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Predictably Irrational May 18, 2010

Posted by Brian L. Belen in Academically Speaking, Books, Ramblings.
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Predictably Irrational: The Hidden Forces That Shape Our DecisionsOne of the first classes I signed up for when I got to grad school was for a course on “Experimental Methods in Finance”. The course aimed to demonstrate how basic principles in finance (and by association, economics) could be understood through carefully designed experiments. The punch line, of course, was that the terminal requirement involved each student designing a financial experiment, putting this together as a paper that we would present to the class.

Even if we didn’t have to actually run the experiment, this was a challenge for me. Not having much experience in finance prior to then, I went about this requirement the only way I knew how: by hitting the books and reading up on other financial experiments (using the bibliographies of our class readings as my starting point). In the end, I settled on proposing a modification to a simple experiment I found in the literature, and thereby ended up doing rather well for myself in the process.

Looking back, I wish Dan Ariely’s book, Predictably Irrational, had already been published. If it had been, it would have been a huge help at the time, and I suspect I would have been able to think up a much better experiment than I eventually did.

The subtitle to Predictably Irrational reads “The Hidden Forces that Shape our Decisions.” Indeed, what Ariely sets out to describe in the book is how human decisions oftentimes consistently deviate from the “rational” models outlined in traditional economics texts, recounting the results from a variety of economic experiments he and his colleagues have conducted in a variety of settings. As the title suggests, the conclusion he draws from these is precisely that there is a certain predictability to how irrational human beings can be, from which we are made to infer that the “rationality” often invoked in mainstream economic thinking can be seriously flawed.

Ariely is one of the foremost behavioral economists of his generation, and this book demonstrates why. It is very accessible reading material for what could potentially be a rather esoteric subject, describing experiments that aim to examine placebo effects (they’re real), how people react to prices are reduced to “free” (everyone loves free chocolate, don’t they?), and whether being reminded of the Ten Commandments induces people to behave honestly (it does!), among others. Granted, not all of these pertain to matters immediately within the ambit of the economics profession; nonetheless, the description of these experiments can be fascinating and does help serve the broader point that human beings may very well be predictably irrational.

At the same time, Predictably Irrational also demonstrates what I consider the shortcomings of economics by experimentation. For instance, one set of experiments described in the book involved understanding how people behave or make decisions when they are sexually aroused. I took exception to this, first owing to what the experiment entailed in terms of what willing volunteers were asked to do , and second because it seemed like an experiment that wanted to be provocative for the sake of being so. Call me prudish, but I think there are some lines that just shouldn’t be crossed even in the name of science.

Furthermore, later parts of the book (mine is the updated and expanded edition), where Ariely offers his two cents’ worth on the recent financial crisis, are arguably the weakest in Predictably Irrational. This is not because Ariely is a bad economist — which he’s not — but because it comes across as a token attempt to be current. The best parts of the book were precisely those that involved describing the different experiments Ariely and his colleagues thought up and the oftentimes surprising results that ensued. But to go from those insights to commentary about world affairs? That seems a bit of a stretch — to me, anyway.

Which, I think is the point. Looking back at that first grad school course I signed up for and the economic experiment it made me think up, what I appreciated the most was knowing that whether or not the result conformed with economic theory I would learn a little more about people and markets in the process. I did, and I feel all the better for it. In much the same way, that’s how I feel about Predictably Irrational.

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