A Brief Historical Review of Behavioral Finance and Economics

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James O. Prochaska PhD, Professor of Psychology and Director of the Cancer Prevention Research Center at the University of Rhode Island, developed the Trans-Theoretic Model of Behavior Change [TTM] which has been evolving since in 1977. Nominated as one of the five most influential authors in Psychology, by the Institute for Scientific Information and the American Psychological Society, Dr. Prochaska is author of more than 300 papers on behavior change for health promotion and disease prevention.

TTM Stages of Change

In his Trans-Theoretical Model, behavior change is a “process involving progress through a series of these stages:

  • Pre-Contemplation (Not Ready) – “People are not intending to take action in the foreseeable future, and can be unaware that their behavior is problematic”
  • Contemplation (Getting Ready) – “People are beginning to recognize that their behavior is problematic, and start to look at the pros and cons of their continued actions”
  • Preparation (Ready) – “People are intending to take action in the immediate future, and may begin taking small steps toward behavior change”
  • Action – “People have made specific overt modifications in changing their problem behavior or in acquiring new healthy behaviors”
  • Maintenance – “People have been able to sustain action for a while and are working to prevent relapse”
  • Termination – “Individuals have zero temptation and they are sure they will not return to their old unhealthy habit as a way of coping”


In addition, researchers conceptualized “relapse” (recycling) which is not a stage in itself but rather the “return from Action or Maintenance to an earlier stage.” In medical care, these stages of behavior change have applicability to anti-hypertension and lipid lowering medication use, as well as depression prevention, weight control and smoking cessation.




Uniting Psychology and Financial Behavior

More recently, validating the emerging alliance between psychology (human behavior) and finance (economics) are two Americans who won the Royal Swedish Academy of Science’s 2002 Nobel Memorial Prize in Economic Science. Their research was nothing short of an explanation for the idiosyncrasies incumbent in human financial decision-making outcomes.

Enter Kahneman and Smith

Daniel Kahneman, PhD, professor of psychology at Princeton University, and Vernon L. Smith, PhD, professor of economics at George Mason University in Fairfax, Va., shared the prize for work that provided insight on everything from stock market bubbles, to regulating utilities, and countless other economic activities. In several cases, the winners tried to explain apparent financial paradoxes.

For example, Professor Kahneman made the economically puzzling discovery that most of his subjects would make a 20-minute trip to buy a calculator for $10 instead of $15, but would not make the same trip to buy a jacket for $120 instead of $125, saving the same $5.


in vitro and in-vivo Economics

Initially, in the 1960’s, Smith set out to demonstrate how economic theory worked in the laboratory (in vitro), while Kahneman was more interested in the ways economic theory mis-predicted people in real-life (in-vivo). He tested the limits of standard economic choice theory in predicting the actions of real people, and his work formalized laboratory techniques for studying economic decision making, with a focus on trading and bargaining.

Later, Smith and Kahneman together were among the first economists to make experimental data a cornerstone of academic output. Their studies included people playing games of cooperation and trust, and simulating different types of markets in a laboratory setting. Their theories assumed that individuals make decisions systematically, based on preferences and available information, in a way that changes little over time, or in different contexts.

University of Chicago

By the late 1970’s, Richard H. Thaler, PhD, an economist at the University of Chicago also began to perform behavioral experiments further suggesting irrational wrinkles in standard financial theory and behavior, enhancing the still embryonic but increasingly popular theories of Kahneman and Smith.


Other economists’ laboratory experiments used ideas about competitive interactions pioneered by game theorists like John Forbes Nash Jr., PhD, who shared the Nobel in 1994, as points of reference.


But, Kahneman and Smith often concentrated on cases where people’s actions departed from the systematic, rational strategies that Nash envisioned. Psychologically, this was all a precursor to the informal concept of life or holistic financial planning. Kahneman was awarded the Medal of Freedom, by President Barack Obama, on November 20, 2013.

READ: Behavioral Economics and Psychology DEM


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4 Responses

  1. Ethics of Capitalism

    Why Social Insurance Is a Necessary Part of Capitalism?




  2. What it is?

    ‘Behavioral Finance combines the psychological characteristics with traditional finance principles in evaluating an investment. Behavioral finance focuses on the cognitive and emotional aspects of the investment decision-making process.’

    More from our paper, here:

    Click to access BFM_Newsletter_07_2011_BehavioralFinance.pdf


    See examples of “cognitive illusions,” and learn why humans make predictably irrational decisions; by Dan Ariely PhD.

    Patrick Bourbon CFA


  3. Behavioral Economics

    A new video from our colleague Victor Ricciardi:

    Dr. David Marcinko MBA


  4. Behavioral Health Economics

    It’s HUGE! Healthcare behavioral economics is the effect of psychological, cognitive, emotional, and social factors on the economic and health decisions of individuals. Not only do consumers and patients face a mind-numbing array of financial healthcare choices, there are also tough decisions navigating the complexities of how, when and where medical care is delivered. It’s no surprise that most consumers say health care is so complicated they don’t know what’s covered, what it will cost or where’s the best place to go to get it. The result often comes in the form of confusion, apathy and disengagement.

    The ability to engage patients in follow-up treatments and adherence protocols is central to the success of population health management programs and ultimately, quality improvement. Today, millions of dollars and countless hours are spent each year to try to get health care consumers to do what’s good for them. It’s a long, slow and expensive effort that sees only modest behavior change. It’s the dilemma of ‘health inertia’…getting people to face personal health challenges, adhere to a plan of action, and stay motivated to proactively deal with their health. It’s fighting human nature to get results.

    Changing behavior takes moving away from educational-based efforts overloaded with complex clinical and instructional messaging about conditions and treatment options. There needs to be a shift from education to inspiration, from features and functions to gut-level emotional appeals that move people to action and sustain engagement. It’s about connecting across the customer lifecycle around personal, relevant motivations and deep, sometimes even unconscious desires and values like freedom, happiness, personal goals, self-esteem, or the ability to be a better parent or partner. It’s the principles of healthcare behavioral economics.

    Effective population health management is about inspiring individuals to make smart, personalized choices in a health care ecosystem defined by significant out-of-pocket responsibility and complicated care delivery choices. Monotone, common denominator off-the-shelf programs to improve patient health around chronic conditions, prevention, early detection or wellness isn’t enough. Success only comes when you can get individuals to respond, interact and engage in a meaningful two-way relationship driven by emotion, psychological drivers, and most importantly built on trust. Payers, providers and employers need to step up and support the underlying belief that connected, motivated and empowered health care consumers will help drive better care, better quality, better outcomes, and ultimately, better value.

    Lindsay R. Resnick
    via Ann Miller RN MHA


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