Tuesday, October 10, 2017

Defending Thaler from the guerrilla resistance


So, Richard Thaler won the Nobel Prize, which is pretty awesome. If you've read Thaler's memoir, you'll know that it was a long, hard, contentious fight for him to get his ideas accepted by the mainstream. And even though Thaler is now a Nobelist and has been the AEA president - i.e., he has completely convinced the commanding heights of the econ establishment that behavioral econ is a crucial addition to the canon - resistance still pops up with surprising frequency in certain corners of the econ world. It's a sort of ongoing guerrilla resistance.

An example is this blog post by Kevin Bryan of A Fine Theorem. Kevin is one of the best research-explainers in the econ blogosphere, and his Nobel explainer posts have always been uniformly excellent. This time, however, instead of explaining Thaler's research, Kevin decided to challenge it, in a rather dismissive manner. In fact, his criticisms are pretty classic anti-behavioral stuff - mostly the same arguments Thaler talks about in his memoir.

Anyway, let's go through some of these criticisms, and see why they don't really hit the mark.


1. The invisible hand-wave

First, a random weird thing. Kevin writes:
Much of my skepticism is similar to how Fama thinks about behavioral finance: “I’ve always said they are very good at describing how individual behavior departs from rationality. That branch of it has been incredibly useful. It’s the leap from there to what it implies about market pricing where the claims are not so well-documented in terms of empirical evidence.”
This is Fama, not Kevin, but it's a very odd quote. Behavioral finance has been very good at documenting asset price anomalies - in fact, this is almost all of what it's good at. This is what Shiller got the Nobel for in 2013, and it's what Thaler himself is most famous for within the finance field. Behavioral finance has struggled (though not entirely failed) to explain most of these anomalies in terms of psychology, especially in terms of insights drawn from experimental psychology. But in terms of empirical evidence, behavioral finance is pretty solid.

Anyway, that might be a sidetrack. Back to Kevin:
[S]urely most people are not that informed and not that rational much of the time, but repeated experience, market selection, and other aggregative factors mean that this irrationality may not matter much for the economy at large. 
This is a dismissal that Thaler refers to as "the invisible hand wave". It's basically a claim that markets have emergent properties that make a bunch of not-quite-rational agents behave like a group of complete-rational agents. The justifications typically given for this assumption - for example, the idea that irrational people will be competed out of the market - are typically vague and unsupported. In fact, it's not hard at all to write down a model where this doesn't happen - for example, the noise trader model of DeLong et al. But for some reason, some economists have very strong priors that nothing of this sort goes on in the real world, and that the emergent properties of markets approximate individual rationality.


2. Ethical concerns

Kevin, like many critics of Thalerian behavioral economics, raises ethical concerns about the practice of "nudging":
Let’s discuss ethics first. Simply arguing that organizations “must” make a choice (as Thaler and Sunstein do) is insufficient; we would not say a firm that defaults consumers into an autorenewal for a product they rarely renew when making an active choice is acting “neutrally”. Nudges can be used for “good” or “evil”. Worse, whether a nudge is good or evil depends on the planner’s evaluation of the agent’s “inner rational self”, as Infante and Sugden, among others, have noted many times. That is, claiming paternalism is “only a nudge” does not excuse the paternalist from the usual moral philosophic critiques!...Carroll et al have a very nice theoretical paper trying to untangle exactly what “better” means for behavioral agents, and exactly when the imprecision of nudges or defaults given our imperfect knowledge of individual’s heterogeneous preferences makes attempts at libertarian paternalism worse than laissez faire.
There are, indeed, very real problems with behavioral welfare economics. But the same is true of standard welfare economics. Should we treat utilities as cardinal, and sum them to get our welfare function, when analyzing a typical non-behavioral model? Should we sum the utilities nonlinearly? Should we consider only the worst-off individual in society, as John Rawls might have us do?

Those are nontrivial questions. And they apply to pretty much every economic policy question in existence. But for some reason, Kevin chooses to raise ethical concerns only for behavioral econ. Do we see Kevin worrying about whether efficient contracts will lead to inequality that's unacceptable from a welfare perspective? No. Kevin seems to be very very very worried about paternalism, and generally pretty cavalier about inequality.

Perhaps this reflects Kevin's libertarian values? I actually have no idea what Kevin believes in. But hopefully the Nobel committee tries to make its awards based on the positive rather than normative considerations. After all, the physics Nobel often goes to scientists whose discoveries could be used to make weapons, right? I just don't see the need to automatically mix in ethics and values when assessing the importance of behavioral economics.


3. The invisible hand-wave, again

Kevin writes:
Thaler has very convincingly shown that behavioral biases can affect real world behavior, and that understanding those biases means two policies which are identical from the perspective of a homo economicus model can have very different effects. But many economic situations involve players doing things repeatedly with feedback – where heuristics approximated by rationality evolve – or involve players who “perform poorly” being selected out of the game. For example, I can think of many simple nudges to get you or I to play better basketball. But when it comes to Michael Jordan, the first order effects are surely how well he takes cares of his health, the teammates he has around him, and so on. I can think of many heuristics useful for understanding how simply physics will operate, but I don’t think I can find many that would improve Einstein’s understanding of how the world works.
This argument makes little sense to me. Most people aren't Michael Jordan or Einstein. And those people surely didn't compete all the other basketball players and physicists out of the market. Why does the existence of a few perfectly rational people mean that nudges don't matter in aggregate? Also, why should we assume that non-Michael-Jordans can quickly or completely learn heuristics that make nudges unnecessary? If that were true, why would players even have coaches?

It seems like another case of the invisible hand wave.

(Also, when it's used as an object, it's "you and me", not "you and I". This grammar overcorrection is my one weakness. If you ever need to defeat me in battle, just use "X and I" as an object, and I'll fly into an insane rage and walk right into your perfectly executed jujitsu move.)

Kevin continues:
The 401k situation [that Thaler's most famous nudge policy deals with] is unusual because it is a decision with limited short-run feedback, taken by unsophisticated agents who will learn little even with experience. The natural alternative, of course, is to have agents outsource the difficult parts of the decision, to investment managers or the like. And these managers will make money by improving people’s earnings. No surprise that robo-advisors, index funds, and personal banking have all become more important as defined contribution plans have become more common! If we worry about behavioral biases, we ought worry especially about market imperfections that prevent the existence of designated agents who handle the difficult decisions for us.
Assuming that a market for third-party advice will take care of behavioral problems seems like both a big leap and a mistake. First, there's the assumption that someone with nontrivial behavioral biases will be completely rational in her choice of an adviser. Big assumption. Remember that people are typically paying financial advisers a fifth of their life's savings or more. Big price tag. How confident are we that someone who treats opt-in and opt-out pensions differently is going to get good value for that huge and opaque expenditure?

Also, suppose that financial advisers really do earn their keep, i.e. a fifth of your life's savings. If the market for financial advice is efficient, and financial advice is all about countering your own behavioral biases, that means that behavioral biases are so severe that their impact is worth a fifth of your lifetime wealth! If a cheap little nudge could make all of that vast expenditure unnecessary - i.e., if it could get you to do the thing that you'd otherwise pay a financial adviser 20% of your lifetime wealth to do for you - then the nudge seems like a huge efficiency-booster.

So this point of Kevin's also seems to miss the mark.


4. Endowment effects and money pumps

Kevin writes:
Consider Thaler’s famous endowment effect: how much you are willing to pay for, say, a coffee mug or a pen is much less than how much you would accept to have the coffee mug taken away from you. Indeed, it is not unusual in a study to find a ratio of three times or greater between the willingness to pay and willingness to accept amount. But, of course, if these were “preferences”, you could be money pumped (see Yaari, applying a theorem of de Finetti, on the mathematics of the pump). Say you value the mug at ten bucks when you own it and five bucks when you don’t. Do we really think I can regularly get you to pay twice as much by loaning you the mug for free for a month? Do we see car companies letting you take a month-long test drive of a $20,000 car then letting you keep the car only if you pay $40,000, with some consumers accepting? Surely not.
First of all, the endowment effect isn't a money pump if it only works once with each object. It's only a money pump if you can keep loaning and reselling something to someone. Otherwise, people's maximum potential losses from this bias are finite - they're just some percent of their lifetime consumption. Maybe not 300%, but something.

But anyway, Kevin says that we don't see car companies letting you take a month-long test drive. Hmm. I guess that is true...for cars.



5. External validity of lab effects

Everyone knows external validity of laboratory findings is a big problem for experimental economics (and psychology, and biology...). Also problematic is ecological validity - even if a lab effect consistently exists in the real world, it might not matter quantitatively compared to other stuff. External and ecological validity do present big challenges for behaviorists who want to take insights from the lab and use them to predict real-world outcomes.

But Kevin chooses some highly questionable examples to illustrate the problem. For example:
Even worse are the dictator games introduced in Thaler’s 1986 fairness paper. Students were asked, upon being given $20, whether they wanted to give an anonymous student half of their endowment or 10%. Many of the students gave half! This experiment has been repeated many, many times, with similar effects. Does this mean economists are naive to neglect the social preferences of humans? Of course not! People are endowed with money and gifts all the time. They essentially never give any of it to random strangers – I feel confident assuming you, the reader, have never been handed some bills on the sidewalk by an officeworker who just got a big bonus! Worse, the context of the experiment matters a ton (see John List on this point). Indeed, despite hundreds of lab experiments on dictator games, I feel far more confident predicting real world behavior following windfalls if we use a parsimonious homo economicus model than if we use the results of dictator games.
Does Kevin seriously think that any behaviorist believes that dictator games imply that people walk around giving away half of any gifts they receive? That makes no sense at all. In the dictator game, there's one other person - in the real world, there are effectively infinite other people. What would it even mean for a person on the street to behave analogously to a person in a dictator game? The situations aren't equivalent at all.

As John List says, context matters. Wage negotiations at a company are different than family gift exchanges, which are different from financial windfalls, which are different from randomly being handed money on the street. Norms in these situations are different. If someone gives you a gift, there's probably a norm of not re-gifting it. If someone hands you money in a dictator game, you probably don't treat it as a personal gift. Etc.

To me, this is clearly not a reason to assume that norms and values only matter in the lab, and that real-world people always behave perfectly selfishly. Quite the contrary. It's a reason to pay more attention to norms and values, not less. Why does Bill Gates give away so much of his money? Why do people give money to some beggars and buskers but not to others? Do these behaviors bear any similarity to how people behave when asking for (or handing out) raises in the workplace? Do they bear any similarity to the way people haggle over the price of a car or a house?

These are not trivial questions to be waved away, simply because if you hand someone cash on the street they don't instantly hand half of it to the first person they see.

Kevin follows this up with what seems like another bad example:
To take one final example, consider Thaler’s famous model of “mental accounting”. In many experiments, he shows people have “budgets” set aside for various tasks. I have my “gas budget” and adjust my driving when gas prices change. I only sell stocks when I am up overall on that stock since I want my “mental account” of that particular transaction to be positive. But how important is this in the aggregate? Take the Engel curve. Budget shares devoted to food fall with income. This is widely established historically and in the cross section. Where is the mental account? Farber (2008 AER) even challenges the canonical account of taxi drivers working just enough hours to make their targeted income. As in the dictator game and the endowment effect, there is a gap between what is real, psychologically, and what is consequential enough to be first-order in our economic understanding of the world.
Kevin's argument appears to be that if mental accounting only matters in some domains, it doesn't matter overall. That makes no sense to me. If mental accounting is important for investing and driving, but not for food purchases or taxi jobs, does that mean it's not important "in the aggregate"? Of course not! Gas is a substantial monthly expense. The compounded rate of return on your stock portfolio can make a huge difference to your lifetime consumption. Even if mental accounting mattered only for these two things, it would matter in the aggregate.


So, Kevin's attacks on Thaler's research paradigm pretty much uniformly miss the mark. Because of this, I half suspect that Kevin - usually the most careful and incisive of bloggers - is playing devil's advocate here, taking cheap shots at behaviorism simply because it's fun. This guerrilla resistance is more like paintball.

25 comments:

  1. Here is one of the more interesting "critiques"

    https://twitter.com/JulianAssange/status/917436164461809664

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  2. But this is economic behaviour taken out of context and put into a market format that most human beings to not interact with. Its ludicrous that someone gets an award for this other than if its elites slapping other elites on their back about how to get richer

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  3. Hi Noah. I assure you I am not taking cheap shots. I think Thaler has done some great work (incidentally, he is a self-described libertarian, and I am not!) Let me paste here a brief extension of my response to my experimental colleague Sandro:

    1) The behavioral folks have completely won the argument that individuals are susceptible to systematic deviations from irrationality, which are often predictable, and which do not necessarily disappear with aggregation and selection (noise trading is a good example). This is why there have been 5 Nobels given for this field of work!

    2) We should take these deviations, in terms of predictive behavior, as similar to risk aversion or time discounting, while noting that behavioral biases cause some unique problems when it comes to talking about welfare since they imply, e.g., time inconsistency. No one thinks we are making an "invisible hand wave" when we abstract away from risk aversion in a growth model: they think we are making a simplifying assumption. It is up to the behavioral folks to model situations where (like with noise traders) the behavioral effects remain important in aggregated long-run equilibrium. We understand completely how the standard model operates in those conditions!

    3) That said, it is not “unscientific” to write a model where firms are risk neutral, even if agents are risk averse. And not “unscientific” to abstract away from heterogeneity in the discount rate in certain models. The framing of psychology-based research as “scientific” and decision theoretic as “unscientific” is infuriatingly common, and a complete misunderstanding of how economic models are used.

    4) Anomalies in the lab are, as I and many others have noted, very easy to shift by changing settings, and often deviate in remarkable ways from observed behavior. Many “real world” examples of irrationality turn out to have sensible, alternative rationality-based explanations. This doesn’t mean there aren’t behavioral biases or that they are unimportant: rather, it means that the movement from “individuals show X effect of irrationality” to “this implies X at the firm level, or the economy level” is incorrect. Thaler is good at avoiding this; many students are not.

    5) As to what the baseline model in economics should be: rational choice retains many benefits. Open a journal. Where is the behavioral model of growth? Of patent policy? Of double marginalization? Of first mover advantage? Of international trade? We *all* agree with point 1 above. We disagree on how much it matters in most aggregated situations.

    6) As an example (since Thaler was in “The Big Short”): the financial crisis was *not* caused by the irrational overconfidence of individual buyers (they need to borrow: see Simsek Econometrica 2013). It was caused by a bank run in the shadow banking sector generated by imperfect information about bank asset holdings, and by mistakes in lending by financial institutions – perhaps behavioral, but in my read much more driven by incorrect incentives. Were individual buyers overconfident? Of course! Who would deny this? Is that first order for understanding how the Fed should respond? This is much less clear, and the posture one gets from behavioral folks that it is unscientific to abstract away from individual biases when modeling this problem – it rankles.

    7) Agree completely that ethics matter for economic design more generally! But the Thaler/Sunstein AER literally begins with an argument that there are no ethical issues with nudging because one must make a choice in any case. This is not a good argument.

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    1. Hi, Kevin! Whom I assume you to be. If you're not Kevin, I'm going to feel pretty silly responding to you as if you are! :-)

      But anyway...

      We should take these deviations, in terms of predictive behavior, as similar to risk aversion or time discounting, while noting that behavioral biases cause some unique problems when it comes to talking about welfare since they imply, e.g., time inconsistency.

      Sure.

      It is up to the behavioral folks to model situations where (like with noise traders) the behavioral effects remain important in aggregated long-run equilibrium. We understand completely how the standard model operates in those conditions!

      And there definitely are quite a few models of this type.

      The framing of psychology-based research as “scientific” and decision theoretic as “unscientific” is infuriatingly common

      Weird, I've never heard this stated, or implied. And I've been around a bunch of behaviorists. Most think that decision theory should be tweaked to include insights from psychology:
      http://citeseerx.ist.psu.edu/viewdoc/download?doi=10.1.1.380.9738&rep=rep1&type=pdf

      Anomalies in the lab are, as I and many others have noted, very easy to shift by changing settings, and often deviate in remarkable ways from observed behavior.

      Yep, this is a huge problem for experimental econ (and psych).

      As to what the baseline model in economics should be: rational choice retains many benefits. Open a journal. Where is the behavioral model of growth? Of patent policy? Of double marginalization? Of first mover advantage? Of international trade?

      This is an argumentum ad verecundiam. As an analogy, open a sociology journal. Now tell you believe all the theories of poverty contained therein. ;-)

      the financial crisis was *not* caused by the irrational overconfidence of individual buyers (they need to borrow: see Simsek Econometrica 2013). It was caused by a bank run in the shadow banking sector generated by imperfect information about bank asset holdings, and by mistakes in lending by financial institutions

      That's a very strong claim with plenty of evidence against it. Yes, there was a run in the shadow banking sector. But there is also plenty of evidence for irrationality playing a big role in the asset price movements that probably sparked that run, e.g.:

      http://www.nber.org/papers/w22065.pdf

      Agree completely that ethics matter for economic design more generally! But the Thaler/Sunstein AER literally begins with an argument that there are no ethical issues with nudging because one must make a choice in any case. This is not a good argument.

      But is this what Thaler got the Nobel for??

      Anyway, this rebuttal feels a bit like a Gish Gallop. I continue to believe that it is to some degree tongue-in-cheek, and you are, as the Australians say, "taking the piss"... ;-)

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    2. The agents who behaved irrationally in the runup to the financial crisis that triggered the Great Recession were not the players in the shadow banking industry but those in the housing market who ran up the housing bubble over a period of time from about 1998 until the peak in 2006-07 (depending on data source). It was the decline of that bubble that triggered all those problems in the shadow banking sector. Shiller, along with others, has documented the "irrational exuberance" that went on in the housing bubble, which was massive.

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  4. Fabrizio Ghisellini10:38 AM

    Great article, Noah! Though -in true Thaler's spirit- while it is true that criticism of Thaler's work is often misplaced, I would make an exception for nudges....May I add an additional criticism of nudge (excerpt from my forthcoming book "Behavioral economics:moving forward" ? "aren’t nudge advocates forgetting the minor detail that, given that governments (and nudge units) are made of people, they, very much as the people they want to nudge, are not immune to biases in the first place? Who will nudge the nudgers?"

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  5. Fabrizio Ghisellini10:56 AM

    Thaler is great almost on everything .But may I add a criticism of nudge (excerpt from my forthcoming book "Behavioral economics:moving forward" ? "Aren’t nudge advocates forgetting the minor detail that, given that governments (and nudge units) are made of people, they, very much as the people they want to nudge, are not immune to biases in the first place? Who will nudge the nudgers?"

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    1. Important question...

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    2. The question isn't who will nudge the nudgers, anyone and everyone will. It's called marketing. The question is what is the basis for the nudge and how sound is it. On this, it is much more ambiguous because people come at this from all different values and viewpoints and the most we can hope for is some utilitarian choice. This is why the basis and soundness the nudge become important. Better explicit and debatable than hidden and obscure.

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  6. wumbotarian11:28 AM

    It's worth mentioning that the long-term reversal "anomaly" identified by DeBondt and Thaler is explained by the value factor HML. See: Fama and French 1996 "Multifactor Explanations of Asset Pricing Anomalies"

    https://faculty.chicagobooth.edu/john.cochrane/teaching/35904_Asset_Pricing/Fama_French_multifactor_explanations.pdf

    See Table VII specifically portfolios formed on t-60 to t-13 (five-year reversal). The p-value on the GRS test is rather high (relatively speaking; especially relative to the 12-1 momentum), so I suspect that the value effect does a good job explaining the anomaly.

    So, there isn't really an "anomaly" here, just a repackaging of the value factor. Granted, value may not be risk-compensation but still I take umbrage with your statement that "Behavioral finance has been very good at documenting asset price anomalies".

    Behavioral economists have been very good at *finding statistical anomalies*, but have yet to provide rigorous economic models that explain such "anomalies". While back in the day it was impressive to find anomalies, today it's not at all sufficient to simply find some whacky anomaly and then make big bold claims about it (see Harvey Campbell's AFA presidential address this past January).

    tl;dr I don't think we can say DeBondt and Thaler is all that important in the grand scheme of the cross section of expected returns. Fama (and by extension Bryan) is right here.

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    1. So, there isn't really an "anomaly" here, just a repackaging of the value factor.

      How was it "repackaging" when DeBondt and Thaler was in 1985 and Fama-French was in 1993? Can you repackage something before it's packaged?

      OK OK, less flippant response: "Risk factors" and "anomalies" are the same thing, they're just things that predict returns. A lot of stuff that predicts returns is correlated. You can take two correlated return predictors A and B and say "A explains B" or "B explains A", and saying the former makes you a behaviorist and saying the latter makes you an anti-behaviorist, but substantively you haven't said anything different.

      The social dynamic in empirical asset pricing is that 1) behaviorists find new return predictors and hand-wave about psychological explanations for them, and then 2) anti-behaviorists either stick those predictors or other very highly correlated predictors in their models and hand-wave about how they represent risks. No one really cares about the hand-waving except for fun/tribal/sociological reasons.

      But it does mean that behaviorists have really pushed the research envelope in empirical asset pricing, which is good. Hence, I give them points. They found interesting stuff.

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    2. wumbotarian7:41 PM

      "Can you repackage something before it's packaged?"

      Yeah, yeah. LT Reversal doesn't add information to a 3-factor asset pricing model. That's the important part.

      "You can take two correlated return predictors A and B and say "A explains B" or "B explains A", and saying the former makes you a behaviorist and saying the latter makes you an anti-behaviorist, but substantively you haven't said anything different."

      A might explain B but B might not explain A despite high correlation between the predictors. As an example, Fama and French are trying to figure out why HML is redundant in their five factor model (though Hou, Xue and Zhang are way ahead of them...) thanks to the low-investment (CMA) factor.

      So I *do* think you can say something different in this context.

      "No one really cares about the hand-waving except for fun/tribal/sociological reasons."

      I am not sure if this is exactly the case. I mean, after all, Harvey's AFA address is essentially all about "how about we get some economic theory in here?" when looking at anomalies.

      I think the people who truly don't care about hand-waving are the fake news smart beta ETF salesmen.

      "But it does mean that behaviorists have really pushed the research envelope in empirical asset pricing, which is good. "

      I think I wrote this on reddit, but I completely agree that Thaler's contributions to asset pricing add to him deserving the Nobel. It's not about whether or not an economist's work is correct throughout time but whether or not they made a contribution that spawned entire research agendas. This is why Prescott does deserve a Nobel despite the fact that congestion is not why recessions happen (and why your boy Friedman deserves a prize too).

      To that end, Thaler definitely helped spawn asset pricing literature. I just question how relevant the "behavioral" part really is *today* for empirical asset pricing, especially in light of papers like "Replicating Anomalies" or "Multifactor Explanations of Asset Pricing Anomalies".

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    3. Yeah, yeah. LT Reversal doesn't add information to a 3-factor asset pricing model. That's the important part.

      Would the 3-factor model have been made (or would it have been widely accepted) without papers like Thaler and DeBondt's? I kind of doubt it. It makes little sense to me to pooh-pooh work done in 1985 just because other people did similar work in 1993.

      A might explain B but B might not explain A despite high correlation between the predictors.

      Sure, but this isn't observable without some sort of causal inference.

      I am not sure if this is exactly the case. I mean, after all, Harvey's AFA address is essentially all about "how about we get some economic theory in here?" when looking at anomalies.

      Rigorous (and testable) theory would be very different from the hand-waving that is typically done in order to label a return predictor a "risk factor" or "anomaly".

      It's not about whether or not an economist's work is correct throughout time but whether or not they made a contribution that spawned entire research agendas.

      There are at least two difference I see here. First, Prescott's models never fit the data very well, while Thaler's long-term reversal paper fits the data (it just doesn't have an interpretation you or Fama favor). Second, I kind of think Prescott's research led to a lot of blind alleys in macro, such as the incessant widespread use of serially correlated TFP shocks to try to explain aggregate macro phenomena at business-cycle frequency.

      I just question how relevant the "behavioral" part really is *today* for empirical asset pricing, especially in light of papers like "Replicating Anomalies" or "Multifactor Explanations of Asset Pricing Anomalies".

      Well, what do you think of as the "behavioral" part of Thaler's contribution there?

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    4. wumbotarian,

      A lot of this value "repackaging" involves blatant handwaving. One of the worst of hand waves in finance lit for a long time, I am now thinking of international fin lit dealing with still poorly understood "anomalies" involving such matters as uncovered interest parities and the like, has involved "time-varying risk factors," a fave hand wave of Cochrane in particular, who regularly drags out as a supposed pony found under a pile of excrement. The problem is that there have been studies using methodologies standard fin people do not but behavioral people take seriously, such as surveys, that find in many of these cases where supposedly there was lots of wildly changing risk factors over time, that alternative sources find no-to-little such variations. Certain forms of handwaving can be shown by different data sources to be pretty questionable.

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  7. Ah yes, this is Kevin - didn't realize it was anonymous!

    On unscientific, I mean, here's Richard Thaler himself (https://truthonthemarket.com/2010/12/13/richard-thalers-rejoinder-to-the-totm-free-to-choose-symposium/): "It is simply unscientific to ignore empirical evidence and theoretical progress. Take prospect theory, for example. This is Kahneman and Tversky’s descriptive model of decision making under uncertainty published in Econometrica in 1979, and one of the most frequently cited papers in all of economics. There is simply no doubt that prospect theory is much better at describing behavior than expected utility theory, both in the lab and in the field. See Colin Camerer’s paper Prospect Theory in the Wild, for example. At some point I am sure that a better theory will come along, but for now this is the best one we have. I teach my students that they should strive to obey the axioms of rational choice and thus be expected utility maximizers, but if they are trying to predict what someone will do, use prospect theory. No one who is really familiar with the literature could seriously disagree with this advice. Isn’t this just good science?"

    Here is Loewenstein on an early behavioral pioneer: "Scitovsky, who did early work in traditional welfare economics, gradually became disillusioned with the economists’ hands-off approach to the study of preferences, which he found unscientific (Scitovsky [1976] 1992, xiixiii). He starts out by writing that people’s tastes and choices “are matters economists have always regarded as something they should observe, but must not poke their noses into” (Scitovsky [1976] 1992, xii). Rejecting this perspective, Scitovsky proposes instead to follow “behavioral psychologists” and “observe behavior ... in order to find ... the foundations of a theory to explain behavior."

    It is easy to find similar examples.

    It is unscientific to model human behavior without prospect theory? That's absurd. There are literally thousands of papers using rational choice theory which provide useful insights about our world. The reason I say "open a journal" is that we have many productive fields of economics which have advanced with essentially zero use of behavioral models, even though the authors are surely aware of the models. Google became one of the most valuable companies in the world by taking insights from auction theory models which are completely rational choice. We stopped trying to move down the Phillips curve because of models of rational choice. We study industrial policy and its effect on inequality using rational choice. We can go on. There are surely behavioral models in these areas, but they have essentially no impact on the field at large.

    My big worry is that behavioral results feel "natural", to students and journalists, in a way that neoclassical results do not. They are therefore accepted with much less pushback. It is not my opinion that behavioral models have made no impact on broad areas of economics: it is simply a fact that they haven't. And the reason is that behavioral anomalies, particularly of unsophisticated players, do not, in fact, matter that much for many economic problems.

    Now, that doesn't mean they never do. But the case for behavioral theory like the one given by Thaler in the quote above - that prospect theory "always predicts better" - is empirically untrue except in the trivial sense that prospect theory is a more flexible functional form. Broad classes of equilibrium behavior in the market is, in fact, described well with rational choice theory. And this is the reason that theory continues to be the workhorse of nearly every branch of our field.

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    1. It is unscientific to model human behavior without prospect theory? That's absurd.

      Yes, it is absurd. However, it IS unscientific to refuse to consider stuff like prospect theory.

      We stopped trying to move down the Phillips curve because of models of rational choice. We study industrial policy and its effect on inequality using rational choice.

      I'm not sure these are great examples, but yes, I agree in general that rational choice models have often been super useful and accurate. :-)

      There are surely behavioral models in these areas, but they have essentially no impact on the field at large.

      Let's be careful not to slip into argument-from-authority. Otherwise we end up with conversations like this:

      Behaviorist: "Not enough people use behavioral models."
      Anti-Behaviorist: "That's because behavioral models suck!"
      Behaviorist: "How do you know they suck?"
      Anti-Behaviorist: "Because not many people use them!"

      You can easily see the flaw in this sort of thinking...

      My big worry is that behavioral results feel "natural", to students and journalists, in a way that neoclassical results do not. They are therefore accepted with much less pushback.

      About this, I am agnostic. I haven't seen this much in practice (usually students and journalists seem to go on political ideology rather than intuitive plausibility), but OK, I'll take your word for it. Still, that doesn't justify a scattershot, Gish Gallop type attack on behaviorism as a whole.

      And the reason is that behavioral anomalies, particularly of unsophisticated players, do not, in fact, matter that much for many economic problems.

      An assertion without evidence. There's plenty of empirical evidence that suggests that behavioral anomalies could matter a lot in many real-world economic situations - flypaper effects, asset pricing anomalies, excess consumption sensitivity, behavior that looks short-sighted...the list goes on and on.

      Why aren't more behavioral theories used, when the evidence is in favor of behavioral effects being important in many situations? My guess: Because behavioral theories tend to be really simple.

      Rational-choice theories often have to get extremely complex to explain things that behavioral theories can explain in a couple of lines of prose or super-simple math. That makes rational-choice theories require whole papers to explain them, while most behavioral theories don't. But is this a weakness of behavioral theories, or of rational-choice theories? Depends on whether you value parsimony or simplicity.

      Broad classes of equilibrium behavior in the market is, in fact, described well with rational choice theory. And this is the reason that theory continues to be the workhorse of nearly every branch of our field.

      Honestly...This isn't really true. Evidentiary standards for validating most of these equilibrium models against data are extremely weak, at least in the fields I know well (macro and finance, and to a lesser degree labor and public). The evidentiary standards and data quality are getting better, and as they get better they're demonstrating how badly most models do. That doesn't mean those models or the people who made them suck - it just means we're still in the very early days of figuring out how most economic phenomena really work. And behaviorism is probably going to play a big part in how we eventually explain the things we can't currently explain (i.e. most things).

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  8. NotMarkT3:08 PM

    One concern is what is used as the benchmark to empirically establish departures from rationality. To this casual observer, it seems the benchmark is often the standard model based on unsupportable theory. For example, comparison of "naive" diversification strategies to "rational" portfolio optimization (that empirically doesn't outperform naive diversification).

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  9. A different response to the invisible handwave is to take Gerd Gigerenzer seriously. His claim is that, in most real world situations, heuristics outperform ostensibly rational algorithms, which means they would survive iteration and selection. My hunch, however, is that the reason most economists recoil at his approach compared to, say, Thaler’s is that it is as destructive to the normative interpretation of economic rationality as it is to the positive, and economists don’t want to give up welfare econ.

    At some point we need to talk about economists’ attachment to an extremely weak normative model.

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    1. NotMarkT9:33 AM

      Indeed. The optimization enterprise has some of the trappings of a cult.

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  10. I would have thought the answer to why everyone doesn't give half their money away obvious. If everyone did, nearly everyone would be a receiver so they are only keeping the portion they already have. They are waiting for it. It takes very few to say no.

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  11. Anonymous9:40 PM

    +1 For Noah.

    "Broad classes of equilibrium behavior in the market is, in fact, described well with rational choice theory. And this is the reason that theory continues to be the workhorse of nearly every branch of our field."

    This is just an outrageous claim. In particular "broad classes" and "described well" do not belong. For macro, see Stiglitz http://www.nber.org/papers/w23795 and Romer https://paulromer.net/wp-content/uploads/2016/09/WP-Trouble.pdf . For a more general critique of how economists use models see Pfleiderer https://www.gsb.stanford.edu/faculty-research/working-papers/chameleons-misuse-theoretical-models-finance-economics . As Noah points out in his BV column today, it may just be impossible to model human behavior with the type of models used in physics. Behavioral econ is about figuring out what works, not about constructing the 'true' model.

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    1. drive-by commenter10:49 AM

      >Behavioral econ is about figuring out what works, not about constructing the 'true' model.

      That's what economics, as a whole, is about. Do you even understand the papers you just linked? Do you not realize they have nothing to do with behavioral economics?

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    2. drive-by-commenter,

      Did you realize that you just crashed into that tree over there as you drove by?

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    3. Anonymous8:20 PM

      drive-by-commenter,

      Do YOU even understand the papers I linked? I did not claim that they were about behavioral economics. They all touch on the issue of economists engaging in research programs (DSGE for example) that demonstrably do NOT help figure out what works.

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    4. No, Anonymous, I am a complete moron who barely knows how to tie his shoes, much less understand anything as deep as the links you provided. But I do know that people who CAPTIALIZE WORDS IN POSTS TO ASSERT THEIR POINTS already crashed into the nearest tree and are not going to be taken seriously by any reader. Hope your insurance company will pay for the wreckage.

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