by Ilio Masprone – Knight of the Principality of Monaco for cultural merits. MONACO. I think that a conscientious examination and a good deal of realism can be useful to better manage our savings. Investing, earn and save are practices that need attention, attitude and, above all, a method. There are tons of complex trading strategies out there. And they all invariably promise to reward investors with unheard-of profits. Financial economics often involves the creation of sophisticated models to test the variables affecting a particular decision.

Often, these models assume that individuals or institutions making decisions act rationally, though this is not necessarily the case.

THE RATIONAL THEORY: the Rational Theory is an economic principle that states that individuals always make prudent and logical decisions. These decisions provide people with the greatest benefit or satisfaction — given the choices available — and are also in their highest self-interest. Rational choice theory also stipulates that all complex social phenomena are driven by individual human actions. Therefore, if an economist wants to explain social change or the actions of social institutions, he needs to look at the rational decisions of the individuals that make up the whole. However, many economists do not believe in the rational choice theory. Dissenters have pointed out that individuals do not always make rational utility-maximizing decisions.

Irrational behavior of parties has to be taken into account in financial economics as a potential risk factor.

Nobel laureate Herbert Simon proposed the theory of bounded rationality, which says that people are not always able to obtain all the information they would need to make the best possible decision. Further, economist Richard Thaler’s idea of mental accounting shows how people behave irrationally by placing greater value on some euros than others, even though all euros have the same value. They might drive to another store to save 10€ on a 20€ purchase, but they would not drive to another store to save 10€ on a 1,000 € purchase.

This is an Example Against Rational Choice Theory: while rational choice theory is clean and easy to understand, it is often contradicted in the real world.

For example, political factions that were in favor of the Brexit vote held on June 24, 2016, used promotional campaigns that were based on emotion rather than rational analysis. These campaigns led to the semi-shocking and unexpected result of the vote, when the United Kingdom officially decided to leave the European Union. The financial markets then responded in kind with shock, wildly increasing short-term volatility, as measured by the CBOE Volatility Index (VIX). Further, research conducted by Christopher Simms of Dalhousie University in Halifax, Canada, shows that when people are anxious, they fail to make rational decisions.

Stressors that produce anxiety have been shown to actually suppress parts of the brain that helps in rational decision-making.

That being said, time has come that we must knowledge more about some recent progress in the field of NEUROECONOMICS: Neuroeconomics attempts to connect economics, psychology, and neuroscience to better understand economic decision-making. The fundamentals of economic theory were built under the assumption that the intricacies of the human brain would never be discovered. However, with advances in technology, neuroscience has produced methods of analyzing brain activity. Neuroeconomics has been broken down into three central areas of study; intertemporal choice, game theory, and decision making under risk and uncertainty. Each study identifies how humans balance their emotions and utility while faced with risk and uncertainty. Fundamental to the rise of neuroeconomics is a need to mend the glaring holes in conventional economic theories. Economic decision-making, in the traditional sense, suggests investors will objectively evaluate risk and react in the most rational manner.  However, if history has told us anything, this has only perpetuated asset bubbles and subsequently, financial crises. That being said, neuroeconomics can provide insight into why humans do not act to optimize utility (and seemingly, irrationally). Typically, our emotions have a  profound effect on our decision making. The brain often reacts more severely to losses than to gains, giving rise to irrational behavior. While emotional responses are not always suboptimal, they are rarely consistent with the concept of rationality.

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