15.

481x Financial Market Dynamics

and Human Behavior
Andrew W. Lo, MIT
Unit 3: Psychology and Behavioral Biases
Lecture: Utility Theory & Risk Aversion
A Brief History of
Psychology
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History of Psychology
The Science of Mind and Behavior
§ Origins in ancient philosophy and religion (mind, soul, spirit, demons);
Aristotle’s De Anima (3 “psyches”)
§ Much was theoretical, but some empirical examples:
– Galen (129–200/216AD): brain controls muscles
– Mesmer (1734–1815) and Braid (1795–1860): hypnotism
– Gall (1758–1828): phrenology
§ Beginning of psychophysics:
– Weber (1795–1878), Fechner (1801–1887)
§ Wundt (1832–1920): Leipzig lab, journal, textbook
© 2020 by Andrew W. Lo
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History of Psychology
Example: Weber/Fechner Law
§ “Just noticeable differences”
§ Weight perception is logarithmic in stimulus:

100g Þ 5g
200g Þ 10g
Lanzara (1994)
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History of Psychology
Example: Weber/Fechner Law
§ Many other senses tested (hearing, vision, touch, etc.)
§ Experimental discipline for mind/brain/behavior
§ Closely related to medical research

© 2020 by Andrew W. Lo
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History of Psychology
Sequence of “Schools of Thought”
§ Structuralism
– Wundt, Titchener
§ Functionalism
– Darwin, Galton, James, Dewey, Angell, the “Chicago School”
– Application to education and testing: Binet (1857–1911), Terman’s “Stanford-
Binet” IQ test (1916)
– Witmer (1867–1956) introduces clinical psychology
– Huge impact on education: from 1890 to 1918, public school enrollments increased
700%, more money is spent on education than defense and welfare combined, and
one high school is built per day!
© 2020 by Andrew W. Lo
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History of Psychology
Sequence of “Schools of Thought”
§ Behaviorism
– Pavlov’s (1849–1936): bells and salivating dogs
– Skinner (1904–1990): operant conditioning, reinforcement learning, “aircrib”
– Watson’s (1878–1958) : conditioned fear reflex in Little Albert

© 2020 by Andrew W. Lo
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History of Psychology
Sequence of “Schools of Thought”
§ Gestalt: “whole is different than sum of the parts”
§ Psychoanalysis
– Freud (1856–1939): unconscious, id/ego/superego/, sex, dream
analysis, Freudian slip, “talking cure”
– Jung (1875–1961): collective unconscious, archetypes
(persona/anim(a)(us)/shadow/self), intro(extra)version, personality
types (thinking/feeling/sensing/intuiting), synchronicity, middle age
– Myers-Briggs Type Indicator

© 2020 by Andrew W. Lo
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History of Psychology
Sequence of “Schools of Thought”
§ Cognitive psychology/cognitive neurosciences
– Science of behavior and mental processes
– Miller (1920–2012): seven “chunks” of information (1956)
– Artificial intelligence: the brain as a computer
– Sociobiology and evolutionary psychology (more later)
– Vision: Poggio
– Development: Piaget, Spellke
– Language: Chomsky, Pinker

© 2020 by Andrew W. Lo
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Contemporary
Psychology
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Obedience to Authority

© 2020 by Andrew W. Lo
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Obedience to Authority

By Fred the Oyster [CC BY-SA 4.0

http://creativecommons.org/licenses/by-sa/4.0)],
via Wikimedia Commons
© 2020 by Andrew W. Lo
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Theory of Mind
False Belief Task of Wimmer and Perner (1983)
§ Can you predict behavior of others empathically?
§ Sally-Anne experiment

§ 80% of autistic children cannot complete this task (“mind-blindness”)

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Theory of Mind
Chimpanzee ToM

Source: Povinelli, Nelson, Boysen (1990)

© 2020 by Andrew W. Lo
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Positive Psychology
Happiness Research
§ Psychology shouldn’t always be about the negaBve
§ ScienBfic study of happiness, saBsfacBon, virtues
§ IniBated by Seligman’s (1998) APA address
§ Examples of research findings:
– Money can’t buy happiness
– Job sa`sfac`on is unrelated to salary
– Higher IQ and more educa`on is not necessarily “beaer”
– Loaery winners oben unhappier
– Hedonic treadmill theory (adapta`on)
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Positive Psychology
Happiness Research

Long-Term (10Y or more) Short-Term (1Y)

Source: Easterlin, McVey, Switek, Sawangfa, Zweig (2010)

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Psychometrics

MIT

Source: Jonathan Plucker

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Psychometrics

Source: http://web.uvic.ca/~lalonde/psyc335/notes/lecture08.html
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Psychometrics
Myers Briggs Type Indicator
§ Based on Jung’s archetypes
– Introvert/extrovert, thinking/feeling, sensing/intuiting,
perceiving/judging
§ 24 = 16 types
§ Compatibility differs among types
§ Types may be useful for management
– Career choice, personnel decisions, enhancing teamwork and
collective intelligence, child-rearing (?), dating (?)
§ Keirsey and Bates (1978)
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Psychotherapeutics
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Psychopathology
Psychopaths:

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Psychopathology
Psychopaths and the Hare PCL-R Checklist:
1. Glibness/superficial charm 11. Promiscuous sexual behavior
2. Grandiose sense of self-worth 12. Early behavior problems
3. Need for s`mula`on/proneness to 13. Lack of realistic long-term goals
boredom 14. Impulsivity
4. Pathological lying 15. Irresponsibility
5. Conning/manipula`ve 16. Failure to accept responsibility for own
6. Lack of remorse or guilt actions
7. Shallow affect 17. Many short-term marital relationships
8. Callous/lack of empathy 18. Juvenile delinquencies
9. Parasi`c lifestyle 19. Revocation of conditional release
10.Poor behavioral controls 20. Criminal versatility
Source: Hare and Neumann (2006)
© 2020 by Andrew W. Lo
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Psychopathology

© 2020 by Andrew W. Lo
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Psychopathology

© 2020 by Andrew W. Lo
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Psychopathology
CogniGve Behavioral Therapy (CBT)
§ Aaron Beck, Albert Ellis (Ra_onal Emo_ve Behavior Therapy); popular
version by David D. Burns
§ Treatment for anxiety, depression, mood disorders, ea_ng disorders,
hypertension, OCD, ADHD, etc.
§ Involves changing one’s thought pacerns
– Monitor mental state; iden`fy mistaken beliefs; revise beliefs;
reinforce revision; evaluate
§ More ra_onal thinking leads to becer outcomes
§ Consider rela_on to ra_onal expecta_ons
© 2020 by Andrew W. Lo
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Psychopathology
The Relaxation Response
§ Cannon’s (1929) “fight or flight” response:
– Increased breathing, heart rate, blood pressure
– Constriction of blood vessels to certain body parts
– Dilation of blood vessels to muscles, dilation of pupils
– Release of nutrients (fat, glucose); slowed digestion
– Inhibited hunger and sex drive
– Reduced hearing, tunnel vision, accelerated reflexes
§ To counteract it, Benson (1975) proposes TM
– Repetition of word or phrase; focus on breath;
let go of other thoughts
– See http://www.massgeneral.org/bhi/basics/rr.aspx
© 2020 by Andrew W. Lo
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Psychology
vs.
Economics
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Psychology vs. Economics
Psychology:
§ Based on observation and experimentation
§ Inductive rather than deductive
§ Inward-looking
§ Empirical analysis Þ theories
§ Field experiments are easy to conduct
§ Multiple theories of behavior
§ Mutual consistency not highly valued (yet)
§ Neuroscience has revolutionized the field
© 2020 by Andrew W. Lo
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Psychology vs. Economics
Economics:
§ Based on abstractions and idealizations
§ Deductive rather than inductive
§ Outward looking
§ Theories Þ empirical analysis
§ Field experiments are difficult to conduct
§ Few theories of economic behavior (expected utility)
§ Mutual consistency is highly valued
§ Finance has revolutionized the field
© 2020 by Andrew W. Lo
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Psychology vs. Economics
A common lament among psychologists today…is that the
field of psychology is far along a path of fragmentation or
disintegration [with] a multitude of independent
psychologies that soon will be or already are incapable of
communicating with one another.
– Ludy Benjamin (2001, 735)

Can We Construct An Integrated Theory of Behavior?

Þ Maybe!
© 2020 by Andrew W. Lo
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Next Time

© 2020 by Andrew W. Lo
Lecture 3 Slide 31
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