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BEHAVIOURAL ECONOMICS & FINANCE

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James Montier is a member of GMO's asset allocation team and is a visiting fellow at the University of Durham.  His book, The Little Book of Behavioural Investing, is a great introduction to behavioural finance for readers that have not approached the subject before.

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Montier introduces numerous key aspects of behavioural finance and approaches the subject from a combination of theory, practice, and examples for the reader to help understand the topic that Montier is trying to get across.

The Little Book of Behavioral Investing

 by James Montier

The Little Book of Behavioural Investing

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Cass Sunstein was a Professor at the University of Chicago Law School for twenty-seven years before serving as the Administrator of the White House Office of Information and Regulatory Affairs during the Obama Administration from 2009 to 2012.  Richard Thaler is one of the leading figures in behavioural economics and was the 2017 recipient of the Nobel Memorial Prize in Economics for his contributions to the field.

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In their book, Thaler and Sunstein begin by introducing the reader to heuristics and biases that humans experience and why, as a result, behavioural economics/ psychology is a vital element for traditional economics to incorporate.

 

The authors then address several topics relating to "money" and "society" to introduce their principal argument of  "nudging".  In essence, the authors contend that as a result of the fallacies of human rationality, society can benefit from nudging individuals to make certain decisions through a variety of means, to influence their behaviour for their own benefit and that of society.

Nudge: Improving Decisions about Health, Wealth, and Happiness

by Richard Thaler and Cass Sunstein

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Andrei Shleifer is Professor of Economics at Harvard University, although this book is based on the Clarendon Lectures he gave at the University of Oxford.  Accordingly, the book is quite advanced and technical - I would say that it is aimed at undergraduate or master's level students.  

 

In his book, Shleifer explores a variety of theoretical ideas as to why the commonly accepted notion of the efficient market hypothesis is not a very accurate representation of how financial markets behave in practice.  Moreover, Shleifer provides a variety of practical considerations and evidence to support his position that financial markets are, in fact, inefficient.  

 

Following this, the author goes on to propose a number of models that incorporate behavioural finance to address some of the flaws that he has identified with the efficient market hypothesis. 

Inefficient Markets: An Introduction to Behavioral Finance

by Andrei Shleifer

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As mentioned above, Richard Thaler is one of the leading figures in behavioural economics and was the 2017 recipient of the Nobel Memorial Prize in Economics for his contributions to the field.

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In his book, Misbehaving, Thaler explores his intellectual journey from his early days of teaching in the 1970s to present as Thaler details the impact that his previous book, Nudge (mentioned above), is having on public life in the U.K.  Throughout this journey, Thaler addresses a variety of topics in behavioural economics and illuminates to the reader how his experience, insightfulness, and genius led to the development of his theories and arguments in favour of behavioural economics.

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Although Nudge, his previous book, is arguably the one that Thaler is better known for, and the theory for which he was awarded the Nobel Memorial Prize in Economics, Misbehabving is a more general book on behavioural economics by one of the subjects leading intellectuals.  Accordingly, I highly recommend this book for anyone that is interested in developing a broad understanding of behavioural economics.

Misbehaving: The Making of Behavioural Economics

by Richard Thaler

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Robert Shiller graduated with a B.A. degree from the University of Michigan in 1967, before going on to earn his S.M. degree and PhD from the Massachusetts Institute of Technology in 1968 and 1972, respectively.  Currently, he serves as the Sterling Professor of Economics at Yale University and was the 2013 recipient of the Memorial Prize in Economic Sciences.

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First published in 2000 during the Dot Com bubble, Shiller's book, Irrational Exuberance (which is a reference to the famed speech by then Chairman of the Federal Reserve Alan Greenspan, warning about the stock market being potentially overvalued), presents the argument, from a behavioural economics/ finance perspective, that the stock market was overvalued/ experiencing a bubble.  Shiller presents structural, cultural, and psychological factors, to support his case. 

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Overall, the importance of this book cannot be overstated, as Shiller correctly identified both the 2000 Dot Com bubble and the 2007-08 Housing bubble.  Accordingly, the insights gained from Shiller's writing can hopefully help the reader identify a potential overvaluation in the financial markets.

Irrational Exuberance

by Robert Shiller

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Michelle Baddeley earned her undergraduate in economics and psychology from the University of Queensland, before going on to earn her MPhil and PhD in Economics from the University of Cambridge.  She is currently a Professor at the University of South Australia.  

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Her book, Behavioural Economics and Finance, is a great overview of behavioural economics and finance, as it is one of the rare books on the subjects that explore the foundation of behavioural economics and finance from both a psychological and biological perspective before exploring their relationship with economics and finance; and how these psychological and biological insights influence our traditional views 

Behavioural Economics and Finance

by Michelle Baddeley

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The Black Swan

 by Nassim Nicholas Taleb

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Nassim Nicholas Taleb is a Lebanese-American former options trader and academic specialising in statistics and financial mathematics (although, he prefers to think of himself as more aligned to philosophical methods of thought, as opposed to the robust/ scientific nature of mathematics).  

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Taleb's book, The Black Swan, is the second of a five-volume philosophical work on risk and uncertainty, titled Incerto.  Like the other volumes in Incerto, The Black Swan is a wealth of knowledge, covering numerous topics from the broader philosophical aspects of probability to more specific examples of human biases that are prevalent when interpreting data.  Although Taleb's way of thinking can be seen as philosophical in nature (yet, I'm confident he is very technically gifted given his success as a derivatives trader and his career in academia), he approaches his subject from a very applied perspective.  That is, he is concerned with what works in practice and includes numerous examples and thought experiments to illustrate to the reader the importance of the points that he is trying to convey.

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Thinking, Fast and Slow

by Daniel Kahneman

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Daniel Kahneman earned his BSc degree with a major in psychology and a minor in mathematics from the Hebrew University of Jerusalem in 1954, before going on to serve in the psychology department of the Israeli Defense Forces (an experience that would later influence his work in psychology).  Kahneman would move to the United States in 1958 to study for his PhD in Psychology at the University of California, Berkeley, which he would ultimately earn in 1961.

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Kahneman would return to the Hebrew University of Jerusalem in 1961 as a lecturer in psychology.  It was during this period that Kahneman would meet and begin his long-term collaboration with Amos Tversky (1936 - 1996), a fellow psychologist.  It was a result of their work on identifying and describing the biases and failures of human rationality that would eventually lead to the publication of their influential paper on prospect theory in 1979.  The ability of Kahneman and Tversky to integrate psychology into economic sciences would result in the foundation of the contemporary field of behavioural economics - for which Kahneman would eventually be awarded the 2002 Nobel Memorial Prize in Economics.

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His book, Thinking, Fast and Slow presents the findings of Kahneman and Tversky's decades of research into cognitive biases and heuristics, prospect theory, and Kahneman's later work on happiness.  The main idea presented by Kahneman, and arguably one of the most important concepts in behavioural economics, is the two modes of thinking present in humans: System 1, is fast, instinctive, and emotional; and System 2 is slow, deliberate, and logical.  Overall, this is a great book that is a must-read for anyone studying economics and/ or finance; and, is an interesting book regardless, as highlighted by the reviews and sales figures of the book.

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