Bounded rationality: psychology, economics and the financial crisis

Schilirò, Daniele (2012): Bounded rationality: psychology, economics and the financial crisis.

Abstract

Classical mathematical algorithms often fail to identify in time when the international financial crises occur although, as the classical theory of choice would suggest, the economic agents are rational and the markets are or should be efficient and behave also rationally. This contribution does not pretend to give a complete answer to these questions, but it will highlight some well-known limits of the classical theory of rational choice. In particular, the present paper will focus on the concept of bounded rationality. The work also makes some references to behavioral economics and to the literature of behavioral finance which has given important contributions in explaining the behavior and the anomalies of financial markets. Finally, following the approch of Simon, the paper proposes an analytical model to describe the behaviour of agents which are rationally bounded, risk averse and loss averse, emphasizing the relationship between psychology and economics which helps to explain the crisis in financial markets.

• Item Type: MPRA Paper
• Language: English
• Keywords: Bounded rationality; rational choice; cognitive economics; behavioral finance; risk aversion
• Subjects: D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D81 - Criteria for Decision-Making under Risk and Uncertainty; B - History of Economic Thought, Methodology, and Heterodox Approaches > B5 - Current Heterodox Approaches > B52 - Institutional ; Evolutionary; D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D83 - Search ; Learning ; Information and Knowledge ; Communication ; Belief ; Unawareness; C - Mathematical and Quantitative Methods > C6 - Mathematical Methods ; Programming Models ; Mathematical and Simulation Modeling > C60 - General

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