Decision at risk

January 2004
Behavioural Finance promises to explain human choices - and even seasoned experts can be deceived.

In December 2000, soon after our establishment, Cardano published the booklet ‘On pirates, pointed caps and paradoxes’. This took a light-hearted look at the influence of complexity in statistics and arithmetic on the decisions, which people ultimately make. The enthusiastic responses we got from readers called for a sequel. Hence this compilation on the theme of Behavioural Finance.

It turns out that rationally operating Homo Sapiens goes about things considerably less rationally as Homo Economicus. During the cognitive thought processes, which precede economic decisions, Homo Economicus, it seems, unconsciously allows himself to be seduced by fallacies. In our previous publication, we already sketched some examples from Daniel Kahneman and Amos Tversky. They are today generally acknowledged as the founding fathers of Behavioural Finance. Amos Tversky died in 1996; otherwise he would certainly have shared the Nobel Prize for Economics, which Daniel Kahneman received in 2002. This high international acclaim underlines the importance of their new discipline. And rightly so. While the economic currents of the past hundred years invariably assumed reason to be triumphant, research of Kahneman et al. shows that when it comes to economic decision-making processes, acting rationally is anything but self-evident.

The theory around Behavioural Finance is new and very much in development. The literature on the subject is therefore still limited and the terminology lacks consistency. We have made a selection from the large number of (thought) experiments, studies and practical experiences which are available, and added some real-life cases. Not original research, then, but an attempt to give an impression, in an accessible manner, of the current status of this field and the aberrations which people are capable of in a decision-making context. We have summarised the provenance of the examples, research results and (thought) experiments in a bibliography at the back.

We hope that the brief introduction provided in this booklet will shed new light on your view of decision-making processes. Be warned: seasoned experts have proved just as prone to being deceived as laymen in the field of decision-making!

In this publication, we have once again attempted to cast complex, relatively new material in a readable form. We wish you as much pleasure in browsing through and reading this booklet as we had in compiling it!