With so much financial turmoil in the past few years, the cognition of economics has become a popular topic. Research in this area has taken two approaches: 1. analyzing the cognitive system to understand why people make certain choices regarding economic theory; and 2. analyzing economic trends in the hopes of extrapolating the cognitive processes that produced certain consequences. While both strategies sound good in theory, what if neither is the correct approach? What if the economy is something other than some combination of environmental and cognitive factors?
While this hypothesis has not been explored exhaustively, a Russian chimp named Lusha offers some interesting insight. In 2009, Lusha (see here) was given 1,000,000 RUB (about €25,000) to invest in eight companies of her choosing. Shockingly Lusha’s portfolio outperformed 94% of Russia’s investment funds that year.
The obvious explanation for Lusha’s success is luck—indeed not only is it unlikely that she possesses the financial know-how to invest wisely, but also that she could apply that information so successfully. In fact in light of Lusha’s success, one Russian financial expert conceded that “financial knowledge does not play a great role in giving forecasts to how the market will change”.
This begs the question: if economic forecasting is “usually a matter of more or less successful guessing”, why has it been the subject of so much cognitive scrutiny? Do cognitive scientists hope to elicit some emergent theory of economics? Do they simply hope to understand why people act the way they do? Either way neither of these topics is directly addressed by the aforementioned theoretical approaches.
Are there other areas of cognitive research where results address issues beyond the scope of the original hypothesis? It seems that if researchers hope to understand either cognition or a certain phenomenon, they must more directly focus their efforts in the future, or risk slipping on a figurative banana peel.
I think you could study the cognitive processes of the financial boom and bust in Ireland for years without coming to any meaningful conclusions! In a boom to bust cycle, does the economic forecasting lead or follow? In Ireland's case, the few economists who forecast the end of the Celtic Tiger were drowned out by others whose "guessing" was more than a little off in the end.
ReplyDeleteLusha had a big advantage that most portfolio managers and individual investors don't possess; she didn't understand if she made or lost money. Humans, who understand the value of money, especially when it is their own, have a different view of investment risk than Lusha. We explored this briefly in our cognitive psychology project on risk-taking in betting behaviour. Our participants bet virtual money on behalf of a charity, and were asked later in a survey if they would bet differently if it were their own money and not for charity. Only 8% said they would be willing to bet more if it was their own money, and half said they would bet less of their own funds. Investment managers are paid handsomely for managing funds, whether the fund loses or gains, so maybe they are more like Lusha than they care to admit and she just got luckier...this time!
Your post reminded me a lot of game theory. There is an open yale course available for game theory that is very interesting and it tries to solve this type of problems. For instance, in the following lecture, http://oyc.yale.edu/economics/econ-159/lecture-19 , a firm has to decide whether to invest in a machine that will reduce its costs of production. A lot of similar games are solved with regard to chess, banks, soccer, and prisoners' dilemma.
ReplyDeleteHere is an interesting article about the relatively new discipline of Neuroeconomics:
ReplyDeletehttp://brainblogger.com/2013/04/01/neuroeconomics-hype-or-hope/
And for those interested, here is a link to the lab of Neuroeconomist Paul Glimcher at NYU, with a number of publications on human decision making and economic behavior:
http://www.decisionsrus.com/index.php?option=com_content&view=article&id=5&Itemid=121
Finally, here is an interesting lecture he gave at Georgetown University:
http://www.youtube.com/watch?v=x8B8RB3YcS0