(Behavioural Economics cont. 1)

Some Psychological Principles that Underlie Human Behaviour

i) much talk but little action or implementation or follow-up ('going to do this and going to do that' but nothing happens, eg plan to save more money but don't; plan to lose weight, but don't start dieting and exercising)

ii) self-control (involves resisting temptation; self-control restrictions are easier to adopt if they take place in the future, eg plan to start dieting soon, but not today; another example is during GFC, when the preference was for refinancing mortgages rather than the traditional way of paying them off, ie
"...then came the helpful mortgage broker who made it all easy. By the turn of the century, the combination of declining interest rates, rising home prices, low initial 'teaser rates', and aggressive mortgage brokers made refinancing (and second mortgages) seem like the apple in the Garden of Eden. But home prices fell and interest rates increased, the party was over..."
Richard Thaler et al, 2021

NB One of the best ways to handle these temptations is for transparency and full disclosure.

 iii) loss aversion, ie more worried about actual losses than potential gains (for more detail, see elsewhere in the knowledge base)

iv) future illusion, eg losses are felt in nominal dollars, and not adjusted for inflation

v) inertia, ie prefer status quo (for more detail, see elsewhere in the Knowledge Base)

vi) bounded rationality, ie when things get complicated, people start to have problems (an example is the GFC, borrowing for real estate became more complicated, ie mortgages came in countless varieties; as a result, many borrowers did not understand the terms of  their loans; instead of mortgages being held by the banks that initiated the loans, they were packaged as 'mortgage-backed securities', such as credit default swaps, liquidity puts, etc; many people working in the finance industry struggled to understand these packages, ie they did not understand the risks their organisations were taking with these complex new securities)

vii) social influences or social contagion or 'follow the herd' (people believe in wildly unrealistic projections, ie baseless optimism; some examples:

        - GFC (in the lead up to GFC, people believed house prices would continue to rise, ie in the USA from 1997 to 2004, prices rose significantly and this was expected to continue, ie 9+% per year; however, from 1960 to 1997 home prices had been relatively stable;

        - The tech bubble/burst (prices on the sharemarket in the late 90s skyrocketed but burst in early 2000 and is another example of social contagion, ie people believed that share prices would continue to rise unabated into the early 2000, as a hand in the late 1990s.

"...baseless optimism was based on two factors: salient price increases in the recent past and the apparent, contagious optimism of other people..."
Richard Thaler et al, 2021)

Remember
"...Greed and corruption helped to create the GFC, but simple human frailty played key roles..."
Richard Thaler et al, 2021