Behavioural Finance & Pensions. Con Keating PIA February

Transcription

1 Behavioural Finance & Pensions Con Keating PIA February

2 In economics, rationality is a very limited concept. It refers merely to the pre-existence of a particular ordering of preferences. This admits the central workhorse concept of Neoclassical economic analysis equilibrium. Even this simple concept gives rise to internal paradoxes These have been long known Allais, Ellsberg Sometimes presented as three axioms: Completeness, Transitivity and Independence But SMD Impossibility Theorem these do not deliver uniqueness and stability Rationality One of the central contributions of game theory has been to make it clear that the rational actor model is not only descriptively inaccurate (as earlier economists had charged) but internally incomplete and / or inconsistent - Joe Stiglitz 1991 An open question: is rational choice theory intended to be positive, a description of things as they are, or normative, prescriptions for how things ought to be?

3 There are many new approaches to economics which do not rely upon the rational actor. Simon Procedural Rationality - detailed empirical exploration of the complex algorithms of thought rather than deductive reasoning within a tight system of axioms Gigerenzer Evolutionary Economics and heuristics Rationality There is an overarching paradox of universal rationality and this is relevant in matters of pension public policy It may be rational to behave irrationally Amartya Sen Rational Fools not everyone is solely motivated by self-interest Jon Elster has explored rationality extensively. I would recommend reading: Rational Choice, Ulysses and the Sirens, Ulysses Unbound, Solomonic Judgements, Alchemists of the Mind, Reason and Rationality, and Sour Grapes (subversion of the rational)

4 Behavioural Finance A large and growing body of reproducible empirical work The economic/finance model is wrong But we knew that All models are wrong but some are useful Some puzzles are based on misunderstandings Risk preference reversals over positive and negative outcomes Some puzzles are semantic misunderstandings Linda the feminist bank teller Wittgenstein: The limits of my language mean the limits of my world Some misunderstand reality Optimists get laid more conveying a genetic advantage

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6 Don't you see that the whole aim of Newspeak is to narrow the range of thought? In the end we shall make thought-crime literally impossible, because there will be no words in which to express it. Every concept that can ever be needed will be expressed by exactly one word, with its meaning rigidly defined and all its subsidiary meanings rubbed out and forgotten.... The process will still be continuing long after you and I are dead. Every year fewer and fewer words, and the range of consciousness always a little smaller. Even now, of course, there's no reason or excuse for committing thought-crime. It's merely a question of self-discipline, reality-control. But in the end there won't be any need even for that.... Has it ever occurred to you, Winston, that by the year 2050, at the very latest, not a single human being will be alive who could understand such a conversation as we are having now?

7 Narratives Thomas Nagel: every subjective phenomenon is essentially connected with a single point of view. This means that we cannot capture subjective experience by objective means Narrative rationality is just such an attempt The recruitment of the word rational in its limited economic and financial applications may have been a major error

8 Behavioural Finance I am consistent You are stubborn I am flexible You are inconsistent Words and viewpoints matter. Elster observes: Human beings are reason-seeking animals. They want to have reasons for what they do, and they create reasons where none exist. John Kay: Often we are too ready to construct a narrative from insignificant information, interpret what we learn in the light of our earlier assessments, and adhere stubbornly to narratives even when further information becomes available. Control of a particular narrative may be achieved, but for how long does control persist A caution single narratives suppress innovation, growth and progress.

9 The big problem The problem for behavioural finance is that there is no unifying theory It is an interesting collection of party-tricks There is not even a way of aggregating from the individual to the collective What does happen when all follow a particular model? The problem today s problem is should we use these techniques in DC pensions. There is an immediate paradox using irrationality to impose a particular vision of rationality Recognise that you believe there is a problem with the world, not with the model. Even if there is such a problem, is coercive paternalism the best solution? Trustees have a duty of care as fiduciaries As a fiduciary is as a fiduciary does, is this extension of assumed responsibility warranted? Indeed is it permitted under scheme rules

10 Behavioural Finance and Marketing Philip Kotler, Kellogg School, Northwestern: if economists now have to study and explain how consumers actually make their choices, they need to turn to marketing and that behavioural economics is another word for marketing. Nudge units and subliminal advertising are applications Where does using insights from behavioural finance (marketing) fit morally and ethically? Can it possibly be correct to influence free-will other than entirely openly and transparently? Does that not require the approval or consent of the concerned member(s)? The question is not can we, but rather should we use these techniques. What recourse is there for those tricked, deceived, misled as a consequence I personally favour the reintroduction of Lex Talionis Incidentally, has anyone spoken with the Advertising Standards Agency?

11 There is very little academic empirical study on individual pension choice There is more on investment choice Some afterthoughts I am all in favour of investigating the empirical properties of individual choice behaviour But it does not follow that we should use these revelations to modify behaviour Outcomes matter, but so does today Does it really make sense to save 35% of your salary over the 40 years of work In order to enjoy a pension of 70% of final salary over the 25 years of retirement? Lest you think the answer lies in consumer education, let me assure you: it does not See Lauren Willis: The Financial Education Fallacy Or Fernandes, Lynch and Netemeyer We find that interventions to improve financial literacy explain only 0.1% of the financial behaviours studied, With weaker effects in low-income samples.

12 And finally Reading about all these behavioural anomalies makes us feel good There is something strangely entertaining in reading about the economic foibles of others: one part schadenfreude, plus one part abashed recognition of one s own past mistakes mixed with quiet relief to find oneself with lots of company in making those mistakes. We have become insiders, illuminati, if not cognoscenti In short, behavioural finance seems to offer insight and a sense of control, imposing order on what otherwise appears chaotic and unpredictable. But isn t that just another behavioural anomaly?