Think fast: Who invented behavioral economics and behavioral finance? Pioneers such as Daniel Kahneman, Amos Tversky, and others brought an understanding of decision making, rationality, and biases to the mainstream by the end of the 20th century.
But three centuries earlier, Joseph Penso de la Vega—born to a family of Spanish–Portuguese Jewish refugees who resettled in Amsterdam—was already theorizing about how human decision making can influence financial choices. In his seminal 1688 work Confusión de Confusiones (Confusion of Confusions), de la Vega remarked that he often saw incongruities at the stock exchange. He observed that poor outcomes resulted from the way people tended to behave, and that good ideas could be muddled by common wisdom.
“If, for example,” Penso de la Vega wrote, “there arrives a piece of news which would induce [someone] to buy, while the atmosphere prevailing at the stock exchange forces him to sell, his reasoning fights his own good reasons … his reasoning drives him to buy, because of the information that has just arrived,” but he decides to sell nonetheless. Why? The risks, even considering the new information, can suddenly feel too high. Or because the market seems to know something, the market must be correct—right?
Not necessarily. As de la Vega pointed out, and as people and businesses continue to grapple with today, information can be incomplete. Perspectives can exist beyond those of any one person’s immediate or broader circle, and different scenarios can lead to very different outcomes.
In a financial context, managers should work to maximize future cash flows, weighting scenarios by their assumed probabilities. Too often, even the smartest and best-informed managers wind up making decisions based on what feels comfortable—or more likely feels the least uncomfortable—even when they have a nagging suspicion that reasoning and reasons don’t quite match up or that not all voices have been heard.
Biases are not just part of the human condition; they can also flourish throughout organizations. More and more, we’ve been pushing our own thinking about how to debias decisions, particularly with respect to resource allocation and strategy.