Behavioral Finance in Decision-Making

This introductory week explores the classical economic model of consumer choice, which is built on the assumption that individuals make rational decisions. We'll delve into the theoretical framework that describes how people ought to make choices, particularly in financial contexts. After establishing this foundation in rational decision-making theory, we'll shift our focus to examine actual human behavior. Special attention will be paid to scenarios where people's choices seem to contradict the rational choice axioms. By contrasting the theoretical "should" with the empirical "does," we'll begin to understand the gap between traditional economic assumptions and real-world decision-making patterns, especially in situations where human behavior diverges from predicted rational outcomes.

In this session, we will discover how our minds are inclined to distort probabilities, and either underestimate or overestimate the likelihood of certain outcomes. We'll also learn about "heuristic-driven bias": the tendency to use rules of thumb that simplify the process of making decisions, but can also lead to predictable errors. These biases negatively affect our decision-making far more than we might expect; especially when the outcome of the decision has great significance for us.

In the final week of the course, we will see multiple examples of how mental heuristics can lead us to make predictably sub-optimal financial decisions, both individually and across the entire financial markets. We will also discuss the many ways in which you can now improve your financial decision-making because of your deeper understanding of the innate biases that have tripped you up in the past!