Making decisions
Making decisions

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Making decisions

3.3 Limitations of the rational-economic perspective

As an approach to understanding economic life, the assumption of formal rationality has been very successful. For example, there is great deal of evidence that, on average, prices in financial markets behave as if investors were formally rational. However, there is also a great deal of evidence that individuals do not behave in this way (e.g. de Bondt, 1998). Even within the field of financial economics, there is increasing interest in developing theories of market behaviour which take better account of how people really make decisions (e.g. see Fenton-O'Creevy et al., 2004).

One of the leading exponents of this emerging field of behavioural finance, Werner de Bondt, suggests that:

For at least forty years psychologists have amassed evidence that economic man is very unlike a real man and that reason – for now, defined by the principles that underlie expected utility theory, Bayesian learning and rational expectations – is not an adequate basis for a descriptive theory of decision making.

(de Bondt, 1998, p.831)

Having considered some of the limitations of the rational-economic perspective on decision making, we turn to the psychological and social perspectives.

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