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HAYEK’S THEORY OF KNOWLEDGE AND BEHAVIOURAL FINANCE Alfons Cortes and Salvatore Rizzello INTRODUCTION All through last century, the Austrian School of Economics introduced a series of original and interesting ideas into social sciences, which are still fruitful for contemporary research. We are not referring only to the ideas that are particularly relevant in economics, such as marginal utility, com-petition, market, entrepreneur, time irreversibility, information, risk, uncertainty, economic cycle, money, theory of capital, public choice, to mention only the most relevant ones. What we have in mind is ideas relevant for all social sciences: methodological subjectivism, apriorism, human knowledge, human action, decision making, praxeology, human freedom, evolution, nature and role of institutions. The ideas expressed by the authors belonging to this school are often so heterogeneous, that they are rather a composite collection of ideas than a single consistent corpus. Nevertheless, a few common aspects characterize the school as a whole. In this chapter we will examine one of the major aspects in detail. It has a paradigmatic value for the comprehension of the Austrian approach to so-cial sciences, and, therefore, its relevance goes beyond economic sciences. It consists in the strict connection between human mind and human decisions, Cognition and Economics Advances in Austrian Economics, Volume 9, 87–108 Copyright r 2007 by Elsevier Ltd. All rights of reproduction in any form reserved ISSN: 1529-2134/doi:10.1016/S1529-2134(06)09004-1 87 88 ALFONS CORTES AND SALVATORE RIZZELLO a concept that has been already dealt with in literature and is here discussed with reference to investment decisions and financial decisions in general. Behavioural finance (an original approach, aiming at explaining financial decisions in new terms) is today one of the most fruitful branches of behavioural economics, and in some respects of cognitive economics.1 Nev-ertheless a systematic study of the Austrian matrix of its foundations has not been carried out yet. After the cognitive revolution (Gardner, 1985), behavioural economics has developed within economic science. The basic idea is that the view on hu-man behaviour developed by cognitive psychology should be considered fundamental in economics, as it gives a realistic explanation of economic decisions, the solution of problems connected with them, the nature, dy-namics and evolution of organizations and institutions. Just like psychol-ogy, neurobiology and philosophy, the microfoundations of behavioural economics lie in the comprehension of human mental activities. Behavioural economics’ models are based on the concepts developed by these disciplines, which confute the idea (supported by the orthodox economic theory) of a discontinuity between the normative science of decision making and the psychology of decision making. With few but fundamental differences with behavioural economics, cog-nitive economics emerged more recently as a branch of the study of decision making. The most relevant differences between these two analogous ap-proaches mainly consist in the fact that cognitive economics considers as crucial the understanding of the process of generation of human knowledge. It emerges from very complex mechanisms, often tacit and linked to the institutional dimension, to the personal history of the individuals and to the processes of social interaction, in an evolutionary context. In the wake of the advances in cognitive sciences – which were made thanks to the contribution of a number of economists, including H. Simon – cognitive economics proposes new, more realistic foundations for economic actions: agents are characterized by bounded rationality and limited know-ledge, they follow imperfect rules and procedures, with the aim of reaching satisfactory outcomes that depend on personal levels of aspiration, in a continuous feedback with the organizational and institutional dimension (rather than confined to the market), and they exist in a historical irrevers-ible time (rather than the logical time used in mainstream models). With a view to the recent advances, it is necessary to underline that this approach to economics draws also on another matrix, the Austrian school of economics and, in particular, on the research carried out by first of all by the founder Carl Menger, who stressed the link between human mind and institutions Hayek’s Theory of Knowledge and Behavioural Finance 89 and by his follower F. von Hayek, who highlighted the role of tacit personal knowledge in decision-making processes and the strict connection existing between mental structure and the nature and role of institutions (Hayek, 1963, 1967).2 The most recent advances in the cognitive approach to economics have developed into new lines of research: neuroeconomics, founded by the Nobel Prize winner Vernon Smith, dealing with the neural mechanisms responsible for human behaviour and connected with economic problems; experimental and cognitive economics, based on the works by Maurice Allais in the 1950s, and the more recent works by D. Kahneman (consisting in laboratory re-search into the processes of individual and organizational learning and the processes of coordination in conditions of uncertainty and limited knowl-edge, taking into account also the role played by emotions); behavioural finance, dealing with agents’ behaviour on financial markets in a psycho-logical perspective. Behavioural finance, in particular, rejects the hypothesis of efficient mar-kets, and it applies the outcomes reached by cognitive sciences to finance, with specific reference to anomalies, inefficiencies, and behavioural biases. In spite of the traditional assumption of efficient markets, financial in-vestors are not perfectly rational, as their decisions depend on cognitive shortcuts, on emotive aspects, on their capacity to represent to themselves the contest they are operating within, on future expectations. All these fac-tors depend, in turn, on their capacity to perceive external data correctly, to interpret them, and to operate accordingly. Therefore, in spite of the as-sumptions of the mainstream approach, financial investors are characterized by limited information and bounded rationality, and – as we will see in detail–their actions follow complex and mostly unconscious and imperfect decision-making mechanisms. As a consequence, their decisions often cause errors in individual investment choices, ‘‘contagion’’ effects, and generally lead to market inefficiencies. The basic assumption in this chapter is that all these factors might be better understood if we correlated them to cognitive economics and to the Austrian tradition, particularly to Hayek’s theory of knowledge. We hope to demonstrate that many typical elements in the foundations of behavioural finance can be found in that theory, with in-teresting implications that will be discussed below. Among the very interesting contributions offered by the Austrian School, the analysis of the decision-making processes connected with human cog-nitive mechanisms is certainly one of the most relevant. This is not only due to the originality of this approach, but, as mentioned above, also to its still fruitful ideas.3 90 ALFONS CORTES AND SALVATORE RIZZELLO Another crucial lesson of the Austrian school is that, in order to under-stand decision-making mechanisms, we need to examine them within their institutional context. More precisely, decision making and institutional dimension are directly connected by the cognitive processes underlying the creation of human knowledge. Therefore, an analysis of the decision-mak-ing processes occurring in a financial ambit should not only include the connections with the neurobiological mechanisms underlying choices, but also the context characterized by social norms influencing those processes and whose nature and evolution are in turn influenced by them, through a feedback mechanism. Also in this case, Hayek is our major reference. Drawing on Carl Men-ger’s lesson, Hayek maintains that social norms and institutions emerge spontaneously from individuals’ free actions, and that they evolve through a social selection mechanism; this is a very delicate, though imperfect, mech-anism, defined by Hayek as ‘‘cultural selection’’ and it should be defended and preserved from any form of planned change. To summarize, Hayek believes that nature, role, and evolution of social norms and institutions are strictly connected with the limits and character-istics of human mind, as well as with the interrelation of each human mind with the others (Hayek, 1963). Thus, Hayek’s merit is disclosing and clarifying the neurocognitive dimension of a phenomenon Menger was intuitively aware of, when it car-ried out that the nature of tacit and explicit rules of conduct and institutions was strictly connected to the characteristics of human mind (Menger, 1883). In order to illustrate this complex theory explaining nature and evolution of social norms and institutions, we may divide its qualifying points into two categories: the endogenous level and the exogenous level of the individual cognitive processes. This is an arbitrary classification indeed, and its only aim is explaining this theory, as the two dimensions are not separated: they are strictly interconnected and influence each other. The endogenous level includes all the elements characterizing human mind: neurobiological dimension, perception, personal knowledge, and feedback. At an exogenous level, we find: interrelation, cultural selection, and feedback. The presence of feedback at both levels underlines its rel-evance, and we might now introduce the concept of internal and external feedback (though we are aware that this is an improper use of these expressions). The ‘internal feedback’ is to a spontaneous retroactive mech-anism between already existing individual cognitive categories, which can give significance to new stimuli. The ‘external feedback’ is an often supra-conscious mechanism, through which the ontogenetic and the phylogenetic Hayek’s Theory of Knowledge and Behavioural Finance 91 dimensions of personal knowledge are assessed and compared. Though we will examine these concepts in detail below, it is important to dispel any misunderstanding immediately. This process cannot be subdivided into (distinct and separate) phases, both in its theoretical–analytical dimension, and in the empirical dimension consisting in the direct observation of such phenomena. The framework of this complex relationship will gradually emerge as we illustrate it: in Section 1 we will briefly discuss the relation between decision making, human perception, human knowledge, and nature and role of institutions; Section 2 is devoted to the relevance of Hayek’s theory of knowledge for financial decision making; in Section 3 we will discuss the path-dependent dimension of this mechanism; the implications for the finance world are taken up in Section 4. The last section briefly offers a general view of the subject and a few concluding remarks. 1. HAYEK’S THEORY OF KNOWLEDGE: MIND, ACTION, AND AN INSTITUTIONAL DIMENSION FOR DECISION MAKING All through his varied research activity as a social scientist, Hayek never forgot the neurocognitive nature of human actions.4 In as few words as possible, we can say that for Hayek there is a circular continuum between human perception, creation and use of personal knowledge, human action (decisions), influence on social reality, and feedback on human perceptual abilities. Since their birth, individuals are endowed with a system of cognitive maps, allowing them to perceive and give significance to external stimuli of any kind. These innate cognitive maps are strongly characterized by the genetic imprinting of one’s parents, which has a double nature: biological and cultural, and it undergoes a selection carried out by evolutionary mechanisms (the biological selection being slower than the cultural one). Innate cognitive maps are characterized by this double nature, and tend to assimilate the external stimuli according to their own classifying principles. As early as at this phase of individual life, an external stimulus cannot be perceived, unless it is related to something ‘‘already known’’ and interpreted (Hayek, 1952). Let us analyse these early phases more in depth, as they contain extremely interesting elements. First of all, innate cognitive maps are influenced by the socio-cultural context. Moreover, everything we perceive need to be ... - tailieumienphi.vn
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