Mind reading, spirituality, happiness?
The next generation of behaviorist faculty goes beyond conventional research topics to study “the good life.”
Image by Jim Frazier/Veer
One of the big ideas typically associated with Chicago Booth is the principal theory of classical economics: that consumers are completely rational people who always behave in their own best interests. So how did the school wind up with eight psychologists on the faculty who study human limitations and say the fully rational model isn’t quite right? And how did it win a three-year grant to study topics like maximizing happiness with a project called “Understanding Human Nature to Harness Human Potential”?
“There are a lot of questions about ‘the good life’ and how to attain it,” said Barnaby Marsh, director of venture philanthropy and new programs development at the Templeton Foundation, which gave the GSB’s Center for Decision Research (CDR) $2.2 million in January to study thrift, altruism, aspiration, humility, spirituality, happiness, purpose, optimism, and wisdom. “There’s actually very little research done on these topics,” Marsh said. “We’re funding some of the science behind it.” The faculty at the CDR “are willing to go beyond conventional research questions into areas that are still mostly unexplored, and whenever you do that, you’re likely to discover something new.”
Among them is Tanya Menon , associate professor of behavioral science, who will research how people develop their concept of God. “When I teach courses on power and influence, many students ask me questions that clearly derive from their personal, cultural, and spiritual values,” she said. “In business, when people think about the types of leaders they become, these questions are crucial.” Also, Menon pointed out, Chicago Booth has traditionally rooted itself in the basic disciplines of psychology, sociology, and economics, which makes such fundamental questions natural to study.
Nicholas Epley, an assistant professor of behavioral science who studies mind reading, agreed. “We’re trying to understand the basic underlying processes that govern behavior across different domains,” he said. “It’s a mistake to think business schools care only about economics. We’re training managers, and management isn’t just about accounting and finance, it’s about dealing with people.”
Having psychologists on the faculty can help economists understand the human beings in their models, Epley said. “Without understanding humans, you can’t understand how these things actually work in daily life.”
A Different Approach
That’s an idea that runs contrary to classical economics, which presumes human beings behave in rational and predictable ways and make decisions that always maximize their well-being, and that on the occasions when they don’t, the overall effect is so small that the market will correct for the anomalous behavior.
But over the past 30 years, a new branch of thought has emerged—behavioral economics, which states that people not only make mistakes, they err in predictable ways that have a measurable effect on the market. Championed by Richard Thaler, Ralph and Dorothy Keller Distinguished Service Professor of Behavioral Science and Economics, the approach uses a rigorous scientific method to measure how people make choices, then reinterprets the results to see how the data hold up in the marketplace. “We have just as many equations in our papers as anyone else,” Thaler jokes.
Behavioral economics has found a home at the Center for Decision Research, where researchers—both psychologists and economists—explore human limitations. Thaler, dubbed “the father of behavioral economics” by National Public Radio, has emerged as a leader in the field. Now other faculty at Chicago Booth are beginning to make important contributions of their own, some of them directly involved with the CDR, others in such traditional areas as finance who use the behaviorist approach.
Straddling the Fence
Assistant professor of economics Emir Kamenica finds himself taking the behaviorist approach in much of his work. “In my research I draw on the results from psychology and take these results more seriously than a classical economist might, but then I do what a psychologist would be less likely to do—I ask, ‘What happens when people who behave like this enter the market?’” Kamenica said. “Psychologists tend to think about an individual making a choice without worrying too much about aggregate effects. But to understand markets, you’d like to know, ‘What happens when many individuals interact, each trying to solve his or her own problems?’” A behavioral economist will take the results generated in a lab experiment and reinterpret them, he said. “There will often be psychological theories of what’s happening that won’t allow us to ask what happens if this person is a consumer rather than a subject.”
Behavioral economists can find themselves pushing back against both psychologists and classical economists. For instance, in one of his papers, Kamenica questions one of the givens of classical economics’ decision theory: the weak axiom of revealed preference. It works this way: A person is asked to choose between items A or B and selects A. Later, she is offered choices A, B, and a third choice, C. According to classical economics, she will either stay with her original choice of A, or she may pick the new item, C, but she will not switch to item B—the option she initially rejected—in the second round just because she has been offered a third option. But Kamenica said, “if you do this in a lab, it’s not the case. You can easily construct examples where systematically, rather than due to noise, you give people two options and they choose A, but if you were to give them an additional option, they would choose B.”
For psychologists, this is evidence against stable preference, which is a building block of economic analysis, Kamenica said. “Psychologists will say, ‘These economists are working from assumptions that we can clearly show are violated.’”
Classical economists often dismiss such findings, and Kamenica said papers that behavioral economists present at workshops can draw skepticism. “A common reaction is, ‘This isn’t really serious. It’s done in a lab. The stakes are low. In the markets, this is not going to matter,’” he said. The problem is that classical economists might be missing information they can use. “They’re not taking the data seriously, not looking at the results carefully to understand whether the seemingly anomalous behavior is real; that makes them unlikely to ask, ‘How might we be able to incorporate such behavior into economics?’”
Kamenica’s approach also can be contrary to the way psychologists think. A behavioral economist might take the results generated in a lab experiment and reinterpret them, he said. In research on choice overload, which shows that sometimes people prefer to have fewer options, he suggests an explanation that sharply departs from the original views of his psychology colleagues. “Some phenomena that look irrational are actually perfectly reasonable. For instance, in a marketing setting—unlike in a lab—people can get a lot of information about what they want from what is available,” he said. “Sometimes behavior looks funny and anomalous because people are in an unnatural setting—a lab—where the choices presented have been generated by an experimenter with his or her own agenda, not by the market forces. In those cases, even though one wants to understand the lab behavior, considering the market forces is extremely helpful.”
Kamenica came to the GSB in 2006 after meeting Thaler at a “summer camp” for students working on a PhD in economics, an event Thaler launched with psychologist Daniel Kahneman in the 1980s to spread the behavioral approach. “You don’t really convert the old guys,” Thaler said.
There was no group of like-minded researchers for Thaler during the early days of his own academic career. As a young assistant professor of economics at the University of Rochester, Thaler “kept noticing that people did not behave the way they were supposed to. I was constantly confronted with the contrast between the models my colleagues were constructing and the behavior I was observing.” He collected a list of anomalies, eventually turning them into a paper. “It was fun and interesting because there was a lot of low-hanging fruit,” he said. “The down side was, there were no role models.”
That changed in 1976 when he came across a paper on loss aversion by Kahneman and Amos Tversky, who had been studying many of the same behaviors. Thaler realized he’d hit upon the approach that would change his work and managed to collaborate with them for 15 months while they were visiting Stanford from Israel. “I learned how to run experiments, for example. But the initial things I was talking about were so big and obvious, it wasn’t so much finding them in the lab and demonstrating they were there as it was demonstrating them to economists who were trained to believe that they couldn’t be.” Kahneman would go on to win the Nobel Prize in economics in 2002 “for having integrated insights from psychological research into economic science, especially concerning human judgment and decision-making under uncertainty.”
Thaler spent the majority of his career at Cornell before leaving for Chicago in 1995. At the GSB, he had a chance to take on the director’s position at the CDR; to him, it was an opportunity to revitalize what had become a small research group with only one tenured professor. Around 1997, he was asked to speak to money managers at an investment firm about how people could increase their savings, and he came up with the concept for Save More Tomorrow (SMarT), in which employees increase savings by agreeing to set aside a portion of future raises for retirement funds. It drew little response until a small Chicago firm agreed to put it in place and give Thaler data about the results. “It worked way better than anybody could have expected,” he said. “I would have bet my house that this idea would work. But to convince anybody, I had to get some company to try it.”
Now such firms as Vanguard offer SMarT, making the plan one of the most well-known projects to come out of the CDR. Last summer, Thaler worked with other academics to help Congress incorporate behavioral principles into the Pension Reform Act. “That was my first attempt to actually influence public policy,” he said. He’s working on a book of programs like SMarT with professor Cass Sunstein of the University of Chicago Law School and hopes it will be finished this summer. Meanwhile, using money from the Templeton Foundation grant, Thaler plans to study which features make SMarT most successful.
Countering Criticism: Behavioral Finance
Behavioral economics—Thaler’s work in particular—has drawn plenty of attention from the media. A February 2001 article in the New York Times said of Thaler, “His increasing following is owed in no small part to the fact that behaviorism, unlike so much of economics, is fun . . . . Most writing in [economics] since the 1970s has been obtuse and highly mathematical, all but inaccessible to the lay person. By contrast, Thaler’s papers are rich with intuitive gems drawn from sports, business, and everyday life.”
In academia, critics are most often those who take a traditional approach, dismissing the laboratory experiments used to collect research data as too controlled to translate to the market. To counter them, Thaler points to the emergence of behavioral finance. “We got to sharpen our tools a lot using financial data. With every stock price going back every day to 1926 for every company that’s ever been traded, who needs experiments?”
The data is the starting point for Andrea Frazzini, who joined the faculty in 2005 as assistant professor of finance. Though not a member of the CDR, he is interested in the center’s research, and in his own work, Frazzini takes a behaviorist approach. “We use empirical research, and our methods are more or less the same as traditional finance. Often we have very similar findings,” he said. “Where we may disagree is on the interpretation.”
On that point, Eugene Fama, Robert R. McCormick Distinguished Service Professor of Finance and advocate of the efficient markets hypothesis, would agree. “The work on individual behavior is quite sound. But finance people want to go further and talk about what that then implies about the way prices get set. That’s a bigger leap, and there, the evidence is less convincing. There are usually other explanations for the results that are observed.”
Frazzini admitted, “What we do is a lot more intuitive than what many do in traditional finance. We try to understand why people behave the way they do.” His research generates portfolios and trading strategy. “Even if you don’t believe the behavioral finance angle, you can still use the portfolios,” he said. In fact, he said, among those who use them are hedge fund managers, who use the information to correct price disparities in the marketplace and sometimes earn huge fees for the work.
Frazzini wants to produce more research that can help people invest their own retirement funds better, a tactic called prescriptive economics. He and Kamenica agreed that Thaler is pioneering such an approach, evident in such projects as SMarT.
Thaler calls it “libertarian paternalism,” meaning that governments or employers can structure programs to offset the ways the average person is likely to make mistakes.
Watching the field of economics change to include the behaviorist approach, Thaler looks forward to a day when it’s no longer seen as separate. “The success will be when the name ‘behavioral economics’ doesn’t exist anymore, when economics will be as behavioral as it ought to be, and you won’t need the qualifier,” he said. Among those yet to be convinced is Fama. “Neither side ever has their views changed by these results,” Fama said. “It’s kind of a situation that may have no resolution.”
Nevertheless, the behaviorist approach continues to move forward. Thaler says the future will include neuroeconomics, which takes the acknowledgement that people don’t always behave in rational ways a step further by explaining why they don’t. Neuroeconomists apply neuroscience—the roles played by different parts of the brain as it performs specific tasks—to economics. On the forefront is Caltech economist Colin Camerer, MBA ’79, PhD ’81, who served as the other “camp counselor” with Thaler and Kahneman at the first behavioral economics “summer camp” in the late 1980s. “Neuro is one of the new directions,” Thaler said. “I’m too old to learn it, though. Let the young guys do that.”
Recognizing that people tend to be poor judges of what others think, Epley will look for new tools and methods to bring out the human capacity for allocentrism, the ability to represent accurately another person’s mental state.
Menon will research how people’s concepts of God develop and how those concepts affect their everyday perceptions of themselves and others. Her studies should yield insights about how the values that give people purpose, direction, and models for relating to others develop in different cultural contexts.
Fishbach will examine how people stay focused on long-term goals that are central to their intellectual, physical, spiritual, or professional success when they have opportunities to pursue competing, tempting goals that produce only short-term satisfaction.
The author, with Shlomo Benartzi, of the Save More Tomorrow (SMarT) plan that helps people turn their good intentions for saving for retirement into actual savings, Thaler will study which features are essential to SMarT’s success, such as the most effective time to introduce the program.
Although cognitive functioning declines for most people around age 75, research by Hastie will examine whether the elderly may be able to thrive in their daily decision-making tasks by capitalizing on intuitive wisdom they have gained over the years.
The effectiveness of goal setting is well documented, but the reason it works has not been identified. Goals lead to better performance, but they also can diminish a person’s satisfaction with the outcome. Wu will examine the paradox to find strategies people can use to get the maximum advantages and avoid the pitfalls of goal setting.
Through hedonomics, Hsee researches how happiness and other subjective experiences are related to external events such as income and wealth, why people sometimes fail to maximize their happiness with available resources, and how to help them improve their subjective well-being.