Risk and Rationality

Risk and uncertainty are central in many fields: insurance, game theory, health economics, game theory, business, finance. Psychologists have discovered many irrationalities in human behavior. Kahneman & Tversky (1979) introduced prospect theory, integrating empirical psychological findings with economic models. It was the first rational model of irrational behavior, so to say, something considered impossible up to that point. This opened the door to nudging techniques.

For each participant, the risk and ambiguity (unknown probabilities) attitudes will be measured, and the best-fitting models will be determined. Financial advices will be given, based on theoretical foundations, such as, in general: do not insure low-cost risks such as bike-theft; (b) invest pension-savings in stocks and not in bonds. Characteristic of the behavioral approach: formal models are used to describe “soft” phenomena. Whereas Micro IV gave a broad presentation of behavioral economics, this course focuses on risk and uncertainty, thus showing how the behavioral approach works in depth. Summarizing, this course shows how to incorporate irrational psychological behavior into economic models. At the end of the course, participants will be able to apply empirically realistic models to economic problems and to nudge other people into more rational decisions.