People Are Not Irrational, Says Statman Recounting Early Challenges Of Understanding Behavioural Finance

People are not irrational, they are normal, says Professor Meir Statman, a renowned behavioural finance expert. In an exclusive interview in 'Wealth Wizards: Money Maestros in Conversation with Nidhi Sinha' series, Statman recounted the challenges encountered in the early days of behavioural finance. Meir Statman is among the second generation of behavioural finance experts who bust the notion of labelling people as “irrational” and instead calls them “normal”. Statman came to Santa Clara University at the beginning of 1980 where he met Hersh Shefrin, Canadian economist and a behavioural finance expert. Shefrin was working on issues of saving, self-control and mental accounting, while framing them in the context of savings. It was here Statman began exploring the issue of ‘dividends’ and tried to understand ‘why people prioritise receiving dividends over creating "homemade dividends" by selling shares’, a concept coined by Nobel laureate Miller Modigliani. 

‘People constrain themselves and spend from dividends and income, but don’t dip into the capital,’ Statman opines. Collectively he and Shefrin wrote a paper that was later published in the Journal of Financial Economics after facing a few objections. 

There was no such thing as behavioural finance when he started, Statman recalls stating ‘We did stuff that was funny to most people in finance.’

Also Read- People Are Normal. They Are Sometimes Ignorant But They Are Not Stupid, Says Meir Statman

The generation(s) of behavioural economists

“I think that people who write about behavioural finance are still fascinated by the notion that people make cognitive and emotional errors. But that is not the end of it,” Statement says.

He believes that scholarships in behavioural finance are still centered on the findings of first generation of economists who often described people as irrational. These economists, Statman believes, moved from standard finance, where people are usually described as ‘rational’. 

The first generation of behavioural economists believe ‘rational people care only about maximising their wealth, and are free of cognitive and emotional errors.’ Whereas the second generation calls them ‘normal’. They believe that people want more than just utilitarian benefits of wealth. They seek expressive and emotional benefits as well.

In 1980s, Statman started exploring the concept of ‘socially responsible investing’ to explain how people are willing to sacrifice some utilitarian benefits in order to achieve expressive and emotional benefits.

The approach identifies how people would care less about their diminish wealth when investing in something that gives them satisfaction such as donating for charity. This also includes people providing for their families, meaning a utilitarian benefit where a person pays to feed and educate their children.

“When we see how normal we ourselves are, how can we pretend that we are rational people who care only about wealth,” Statman says remarking on the transition of understanding behavioural finance.