B is for Bias

Abstract

Standard economic theory assumes rational agents. Individuals are expected to have rational expectations and constantly optimize their choices. Modern economic and financial theory is build under the assumption of rationality. There is plenty of evidence from psychology, however, that individuals are biased and rely heavily on heuristics in order to make decisions. Yet, this is not a mere fluke, a behavioral oddity. Because the social and economic environment in which individuals evolve is complex, behavioral biases represent evolutionary adaptations allowing economic agents to deal with undecidability and computational irreducibility.