Wednesday, August 09, 2006

Adam Smith and Behavioral Finance

Harvard Business Schools "Working Knowledge" has a fascinating look at Adam Smith and Behavioral Finance/Economics.

Super short version: Smith's early writings (pre Wealth of Nations) laid much of the ground work for what we now call Behavioral Finance.

A few look-ins:

  • "The Theory of Moral Sentiments [TMS]... caught the attention of Harvard Business School professor Nava Ashraf and coauthors Colin Camerer and George Loewenstein....the authors find that Smith's insights from 1759 can contribute to modern thinking on everything from our fascination with celebrity to the theory of loss aversion. In fact, says Ashraf, Moral Sentiments presages the emerging field of behavioral economics."
  • " TMS, he describes the psychological factors that underlie human decision making, motivation, and interaction, which of course have strong implications for what drives consumption and savings decisions, worker productivity and effort, and market exchange"
  • "Smith believed that much of human behavior was under the influence of the "passions"—emotions such as fear and anger, and drives such as hunger and sex—but these passions were moderated by an internal "voice of reason," which he called an "impartial spectator.""
  • "Economics has had success as a field of scientific inquiry because it's been able to develop tractable models with strong predictive capacity; in other words, it simplifies the complex phenomena of human decision-making, interaction, and exchange into its barest form and makes predictions based on those. Of course, this has meant that economists have often had to sacrifice realism for tractability. Only recently has the field of economics advanced enough to have the tools to reincorporate the factors that Smith and others had always felt were important in human interaction: our caring about each other and about fairness, our difficulties with aligning our long-term interests with short-term pulls, etc."
Great stuff! It makes me want to read the Theory of Moral Sentiments!!

The journal article on which this interview is based is available here.

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