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Behavioral economics and the related field, behavioral finance, study the effects of
psychological, social, cognitive, and emotional factors on the economic
decisions of individuals and institutions and the consequences for market
prices, returns, and the resource allocation. The fields are primarily
concerned with the bounds of rationality of economic agents. Behavioral
models typically integrate insights from psychology, neuroscience and
microeconomic theory; in so doing, these behavioral models cover a range of
concepts, methods, and fields.
Behavioral
Economics of Shipping Business Behavioral
Economics and Rationality Postulate In the last few decades, the psychological factors
and the cognitive nature of human mind have become an interest of economics
and finance since the role of economic actors is an essential part of
conventional economic interpretation. Although it is a topic of economics for
centuries in the seminal works such as ‘The
Theory of Moral Sentiments’ of Adam Smith or ‘Human Action: A Treatise on Economics’ of Ludwig von Mises,
modern economic and financial viewpoint is developed and established over the
statistical empiricism and mathematical statistics. The mechanistic and
positivist school thought that human action can be mathematically estimated
and modelled. However, the intellectual accumulation on behavioral sciences
as well as neuroscientific evidence have revived the debate, and the
behavioral economics is born with the fundamental works of Daniel Kahneman
and Amos Tversky. The prospect theory and subsequent theories of
Kahneman and Tversky played a significant role and it is thought to be a
milestone in behavioral research. The prospect theory ignited a stream of
scholarly publications and sophisticated research on behavioral aspects of
economic decisions.
Prospect Theory and the difference between price and
perceived value. The modern Austrian School of economics is closely
interested in behavioural economics and its
heterodox viewpoint is also one of the drivers of the field. Behavioral
economics is broadly a reaction to implicit assumptions and a strong
criticism of neo-classical economic approach. The major debate is arisen from
the rational actor assumption (i.e. rational choice theory, rational
expectations, and homo-economicus) and its
spillover to several associated principles (e.g. efficient markets). Medical science has contributed to the problem from
physiologic and neuroscientific perspectives. In the last decade, a stream of
empirical research is performed to clarify functions of brain on decision
making and economic behaviour. Neuroimaging methods
(i.e. fMRI – functional magnetic resonance imaging) are used to visualize
brain activity in case of particular mental conditions. One of the
change-making discoveries of Neuroimaging is the role of Amygdala (an inner
part of brain) on emotional reactions and memory. The term, Amygdala Hijack,
is used as biological reasoning behind the irrational exuberance (i.e. mental
state of market bubbles, passions boil over and dominating the behaviour).
Neuroeconomics is arisen as an interdisciplinary field which uses
neuroscience tools and concepts for explaining the economic phenomenon. From
neuroscientific viewpoint, rationality postulate is unfeasible and
biologically irrational since we are all humans with Amygdala which drives us
unconsciously. Even research on patients with Amygdala damage indicated the
impossibility of rationality while presenting merits of overlooking and being
imposed emotionally. Without Amygdala, human brain is enforced to think
purely rational and execute every piece of information to reach optimal
solution by calculating the equilibrium for every single decision. Therefore,
a simple shopping decision would become a burden of cognitive process without
this small section of human brain. One of the thought-provoking outcomes of
Amygdala discovery is the medical collapse of hypothetical rationality
postulate in economics. Behavioral
Economics and Wisdom Hierarchy Behavioral Economics is a new topic in the shipping
business field, and there is a limited number of academic and professional
experts. However, there is a growing academic interest since it becomes
mainstream in economics literature. In addition to that, there are some
previous studies indicated irrationalities indirectly. Many studies on market
efficiency reported that the shipping markets are probably inefficient based
on the rejection of fundamental evidences behind the hypothesis. One can
easily find contradictory results found by different researchers and/or for
different periods of markets. In 2013, I first mentioned the irrationality debate
in the shipping business, and at that time I emphasized the Wisdom Hierarchy
for illustrating the cognitive basis. Quote from Duru, O. (2013). Irrational exuberance, overconfidence and short-termism:
Knowledge-to-action asymmetry in shipping asset management. The Asian Journal of Shipping and Logistics, 29(1), 43-58. “One of the fundamental foundations of information
science is the wisdom hierarchy (i.e. knowledge hierarchy or information
hierarchy) which is a framework to classify the function and the degree of
knowledge. Although, there are some variations among the literature, the most
basic structure of the hierarchy is based on Data, Information, Knowledge and
Wisdom (DIKW). Therefore, an acronym, DIKW hierarchy, is frequently used for
expressing the same meaning. DIKW hierarchy briefly illustrates the process
of generating knowledge and how to settle wisdom of a science or system. The
difference between these levels is usually figured by the major questions.
Data has no questions and it is just a value and record. Information asks
“What?” (Know what) while Knowledge asks “How?” (Know how). Wisdom is a more
intellectual perspective which asks “Why?” (Know why). The jargon, know-how,
is frequently used to express the intelligence, experience and profession. A
recent interpretation is presented by Jennifer Rowley. Rowley also indicates
the reduction of programming capability and algorithm building by the
increasing level of intellectual accumulation or the decreasing gap between
the wisdom and current position. In other words, this statement indicates the
role of sentiments and limitations of rule-based representations in higher
levels of intellectuality. While data is objective facts, subjectivity has a
critical role in further steps. Action-Knowledge vs. Information Knowledge- The role
of subjectivity can also be derived from the fact that knowledge does not
significantly contribute to the action in several cases. Israel M. Kirzner discussed the action-knowledge and the
disparities between known facts and practice. Some knowledge is gained from
processes, experiences etc. However, practicing knowledge is another
dimension of DIKW hierarchy. In economic research, such kind of disparity is
particularly indicated by behavioral economists since the rational actor is
expected to practice according to the known facts. Daniel Kahneman discusses
the overconfidence in economics and the reason of overconfidence is stated as
“collective blindness to a risk and uncertainty”. He is also founder of
prospect theory which criticizes the validity of expected utility model of
rational choice theory. Although, many scholars presented the dynamics of
business cycles and there is no dramatic shift from the business cycle
framework, entrepreneurs still tend to invest on higher prices of peak market
with very high risk of market collapse. David Colander stated the “systematic
failure of economic profession” which is based on the illusion of control.
The mainstream economists are usually figured by hindsight bias. In the last fifty years, there are several stories
of market crash and loss of value in a few months. Textbooks, articles and
academic papers have indicated the nature of freight markets while
knowledge-to-action asymmetry can be found in market statistics yet. In a
previous study, I indicated an example of new building contracts. The study
conceptually presented the existence of irrational behavior which accounts
for the impatient capital. The impatient capital of shipping business is an
industrial problem which makes shipping a sort of venture capital. Since the
freight markets are considered as one of the most powerful leading indicator for global economy, the instable nature of
shipping business also influences the rest of the economic life” COLANDER, D. (2011), “How economists got it wrong: A
nuanced account”, Critical Review: A Journal of Politics and Society, Vol.
23, No. 1-2, pp. 1-27. DURU, O. and YOSHIDA, S. (2008), “Market
psychology”, Lloyd’s Shipping Economist, August issue. DURU, O. (2012), “Incentives and sentiments in
shipping investments: Intermediary prospects between the impatient capital
and long-term competitiveness”, Journal of Logistics and Shipping Economics
(JSLSE), Vol. 45, pp. 63-72. KAHNEMAN, D. and TVERSKY, A. (1979), “Prospect
Theory: An Analysis of Decision under Risk”, Econometrica,
Vol. 47, No. 2, pp. 263-291. KAHNEMAN, D. (2011), Thinking Fast and Slow, New
York: Farrar, Strauss and Giroux. KIRZNER, I. (2005), “Information–knowledge and
action–knowledge”, Econ Journal Watch, Vol. 2, No. 1, pp. 75-81. ROWLEY, J. (2007), “The wisdom hierarchy:
Representations of the DIKW hierarchy”, Journal of Information Science, Vol.
33, No. 2, pp. 163-180.
The impatient capital vs. patient capital “The course of action that is best in the short term is not the same
course of action that is best over the long run“ Laverty Quote from DURU, O. (2011). Incentives and sentiments in shipping investments:
Intermediary prospects between the impatient capital and long-term
competitiveness. Journal of Logistics and Shipping Economics 海運経済研究, (45), 63-72. “James Crotty (2003) investigates the
impatient capital phenomenon under the neoliberal paradox. He indicates that “Financial market
pressures led to shorter planning horizons, a declining allegiance of
stakeholders to long-term corporate goals, and a large increase in the
percentage of cash flow paid to financial market agents“ Particularly publicly
traded firms are leaded to be short-oriented in terms of company strategies
and investment opportunities. Crotty also draws attention to the conversion
of investors in stock markets. Rather than 1960s, the most
of the shares in financial markets are now hold by the institutional
investors (such as pension funds, insurance companies etc.) and these
investors do not mind what the long term goals of a company. A few decades
ago, households were active in stock markets and they are figured by long
term investments. Today’s institutional investors manage their large amount
of funds which has an extreme power on price movements and tend to
investigate short-term gains. Kevin J. Laverty (1996)
discusses that issue and presents it as the major cause of short-termism in
American business society. He also argues that American companies lose their
competitive advantage to Japanese and German companies particularly. Laverty
indicates the critical role of intertemporal choice and the undervaluation of
future outcomes is given as a business symptom. The origin of intertemporal
choice is defined by the theory of “The course of action that
is best in the short term is not the same course of action that is best over
the long run“ Actually the major problem exists
on the valuation of the future cash flows in financial tradition. Net Present
Value method is frequently used for calculating the cumulative present value
of series of future cash flows. The following figure illustrates two
intentions, project A and project B, on the long horizon.
The
long term difference between projects A and B (Laverty, 1996). Under the principles of
classical NPV approach, the discounted cash flow of projects is calculated by
using the value of cash flow, its timing and the discounting rate. Among
these components, the most critical contribution is arisen from the rate of
discounting process. Since the higher discounting rate undervalues the
distant future and overestimates the near future, a single point change on
the rate may contributes to radical shifts between projects and future
prospects. Laverty also debates the negative impacts on innovative motivation
of firms. Short-termism triggers to ignore many innovative business
opportunities” CROTTY, J., “The Neoliberal Paradox: The Impact of Destructive
Product Market Competition and Impatient Finance on Nonfinancial Corporations
in the Neoliberal LAVERTY, K.J., “Economic "Short-Termism":
The Debate, the Unresolved Issues, and the Implications for Management
Practice and Research”, Academy of Management Review, Vol.21, No.3, 825-860,
1996. Why DCF capital budgeting is bad for
business and why business schools should stop teaching it! This is the title of an
academic paper written by Ralph W. Adler (2006). Adler indicates the
deteriorating and biased nature of Discounted Cash Flow method in the same
way of Kevin J. Laverty. ADLER, R. W. (2006). Why DCF capital budgeting is
bad for business and why business schools should stop teaching it. Accounting
Education: an international journal, 15(01), 3-10. |
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Copyright Okan
Duru©2014