BBI of Chicago
The influence of mental processes on decision making
By: Alex Toshio Kassada.
In the American film “The Big Short,” based on actual events, Michael Burry is the real main character and manager of his investment fund (Scion Capital), with good analytical and decision-making skills. He decided to bet against the market of American real estate when he realized, after carrying out some studies on the incentive for the assignment of real estate credit carried out by the FED (American Central Bank) and the American Government, that an enormous bubble was forming in the American economy. In the reality of Michael Burry, there were some setbacks (losses) at the beginning of the story but incredible financial return at the end. It portrays a case that expresses decision-making of high impact by the character: since the interpretation of the financial market is very complex due to several economic variables. Furthermore, note that current science still lacks information on this subject.
First, it is necessary to mention the theory of behavioral finance in decision-making situations, where Kahneman and Tversky (1979) founded behavioral finance and confronted it with the paradigm of traditional finance theory after scientific experiments. In these experiments, the implementation of psychology or mental processes was the main factor in the individuals' decision-making. In other words, investors' decisions are considerably affected by psychological issues.
Secondly, it emphasizes an evident propensity of the individual to distort the identification and perception of facts in which the rationality imposed by the traditional theory of finance doesn't exist. In this sense, it is pertinent to refer to the studies of Thaler (1980). He demonstrated from his experiments that loss aversion is one of the main factors that confront the traditional theory of finance with that of behavioral finance, where losses have more weight than gains during the change in the value of a given asset. Therefore, it is possible to infer that movements in the financial market are correlated with information and mental processes, demonstrating that human beings are not 100% rational in their decision-making.
In conclusion, decision-making is difficult due to the complexity of self-control difficulties. For example, Michael Burry went ahead with his convictions even though he had losses at first. Most individuals cannot interpret and/or understand the market and give up as soon as they start to lose money, given the strong aversion to losses, as seen in the works by Thaler mentioned above. Furthermore, the collapse of the real estate market, as portrayed by the film, reveals that the financial regulatory bodies and the government greatly influence the investors' behavior and the country's economy. Thus, each decision by one of the parties has the possibility of moving the market in different directions and confronting different interpretations of markets. And these are also influenced by the mental processes of individuals acting in this context.
THALER, Richard. Toward a positive theory of consumer choice, Journal of Economic Behavior & Organization, v.1, n.1, p. 39-60, 1980.
KAHNEMAN, Daniel; TVERSKY, Amos. Prospect Theory: An Analysis of Decision under Risk, Econometrica, v. 47, n. 2, p. 263-91, 1979.