80.2K

Verified Solution

Link Copied!

Behavioral Finance

1) Discuss the problem of paradigms. That is, has Thaler et.al. developed their model far enough to have created a new paradigm? Does it continue to be only a relevant but case by case model? It is clear that rational expectations is a strong paradigm, even if wrong in many cases, and that most University courses continue in economics and business to employ the model. In addition, most businesses also require rational arguments for pursuing new projects. Do you have ideas about how to employ behavioral finance to your understanding of financial decision-making?

2) Behavioral Finance opines that nudging economic units to do more rational things is a reasonable way to conduct government policy. Thaler gives the 401K argument. Change the default to a pre-proscribed model. The typical pension default model (that is if you do not respond to your 401 allocation) is to assume you do not want to invest in a pension fund. A behavioral model would change the default to a model that would likely improve your retirement circumstances. That is when someone is young, the default model might be to take the full amount of pension money available (after all if you can put 5 percent of your income into the fund and the firm will match, you have already earned 100 percent on your money) and have it invested in the stock market. As the worker ages some money will be reallocated to less volatile instruments. This as opposed to the default being no pension at all. Is this an infringement on the pensioners rights or is this a recognition that the average person does not have the sophisticated knowledge needed to make the right decision. Note that what has happened is that the pensioner can still choose to not take the pension, but doing nothing results in a better pension decision. Is this all too paternalistic?

3) What is the endowment effect? Why do you think there is an endowment effect? Give an example of the endowment effect from the lectures and from your own life experience. Are we all irrational or does this effect make sense?

Answer & Explanation Solved by verified expert

See Answer