Read These Five Papers to Understand Thaler's Nobel-Winning WorkBy
Research ranges from social preference to self-control
Thaler helped define the field of behavioral finance
People act irrationally, a fact economists long ignored. Richard Thaler, winner of the 2017 Nobel prize in economics, has made a career of fixing that oversight.
In research that’s typically quirky, often funny, infused with pop-culture and written for a lay audience, Thaler of the University of Chicago has made the case that human decisions are shaped by social context, expectation and temptation -- not cold rationality.
Here, we run down some of his greatest hits, a body of work that on Monday lifted Thaler to the pinnacle of economics.
Thaler co-wrote the 2008 global bestseller Nudge with former White House adviser Cass Sunstein, a law professor at Harvard University and a Bloomberg View columnist. In it, the authors examine why people make the choices they do, looking at biases and the limits of human reason. In it, they make the case that while humans often make choices that don’t result in their longer-term well-being -- for example, eating unhealthy foods that lead to obesity -- society can drive better decisions via "choice architecture," or by better organizing the context in which people make decisions. To illustrate, they use the example of an actual architect. "As good architects know, seemingly arbitrary decisions, such as where to locate the bathrooms, will have subtle influences on how the people who use the building interact," they write in their introduction. “A good building is not merely attractive; it also ‘works.”’
This book is an especially important part of Thaler’s repertoire because it’s influenced the Conservative government in the U.K. and U.S. Democrats.
Nudge: Improving Decisions About Health, Wealth, and Happiness
Available on Amazon
2. Deal or No Deal?
Thaler and his co-authors show that TV game show contestants make so-called path-dependent choices in this paper: what happened earlier in the show influences how they behave as the program progresses. In the game show, various sums of money have been allocated to 26 briefcases, and as the show progresses -- as briefcases are opened, revealing the sums within -- she has the option to take a deal to walk away or continue to play, risking losing out in exchange for the chance at a bigger reward. They find that risk tolerance in later rounds varies widely among contestants, but it’s limited among those who do badly (eliminating high-value briefcases) or those who get lucky (opening low-value briefcases) early on in the game. “The relatively low risk aversion of losers and winners is hard to explain with expected utility theory and points in the direction of reference-dependent choice theories,” the authors write.
Deal or No Deal? Decision Making Under Risk in a Large-Payoff Game Show
Available on Thaler’s website
3. Save More Tomorrow
Thaler proposed a prescriptive life savings program in this paper with the University of California at Los Angeles’ Shlomo Benartzi. The idea is that at least some low-saving employees with defined contribution plans are making a mistake and would be better off saving more, so if they committed in advance to allocating a portion of their future salary increases toward retirement savings, they would wind up better off. Their experiment with the program at a midsize manufacturing company returned some encouraging results. About 78 percent of those offered the program joined, about 80 percent of those participants stuck with it through four pay raises, and that groups’ average savings rate climbed to 13.6 percent from 3.5 percent over 40 months.
This paper is important because it brings a real-world experiment to bear on one of Thaler’s big ideas: “libertarian paternalism." The idea is that society should design institutions that help people to make better decisions, but without impinging their freedom to choose.
Save More Tomorrow: Using Behavioral Economics to Increase Employee Saving
Available on Thaler’s Chicago Booth faculty webpage
4. The Loser’s Curse
Thaler and co-author Cade Massey analyzed American football teams’ player draft decisions in this paper, concluding that top draft picks are consistently overvalued. “Rather than a treasure, the right to pick first appears to be a curse," the duo writes. Buying expensive players, even very good ones, results in opportunity costs lower on the roster -- teams might have to pass on other players that would, together, result in better teams down the road. "The irony of our results is that the supposed benefit bestowed on the worst team in the league, the right to pick first in the draft, is only a benefit if the team trades it away," they wrote in the 2010 version.
In his 2015 book, a memoir-cum-manifesto, Thaler clearly states the crux of his career-long argument: economics needs to take human behavior into account. People give into biases when making decisions, and that human miscalculation can come with serious consequences. Both economic forecasters and policy-setting governments need to take the fact that actors are human into account, he argues. "The primary reason for adding Humans to economic theories is to improve the accuracy of the predictions made with those theories,” he writes, quipping that behavioral economics comes with the added benefit of being more interesting and more fun. “It is the un-dismal science.”
Misbehaving: The Story of Behavioral Economics
Available on Amazon