Our understanding of economics and finance, specifically in an academic context, is based on models and theories available in the said disciplines. These archetype postulations make up most of the ‘copybook’ information in understanding these subjects. They provide the foundation for various complicated and straightforward concepts in the field. They are critical for understanding how economics and finance should and would operate at the micro and macro levels. Despite their importance and our reliance on them in comprehending commerce and allied fields, there is one crucial element that I, as an academic, often find missing in understanding finance: the significance of human behaviour!
We are often caught contemplating the volatility of the stock market or the patterned rise in the prices of petrol, for instance, without factoring in the volatility of the very force that influences them, i.e. the force of human behaviour. Not that understanding the fundamental and technical aspects of finance are unimportant; it rather forms the core, but without interpreting the human reactions, emotions, and cognitive biases, this study is incomplete and defective.
It is not a challenge to assess why studying human behaviour’s impact on finance is vital. After all, our decision as a customer ultimately frames different financial aspects of a product at the micro level and the total market at the macro level. Everything regarding money and the economy is determined by how humans act in the market, which is, in turn, dependent on our behavior as individual consumers and collectively as a society.
To better comprehend the significance of human psychology in finance in the context of academic programs, one must examine how it is taught in educational institutions. As previously said, we study economics and finance using models and theories that are always founded on certain assumptions. We do not consider the consumers’ human behaviour in these models for the sake of convenience and linearity. This is because we humans do not all behave in the same way, and each individual is unique in terms of how they act and make judgments.
When studying economic models, it’s nearly impossible to consider the diversity of human behaviour. As a result, among many assumptions we make, we merely presume consumer rationality, but it doesn’t stand its ground at a societal level. While these models based on such assumptions can help grasp various concepts, the lack of information about human behaviour in them leaves our comprehension of economic and financial ideas incomplete.
Behavioural Finance is dedicated to addressing this gap in our understanding of how we, as people, influence the financial decisions of market participants. Also, it helps assess how our market actions affect the economy of our society in the longer run. Our choices, while often well-intentioned, are not necessarily reasonable. We may make a decision simply based on our feelings and intuition. Such a step can lead to a slew of bad investments, poor resource allocations, as well as erroneous risk estimates, and so on.
No matter how deeply we delve into these decisions’ financial nuances and repercussions, they are all influenced by distinct human characteristics. This is to say, that without the study of decision-making and more broadly, human behaviour, the study of finance is incomplete. This is precisely where the know-how of the field of ‘Behavioral Finance’ should come in handy. Thus, I firmly believe that greater integration of these two disciplines the need of the hour.
To achieve this end, we at O.P. Jindal Global University have introduced the M.Sc. programmes in Finance. I believe the course offer a fresh approach, where psychological knowledge serves as the foundation for making informed financial decisions. To re-assert, a psychologically informed lens into finance is the very catalyst we need to step into a financially rewarding future.
Daniel Kahneman, a professor of Psychology at Princeton is someone whom I often quote as a pioneering example. He dedicated his life to research that revealed deep-rooted biases that often interfere with our ability to make sound decisions. While he came from the field that investigates human behaviour, his work generated an impact on the world of finance so significant that he was awarded the Nobel Prize in Economic Sciences in 2002. Kahneman, while the most widely known, is not the only psychological scholar to create ripples in the waters of the financial world. No less than five Nobel Prizes have been awarded to behavioural research that reshaped our approach to finance.
Diving deeper into this ever-evolving lens, it is essential to acknowledge that perhaps our conventional understanding of money-matters, both at the micro and macro levels, rarely intersects with our understanding of human behaviour. And that is what precisely has to change!
The article is written by Prof. (Dr.) Sanjeev P. Sahni, Principal Director, Jindal Institute of Behavioural Sciences (JIBS).
