Finance is only human after all !
LFF talked with Dr. Thomas Fenzl about the role that humans play in the financial business. The Economic psychologist teaches at the Institute of Psychology at the Alpen-Adria University of Klagenfurt. In the following interview, he points out risks and opportunities linked to human behavior in the financial industry.
LFF: How old is the science of behavioural finance?
TF: A milestone for the development of Behavioral Finance was the “Prospect Theory” by Daniel Kahneman and Amos Tversky in the 1970’s.
LFF: Allegedly 50% of economic activity is psychologically determined. Do you agree?
TF: I don’t feel too comfortable talking about percentages, nevertheless theoretical models, whether economic or financial, should always consider the factor of the human psyche. Ultimately economic behavior is influenced by dynamic factors.
LFF: Were certain developments that lead to the financial crisis foreseeable?
TF: In the past there have always been financial bubbles. “Herd behavior” is a driving force behind them. Personally I believe that investor sentiment and mood are the crucial factors. In order to predict events such as a financial crisis, it is vital to recognize whether people are euphoric or pessimistic and to determine when their mood switches between these two extremes.
LFF: How does the current economic crisis affect investor behavior?
TF: I believe that investors have become more skeptic and cautious, but only until the next boom is expected. The current circumstances won’t be present in the minds of people for too long.
LFF: To what extent are political decisions influenced by cognitive biases or herd behavior?
TF: It is absolutely vital to state that we are all susceptible to cognitive biases and false interpretations. Hence politicians are most certainly influenced by such biases including their herd instinct. Nonetheless I cannot fully agree on the term “herd behavior” because humans are not animals. Contrary to animals we have the ability to reason and therefore to reflect on our actions. However, I would also like to mention manipulation. I would argue that decision-makers also manipulate the public for their own benefit. Why else would they try to preserve a system that needs radical changes.
LFF: Are facts or opinions more likely to affect decision-making?
TF: People are rather influenced by their opinions about facts. It is not the facts themselves but the way in which they are being interpreted that determines the outcome.
LFF: How can behavioral finance contribute to the well being of the economic environment?
TF: Behavioral finance should avoid restricting itself to being a “laboratory science”. The biggest advantage of Economic Psychology or Behavioral Finance is that it covers practice-relevant topics. Economic psychologists should work together closely with decision-makers in order to provide detailed information about economic and financial behavior and thus help to improve legislation and the economic environment. We should abandon the notion of “this is the way economic systems work” because in the end humans are part of these systems and their behavior ultimately shapes them.
Interview: Till Noack