Behavioral Economics and Financial Decision Making

17 Pages Posted: 19 Jul 2021

See all articles by Angela Lyons

Angela Lyons

University of Illinois at Urbana-Champaign - Department of Agricultural and Consumer Economics

Josephine Kass-Hanna

University of Saint Joseph (Beirut) - Faculty of Business Administration and Management

Date Written: July 14, 2021

Abstract

Behavioral economics provides insights into how people process information and make decisions. It also helps to explain why and how people tend to make decisions that are not in their best interest, as opposed to what rational choice theory would suggest. This chapter provides an introduction to behavioral economics and highlights its relevance to understanding and influencing financial decision-making. The chapter explores major cognitive biases that commonly lead to mistakes in financial decisions, such as confirmation bias, overconfidence bias, loss aversion, the endowment effect, and status quo bias. The chapter also highlights the challenges brought about by choice overload, that is the multiplicity of options that overwhelms people and undermines their ability to make appropriate financial decisions. The chapter then discusses how choice architecture and nudges can be used to address the limitations resulting from cognitive biases and choice overload. In particular, we examine default choices, pre-commitment mechanisms, framing, and priming approaches and discuss how these can foster positive financial behaviors. This chapter thus represents a useful starting point for researchers and practitioners interested in developing and applying behavioral economics principles and tools to prompt financial decisions that lead to long-run financial security.

Keywords: behavioral economics, cognitive biases, choice architecture, nudges, financial decisions

JEL Classification: D14, D90, D91, G41, G50

Suggested Citation

Lyons, Angela and Kass-Hanna, Josephine, Behavioral Economics and Financial Decision Making (July 14, 2021). Available at SSRN: https://ssrn.com/abstract=3887605 or http://dx.doi.org/10.2139/ssrn.3887605

Angela Lyons (Contact Author)

University of Illinois at Urbana-Champaign - Department of Agricultural and Consumer Economics ( email )

1301 W. Gregory Drive
Urbana, IL 61801
United States
1-217-244-2612 (Phone)

Josephine Kass-Hanna

University of Saint Joseph (Beirut) - Faculty of Business Administration and Management ( email )

Campus of Social Sciences, Huvelin Street
P.O. box 17-5208 Mar Mikhael
Beirut, 1104 2020
Lebanon
+9611421000 (Phone)

HOME PAGE: http://www.usj.edu.lb/

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