Leavey Behavioral Finance Pioneer Introduces Third Generation of Behavioral Finance in New Book
Meir Statman, the Leavey School of Business’ Glenn Klimek Professor of Finance, was always interested in human behavior, but in the late 1960s, when he was contemplating his major at the Hebrew University of Jerusalem, his father suggested that he study accounting, a practical subject that would lead to a practical career.
“I chose economics and finance instead, thinking they were closer to human behavior,” says Statman. “But, it turned out that the standard economics and finance of that time were far from human behavior. They assumed that people are “rational”, like computers, and went on to present them in mathematical models.”
While continuing his studies in economics and finance at Columbia University Statman took notice of a May 1974 article in the New York Times: “Stockholders and Pickets Score Con Ed Management.”
“I remember being struck by the fury of the shareholders at the Con Ed meeting. They were not acting as “rational” investors who react to a missing dividend by selling a few shares to obtain an equal amount,” recalls Statman.” But, at the time there was no explanation for any “irrational” behavior of investors since it could not be presented within the “rational” boundaries of standard economic and finance”
Statman joined Santa Clara University at the end of 1979 and some months later heard Hersh Shefrin, the Mario L. Belotti Professor of Finance, describe his work on framing, mental accounting, and self-control, and their relation to saving behavior. With a shared vision of the solution to “irrational” investors, the two began working closely together.
In 1984, they published their first research article, “Explaining Investors Preference for Cash Dividends,” in which investors frame their money into separate mental accounts, one for income and one for capital, and follow the self-control rule of “spend income but don’t dip into capital.” Their article was the first treatment of behavioral finance by modern financial economists.
Statman describes the early 1980s as the time of the first generation of behavioral finance, moving from describing investors as “rational” to describing them as “irrational.” Statman continued his behavioral finance work, moving it closer to human behavior when in 2019, he published “Behavioral Finance: The Second Generation,” where he described investors as “normal” people, like him and you, neither “rational” nor “irrational”.
“The “normal” investors of the second generation of behavioral finance care about the expressive and emotional benefits of their investments, in addition to their utilitarian benefits,” Statman says. “For example, socially responsible investors care about getting high utilitarian returns from their investments, but they also care about getting expressive and emotional benefits in staying true to their values.”
The next step in moving behavioral finance closer to human behavior, the third generation of behavioral finance, is presented in Statman’s most recent book “A Wealth of Well-Being: A Holistic Approach to Behavioral Finance”, which also describes investors as “normal” but is explicit in describing life well-being as people’s ultimate goal.
Through personal and shared experiences, lessons, and advice, the book helps readers explore why wealth is important to them and guides them to reflect on their financial and life well-being and how to enhance them for a meaningful and fulfilling life.
“Life well-being has many domains including finances, family, friends, health, work, education, religion, and society, but the domain of finances has a special place among the domains of life well-being because it underlies all other domains, " explains Statman. “We need finances to support ourselves and our families, to pay for food and shelter, maintain our health, pay for education to qualify us for well-paying and satisfying jobs, and to express our religion. We need financial well-being to enjoy life well-being, but ultimately, it is well-being that we seek.”