Abstract

http://ssrn.com/abstract=500203
 
 

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Behavioral Economics and the SEC


Stephen J. Choi


New York University School of Law

Adam C. Pritchard


University of Michigan Law School

February 23, 2003

Michigan Law Econ. Paper No. 03-002;Georgetown Law Econ. Paper No. 389560;UC Berkeley Public Law Paper No. 115;CLEO Research Paper No. C03-6

Abstract:     
Investors face myriad investment alternatives and seemingly limitless information concerning those alternatives. Not surprisingly, many commentators contend that investors frequently fall short of the ideal investor posited by the rational actor model. Investors are plagued with a variety of behavioral biases (such as, among others, the hindsight bias, the availability bias, loss aversion, and overconfidence). Even securities market institutions and intermediaries may suffer from biases, led astray by groupthink and overconfidence.

The question remains whether regulators should focus on such biases in formulating policy. An omnipotent regulatory decisionmaker would certainly improve on flawed investor decisionmaking. The alternative we face, however, is a behaviorally-flawed regulator, the Securities and Exchange Commission (SEC). Several behavioral biases may plague SEC regulators including overconfidence, the confirmation bias, framing effects, and groupthink. While structural solutions are possible to reduce biases within the agency, we argue that such solutions are only partially effective in correcting these biases.

Instead of attempting to determine when the behavioral biases of regulators outweigh those within the market, we take a different tactic. Because behaviorally flawed (and possibly self-interested) regulators themselves will decide whether market-based biases outweigh regulatory biases, we propose a framework for assessing such regulatory intervention. Our framework varies along two dimensions. The more monopolistic the regulator (such as the SEC), the greater is the presumption against intervention to correct for biases in the market. Monopolistic regulatory agencies provide a fertile environment for behavioral biases to flourish. Second, the more regulations supplant market decisionmaking, the greater is the presumption against such regulations. Market supplanting regulations are particularly prone to entrenchment, making reversal difficult once such regulations have become part of the status quo.

Number of Pages in PDF File: 88

Keywords: behavioral economics, securities regulation

JEL Classification: K23

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Date posted: February 9, 2004  

Suggested Citation

Choi, Stephen J. and Pritchard, Adam C., Behavioral Economics and the SEC (February 23, 2003). Michigan Law Econ. Paper No. 03-002;Georgetown Law Econ. Paper No. 389560;UC Berkeley Public Law Paper No. 115;CLEO Research Paper No. C03-6. Available at SSRN: http://ssrn.com/abstract=500203 or http://dx.doi.org/10.2139/ssrn.500203

Contact Information

Stephen J. Choi (Contact Author)
New York University School of Law ( email )
40 Washington Square South
New York, NY 10012-1099
United States
Adam C. Pritchard
University of Michigan Law School ( email )
625 South State Street
Ann Arbor, MI 48109-1215
United States
734-647-4048 (Phone)
734-647-7349 (Fax)

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