I've been very much involved with this field since around the late 1980s, joining psychology and finance, and it's a deep belief of mine that it really matters. So I'm trying not to over emphasize this in this course, because this is a general course in finance and I don't want to over emphasize one aspect of it. On the other hand, it sounds to me extremely relevant. Maybe I'm influenced by the fact that my wife is a psychologist but I don't think it's just that. I think there's a problem in academia, that departments are too separated. Professors don't go to each other's seminars and get to know other fields as well as they ought to, though there's so many topics in behavior. By the way, it's a revolution. I don't know if I said this before. The first one we just talked about was the efficient markets revolution. It came in with, also, the capital asset pricing model and mathematical finance. That was an important revolution. I'm not saying they were wrong, everything is half truth in life. Isn't that true? No simple model will explain everything. But the next one was behavioral finance or, more broadly, behavioral economics, and that came in around, well, it's fuzzy but around 1990. Well, I think the term behavioral economics appeared then and it became a sort of revolution. But the ideas go back very far and they go back, in fact, to the father of economics, Adam Smith. Now you know Adam Smith for his book, The Wealth of Nations, which he wrote in 1776, which describes free market economics and is interpreted widely to be a Libertarian or a free market tract. Adam Smith was a champion of letting prices go where they may because they allocate scarce resources. I don't think he used that term exactly but had that meaning. He's famous for the quote, invisible hand, that the free market is the invisible hand that's directing the economy. And he said that, who makes sure that enough coal is being dug out of the ground for next winter? Is there a government department of coal production? Well, there isn't now and there wasn't in 1776. So what determines it? Well, it's the profit motive. This is Adam Smith in his famous book, The Wealth of Nations. And prices guide it, if price gets high, the coal mines will produce more because it's profitable for them to do that. And so, the price equilibrates at a level that is just right for the upcoming winter when people have to heat their homes. There will be enough coal. But the other side of Adam Smith is in this other book called the Theory of Moral Sentiments. Now he's not any academic psychologist. He's just writing as a public intellectual in 1759. He said that he has noticed throughout life that people really like to be praised. Now I guess that's obvious, right? You notice this in young children. You tell them, you did something good, they seem to respond and it goes throughout life. But then Adam Smith points out, are you happy with being praised for something that you didn't do? Suppose somebody makes a mistake and thought that some achievement was yours, but, in fact, it's just a mistake. Now suppose you also know that the mistake will never be revealed, so you've got this on your resume, some great achievement. Do you get pleasure from being praised for this? And he said probably not, right? You want to be praised for something you really did, and so he said, especially as one gets more mature and thinks more about life. As people mature, the desire for praise morphs into a desire for praiseworthiness. So people want to be, Suitable for praise, even if nobody knows it. So he gives the example of mathematicians. Mathematicians are not famous usually. [LAUGH] That's because the public can't see or understand what they do. In contrast, even in 1759, actors and singers were famous, were wildly famous, compared to mathematicians. So why don't mathematicians despair? Nobody knows who I am, I'm doing all this work. It is because they have a small community of mathematicians who've read your work and respect it. And you know that you are praiseworthy for this work, even if you're totally unknown. So that's what he said, and I think that's a real insight that he has. This is really true, at least for mature adults, that you develop a sense of your own praiseworthiness. So that’s very different from the usual assumption in economics, that one wants to maximize consumption.
