps most famous for his relatively recent work on ‘libertarian paternalism’ in his co-authored book ‘Nudge’ (2008). Libertarian paternalism is about leaving people with free choice, but framing questions (“choice architecture”) so that our cognitive biases are more likely to lead us to make the “right” choice.

A couple of examples are:
1. Retirement saving: If individuals who do not have a financial advisor have to actively seek out, establish and fund a pension for themselves they are unlikely to do so, even if they are underfunded for retirement and pension savings would attract tax savings. If instead it is obligatory for companies to offer a pension to their employees as a default option and each employee has the option to opt out, they are much more likely to keep the pension. The crucial difference here is that employees have to complete paperwork to opt in versus having to do it to opt out.
2. Healthy food: We are more likely to pick products that are at eye level than products that are above or below. Therefore, if healthy food is placed at eye level in the cafeteria people are much more likely to eat healthily than if it is placed further out of sight than the unhealthy options.

In summary, Professor Thaler’s work is helping governments make policies that improve lives on a massive scale. Even though companies have sometimes exploited this research in the opposite direction – the positioning of Coca-Cola in supermarkets is no coincidence – this is clearly very important work of huge practical relevance.

Prize well deserved!

 


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