While its basic tenets have been proven beyond doubt — and some of its developers have received Nobel Prizes for their work — interest in Behavioral Finance still dwells largely within the confines of academia. It roots, however, go back many decades.
Such early and noted American economists as Frank Knight, and his famous English contemporary, Maynard Keynes, recognized that, with respect to financial decisions, there is much in our nature that contributes to the decision process that is beyond logic or calculation. In other words, feelings and emotions play a part.
Knight declared, “Human valuations are largely independent of desire for any concrete thing or result.” And Keynes used the term “Animal Spirits” to describe an extra quality or exuberance that he perceived as influencing decisions. Keynes even alluded to the “sanguine temperament” as driving the entrepreneurial spirit. So arguably Capitalism’s most important theorist had temperament on his mind (note that temperament is a very close cousin of what we call “motivational style”) when it came to explaining how enterprise, the economy, and markets work.
In more recent times, mathematical modeling with respect to decision-making starts with Von Neumann and Morgenstern in their classic work, Theory of Games and Economic Behavior.
Neumann and Morgenstern presented six axioms to define rational behavior. And from this premise they constructed a single index called the utility function. “Rational” in a behavioral finance context is always contextual. It implies someone will make the “best” decision based on available information. This proved to be the weak point in their theory.
Neumann and Morgenstern’s model is not a psychological model of decision-making. It is an idealized model of rational choice. They analyzed choice in a completely abstract way, removing emotional and psychological factors. They based their model on the notion of maximizing utility, assuming that is what people always do and always want. And further, that they are capable of performing the necessary calculations to arrive at the best decision, no matter how the choices at hand are expressed.
Later, psychologists like Kahneman and Tversky, and others (like Daniel Ellsberg and Richard Thaler) came along and made relatively easy work of showing how real-life decisions rarely fit the abstracted, Neuman/Morgenstern model.
Kahneman and Tversky, in particular, set a new framework for the why and wherefore of decision-making. Called “Prospect Theory,” it includes three major premises: (1) Risk versus Loss. (2) Framing Effects. (3) Invariance.
Their notion of risk versus loss was groundbreaking because it showed that people are much more loss-averse than risk-averse. Because people are more loss-averse than risk-averse their decisions can be easily influenced by how the choices are “framed.” And, because their choices are subject to framing effects, their decisions are not invariant. In other words, the very same data can be perceived differently, and lead to a different decision, based on how the information is presented. This is where Behavioral Finance and Motivational Styles cross paths.
How is value perceived? And, what do these perceptions rest on? How do beliefs inform our decisions? How do intimates influence or participate in the decision process? And how can we use this understanding to make predictions and influence marketing outcomes?
Minds+Motives connects behavioral finance principles and consumer understanding at the individual level to reveal the most effective ways to speak to clients. Financial Institutions can apply our principals to better align their messaging, products, and investment strategies to boost acquisition efforts and build stronger customer relationships over the long term.