Final Paper_Essay

Final Paper_Essay - When Intuitio n Fails December 1 2008...

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1  |  P a g e When Intuition Fails December 1 2008 Creating the link between the global financial crisis and behavioral  economics.  Applying behavioral anomalies in a quest to better  understand the current state of our financial markets. Adding Systematic Errors to Rational Choices
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AEM 414 Managing Market Driven Growth Professor Schulze 11/15/2008 When Intuition Fails: Adding Systematic Errors to Rational Choices Over the course of the semester we have studied various behavioral anomalies that arise when the rational choice theory (expected utility theory) fails to predict one’s actions based on what a rational individual would do . Thus, decision theory goes to explain why we may have made an “irrational” decision, or tries to analyze what decision(s) was actually made . These anomalies may arise from the decisions people make in every day auction situations such as the Vickery Auction Fallacy and The English Auction Fallacy as well as many First Bid Price style auctions (Lecture 2) . Other anomalies range from the Winners Curse, to the Hot Hand Theory, Choice Strategies, Hyperbolic Discounting, Prospect Theory, Risk Seeking behaviors, Loss Averse behaviors, the Status Quo Bias and even the Sunk Cost Fallacy among others (Lectures 3-10) . In class we discussed how these anomalies could be applied to a wide range of topics; from decisions we make between purchasing a TV set or a new car, to many sports fanatics’ incorrect beliefs in the prevalence of streaks, all the way to salesperson-of-the-month programs . At the same time we were studying these various anomalies and their many applications, the world was experiencing a global financial crisis . The United Stated was experiencing one of the worst financial meltdowns since the Great Depression . If the aforementioned anomalies/ fallacies could be applied to such a broad range of topics, the question begging to be asked was if they could also somehow lend to our understanding of what was going on throughout the broader 2  |  P a g e
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financial industry? Were there certain factors which led to the financial crisis that could have been avoided had the individuals making some of the major decisions known about such fallacies? Although, knowledge is a factor in our ability to avoid such fallacies, we will come to find that end the end experience trumps all . Before we can delve into some of the major decisions that were made leading up to our current economic situation, we must first gain a basic understanding of what happened and why it happened . Many site the catalysts of our current economic crisis to be that of the Unites States housing bubble which formed toward the end of the late 20 th century (Saxton) . Due to deregulation in the financial industry that had been taking place even before the Clinton administration (Lecture 10), banks were able to issue mortgages to individuals with low incomes and little to no assets . Many of these mortgages were being issued with no money down
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This essay was uploaded on 02/20/2009 for the course AEM 4140 taught by Professor Schulze,w. during the Fall '08 term at Cornell.

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Final Paper_Essay - When Intuitio n Fails December 1 2008...

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