Models of bounded rationality and the credit environment

Summary (via

This column argues responses to the recession should not be based on unrealistic expectations of rational behaviour. It argues that models of bounded rationality provide reasons that traditional macroeconomic policy responses may fall short and suggests more sophisticated solutions that could break the crisis’s psychological hold on markets.

Excerpt (via

Bounded rationality is the broad term for behavioural models that do not follow the rational-maximiser formula. There is not yet a generally accepted alternative model. Lots of individual non-rational behaviours have been discovered, but they are grafted onto a rather clunky ‘rational actor with bits’ instead of forming a coherent behavioural model.

However, the best place to test a new theory is often at the edges of the old one, where the existing model breaks down. So the current troubles in the financial and real economy may be a good opportunity to try out some alternative models and see which give a reasonable description of what we see.
Models of bounded rationality

Different models of bounded rationality vary basic assumptions of the rational agent model in different ways. Some of those assumptions are:

* Utility is discounted over time in a consistent way
* People have access to all relevant information
* All relevant information is expressed through market prices
* People can instantly weigh up the change in utility given by any buying or selling decision
* People act to maximise their utility

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03. March 2010 by Miguel Barbosa
Categories: Curated Readings, Finance & Investing | Leave a comment

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