An introduction to Behavioural Economics

1. An introduction to Behavioural Economics And why it is of increasing interest to the FCA

2. BE- What is it • Why people behave the way they do in making decisions • Uses insights from psychology

3. Two modes of thought

4. Two modes of thought • We use both systems • Most decisions intuitive • Intuition affected by biases • Biases can lead people astray in systematic and predictable ways • People are mostly blind to their biases and trust their intuition, driven by heuristics and institutions (figures of authority, IFAs, well known brands)

5. Heuristics • Defined as rules of thumb, mental shortcuts that simplify judgements

6. Biases • Specific ways in which normal human thought departs from being fully rational. • Biases can cause people to misjudge important facts or be inconsistent • BE goes beyond intuition and helps you be more precise in detecting, understanding and remedying problems that arise from consumer mistakes – this is why the FCA is interested in the subject

7. Why more behavioural problems in financial services • Many products are inherently complex for most people • Customers can simplify decisions in ways that lead to errors such as focusing on headline rates • Many products involve trade offs between present and future • People make decisions against their long term interests because of self control problems e.g. borrowing excessively using payday loans • Decisions may require assessing risk and uncertainty • Misjudge probabilities and make poor insurance or investment decisions

8. Cont’d • Decisions can be emotional • Stress, anxiety, fear of losses and regret, rather than the costs and benefits of the choices • Some products permit little learning from past mistakes • Some financial decisions are made infrequently ( retirement planning) and consequences are revealed only after a long delay

9. Which biases affect consumer financial decisions • Preferences • Influenced by emotions and psychological experiences • Beliefs • Rules of thumb can lead to incorrect beliefs • Decision Making • Short cuts when assessing available information

10. Behavioural biases - preferences • Present bias • Reference dependence and loss aversion • Regret and other emotions

11. Behavioural biases - beliefs • Overconfidence • Over extrapolation • Projection bias

12. Behavioural biases – decision making • Framing, salience and limited attention • Mental accounting and narrow framing • Decision making rules of thumb • Persuasion and social influence

13. Looking at 10 key biases in more depth • Examine in groups and identify any actions you feel may affect your firm and what should be done to improve matters