Laudatio for Richard H. Thaler by Kees Koedijk, Professor of Financial Management
Today we celebrate the 92nd Dies Natalis of our University. On this occasion we would like to honour the work and achievements of Professor Richard Thaler of the Graduate School of Business, of the University of Chicago. First and foremost we would like to pay tribute to his academic leadership of the past thirty years, during which he has bridged economics, finance and psychology, and as a result, truly innovated the study of economics and finance by establishing the field now known as behavioral economics and finance. Professor Richard Thaler is really one of the main founders and innovators of this field. His contribution through-out the past thirty years has been truly enormous.
Traditional financial-economic models assume that humans are rational and utility-maximizing agents. It also assumes that agents have unlimited cognitive abilities, perfect willpower and no concern for other people - except possibly members of their own family - while markets are assumed to be able to quickly discipline and correct departures from the norm.
Using well-known psychological research as his starting point, Thaler has shown that these assumptions are not always sufficient to describe actual human behaviour. Behavioral economics and finance instead rely on the idea that humans have "bounded rationality", and hence sometimes make biased decisions that can, in some cases, run counter to their own interests. And in some, often very important cases, this concept of bounded rationality can make a very large difference.
Professor Thaler discusses this issue in a recent interview (I cite Richard Thaler here) "Most economists recognize that some of the people are not fully rational some of the time and some of the time that matters. What most traditionalists are not willing to grant is that bounded rationality carries much weight in a market setting; they believe that rational actors cancel out the irrational ones. Behavioralists disagree, arguing that bounded rationality does indeed bump the market’s invisible hand." (end of quote)
The study of behavioral economics has also enriched the study of economics with new concepts and words. Words like Loss Aversion (people fear loss because it causes them far more pain than they receive from gain), Status Quo Bias (people are reluctant to change) and Mental Accounting (people have a stressing need to direct different streams of money into so-called different "accounts") were unknown twenty years ago and are now standard in every economist’s toolkit.
While it appeared for a very long time that the so-called traditional and behavioral camps would never meet, it is to a large extent thanks to the work of Professor Richard Thaler and his associates that behavioral economics and finance have made headway into the mainstream. This can be illustrated by the fact that Richard Thaler’s research and that of his colleagues since the early 1980s, have been published in leading journals like the Quarterly Journal of Economics, the American Economic Review, and the Journal of Finance, to mention a few. It can also be seen in his many other achievements: Richard Thaler has been co-directoring the Behavioral Economics program of the prestigious and influential National Bureau of Economic Research in the United States since 1992, together with professor Robert Shiller of Yale University. He has also been a regular contributor to the well-known series called "Anomalies" in the Journal of Economic Perspectives.
This morning Prof Thaler spoke on pensions at the Pension roundtable with Dutch specialists on future Dutch pension schemes. His work with colleague Benartzi on Myopic Loss Aversion and the Equity Premium Puzzle is well-known in the pension area, and was published in the Quarterly Journal of Economics in 1995. This work deals with the effect of short evaluation periods and long investment horizons. More recently, his work with Henrik Cronquist on the design of the Swedish pension reform in 2000 has drawn a lot of attention.
In 2000 a reform of the Swedish pension system was implemented which aimed to make individuals more responsible for their own pension plan. It was part of a campaign for active choice in pensions/social security? Citizens could invest 2.5% of their annual pay in new investment funds, while 18.5% of their annual income that was contributed to social security, would remain in the traditional pension system. 4.4 million Swedish workers were given the choice between no less than 456 (!) investment funds in which to invest their pension money. The alternative offered was a low-cost, well-diversified default fund. As a result of the ad campaign by the Swedish authorities, 67% of Swedes made an active choice and acquired a specific investment fund. In their study, Cronquist and Thaler analysed what happened as a result of this. Interestingly, they found that Swedes who actively invested and managed their own pensions, chose relatively expensive, poorly performing and less diversified funds than those picked by the default plan and hence, they and society as a whole, were less well off/worse off than before.
An important message of Cronquists and Thalers research is that the framing and wording of active choice makes a big difference, especially when it comes to issues like pensions and mortgages, where setting and horizons matter. Cronquist and Thaler argue that it can be in people’s own best interest to be offered limited choices, something that Thaler, in his writing, refers to as Libertarian Paternalism. A few well-diversified pension choices would be enough. In this country, structural reform of the pension system and the healthcare system are also currently underway through so-called life-cycle funds and a revision of the costs of the public health system. Consumers will have to choose between many different options in a short period of time. The authorities in place would do well to take note of the important lessons that can be taken from behavioral economics, in regards to these reforms.
Next to his academic leadership I would also like to pay tribute to the truly multidisciplinary character of Thaler’s work. As you may know, multi-disciplinarity is close to the heart of RSM Erasmus University. Prof Thaler combines in a creative, innovative way, theory, empirics and experiments and his work covers many, many fields and disciplines. Not only has his work been published in the leading finance and economics journals, but his contributions have also found their way to important journals in the area of Accounting, Operations Research and Marketing.
Richard Thaler is also an expert in translating his academic work to practitioners and to a much broader audience in general. He has been published widely in the so-called practitioners-journals, which have a high impact among the professionals in the finance industry. He has also written books that reach out to larger audiences. Well-known are his books The Winner’s Curse, which is an overview of the most important paradoxes in the financial world, Advances in Behavioral Finance, which deals with the effect of psychology on finance, and his book Quasi-rational economics, which discusses irrationalities in economic models. All these books have had a big impact
I would like to conclude by saying that Richard Thaler is a highly important and creative scientist, both influential and a role model for academic thought-leadership. Here at Erasmus University, and around the world, his work serves as a source of inspiration to many. It is therefore a great honour and with great pleasure that I can pay tribute to a man who has helped form a new field of science, and redefined the existing field of finance: Professor Richard H. Thaler.
