Thursday, November 10, 2011

Ironic Research

Heuristics are a tool kit of intuitive strategies we use to solve the problems we encounter in life. Unfortunately, the products of this tool kit are, with great regularity, entirely wrong.

Nobel Laureate Daniel Kahneman's research helps explain why everyone from economists, baseball managers, investors - problem solvers of all kinds - rely on patterns of analysis that are utterly wrong.

"Tversky handed Kahneman a paper on the psychological assumptions of economic theory. As Kahneman recalled:
I can still recite its first sentence: “The agent of economic theory is rational, selfish, and his tastes do not change.”
I was astonished. My economic colleagues worked in the building next door, but I had not appreciated the profound difference between our intellectual worlds. To a psychologist, it is self-evident that people are neither fully rational nor completely selfish, and that their tastes are anything but stable.
The paper that resulted five years later, the abovementioned “Prospect Theory,” not only proved that one of the central premises of economics was seriously flawed—the so-called utility theory, “based on elementary rules (axioms) of rationality”—but also spawned a sub-field of economics known as behavioral economics. "

Read more:    The King of Human Error     by Michael Lewis