A behaviorist refers to one who adheres to the behavioral economics theory. This theory holds that investors neither act rationally nor do they act in their best interests. Investing decisions, like every human activity, are subject to a complex mix of environment, emotion, and bias. The failure of following pure reason results in market inefficiencies, as well as, profit opportunities for investors who are informed. Behavioral economics opposes the ancient rational choice model, as well as, the efficient market hypothesis, both of which have completely rational investor behavior based on available information.
A Little More on What is a Behaviorist
The behaviorist theory of investing includes psychology elements to explain market defects which the efficient market hypothesis (EMH) doesn’t address. The behaviorist detects imperfections like volatility spikes, unsteady price movements, and superstar traders who always beat the market as proof that the EMH’s assumption of completely rational markets doesn’t explain typical investor behavior.
Behaviorism starts with the idea that investors are humans, thus making them neither identical nor perfect. Every individual is unique in his or her cognitive abilities, as well as, backgrounds. Behavioral inconsistencies form an individual to another can be slightly explained by the human brain’s physiology. Research has revealed that the brain comprises sections with unique and often competing priorities. A human decision-making process like choosing an optimal investment includes a resolution if these competing priorities. Close to this end, the brain gets involved in psychological tics which behaviorists have termed to be biased.
Biases as the Foundation of Behaviorism
Behaviorists often cite biases to explain recurring errors in human judgment. Common faults in our decision-making process include:
Hindsight bias is the belief that previous events were predictable and this is meant to inform future decision making.
Gambler’s fallacy is the likelihood that the result of a coin toss is somewhat contingent on past tosses. Each coin toss is a different and unrelated event that has 50-percent heads or tails probability.
Confirmation bias, or the possibility of believing that present or future results support one’s explanation or existing theory.
Overconfidence has a universal belief that we’re smarter than we are.
This sampling is a fraction of a long list of behavioral biases which can help explain inefficiencies in our markets. In response to these flaws, the behaviorist portfolio theory recommends investment layers designed to unique and well-defined objectives as against the EMH approach that endorses passively-managed index funds.
Reference for “Behaviorist”
Academics research on “Behaviorist”
Economics and psychology: Lessons for our own day from the early twentieth century, Lewin, S. B. (1996). Economics and psychology: Lessons for our own day from the early twentieth century. Journal of Economic Literature, 34(3), 1293-1323.
Joyful economists: remarks on the history of economics and psychology from the happiness studies perspective, Edwards, J. M. (2010). Joyful economists: remarks on the history of economics and psychology from the happiness studies perspective. Journal of the History of Economic Thought, 32(4), 611-613.
[PDF] Social exchange theory under scrutiny: A positive critique of its economic-behaviorist formulations, Zafirovski, M. (2005). Social exchange theory under scrutiny: A positive critique of its economic-behaviorist formulations. Electronic journal of sociology, 2(2), 1-40.
John R. Commons and the foundations of institutional economics, Hodgson, G. M. (2003). John R. Commons and the foundations of institutional economics. Journal of Economic Issues, 37(3), 547-576.
The approach of institutional economics, Hodgson, G. M. (1998). The approach of institutional economics. Journal of economic literature, 36(1), 166-192.