Getting started in thinking about behavioral economics
[L]ater I would call them anomalies, but for a while I just called them “the list.” And I started writing a list of funny behaviors on my blackboard, such as paying attention to sunk costs. I mean, at first they were just stories. Like, a buddy of mine and I were given tickets to a basketball game. Then there’s a blizzard and we don’t go. But he says, “If we had paid for the tickets, we would have gone.” Another thing on the list was a story about having a group of fellow grad students over for dinner and putting out a large bowl of cashew nuts. We started devouring them. After a while, I hid the bowl in the kitchen and everyone thanked me.But as econ grad students, of course, we immediately started asking why we were happy about having a choice removed. For years, some of my friends referred to my new research interests as “cashew theory.”
Behavioral economics and finance
The biggest surprise about behavioral economics, I think, looking back on it all, is that the subfield where behavioral has had the biggest impact is finance.If you had asked me in 1980 to say which field do you think you have your best shot at affecting, finance would have been the least likely, essentially because of the arguments that [Gary] Becker’s making: The stakes are really high, and you don’t survive very long if you’re a trader who loses money.But for me, of course, that was exactly the attraction of studying finance ...The random walk and the rationality assumption
Bob Shiller has this great line in one of his early papers to the effect that if you see a random walk, concluding from that that prices are rational is the greatest error in the history of economic thought. Why? Because it could be a drunken walk. A drunken man will have a random walk and it’s not rational.
No free lunch and price is right?
I separate these two aspects of the efficient markets argument: Whether you can get rich (the “no-free lunch” part) and whether the “price is right.” It’s hard to get rich because even though I thought Scottsdale real estate was overpriced, there was no way to short it. Even if there were a way—[Robert] Shiller tried to create markets in that, so that you could have shorted it—you might have gone broke before you were right. … I think it’s hard to beat the market. Nobody thinks it’s easy, and so that part of the hypothesis is truer, but if we look at what happened to Nasdaq in 2000, and then the recent crash, well, of course, we’ve never gotten back to 5,000. So it’s very hard to accept that markets always get prices right. … If anything, the Internet has wildly exceeded our expectations, but the Nasdaq has still not gotten close to where it was in 2000. So I think it’s pretty obvious that market was overheated, just like the Las Vegas and Phoenix real estate markets were, but you couldn’t say necessarily when it was going to end.A story of a non-price behavioral economics intervention in the United Kingdom
Let me tell you another story about the U.K. We had a meeting with the minister in charge of a program to encourage people to insulate their attics, which they call “lofts”—I had to learn that. Now, any rational economic agent will have already insulated their attic because the payback is about one year. It’s a no-brainer. But a third of the attics there are uninsulated. The government had a program to subsidize insulation and the takeup was only 1 percent.
The ministry comes to us and says, “We have this program, but no one’s using it.” They came to us because they had first gone to the PM or whomever and said, “We need to increase the subsidy.” You know, economists have one tool, a hammer, and so they hammer. You want to get people to do something? Change the price. Based on theory, that’s the only advice economists can give. ...
So we sent some team members to talk to homeowners with uninsulated attics. “How come you don’t have insulation in your attic?” They answered, “You know how much stuff we have up there!?” So, we got one of the retailers, their equivalent of Home Depot, that are actually doing the [insulation] work, to offer a program at cost. They charge people, say, $300; they send two people who bring all the stuff out of the attic. They help the homeowners sort it into three piles: throw away, give to charity, put back in the attic. And while they’re doing this, the other guys are putting in the insulation. You know what happened? Up to a 500 percent increase. So, that’s my other mantra. If you want to get somebody to do something, make it easy.