Ecological rationality and the maximum entropy heuristic: potential applications in financial economics

The behavioural finance literature largely analyses deviations from rationality and its impact on financial market anomalies. The organization of the finance industry, however, in light of the behavioural aspects is not much analysed. Moreover, the interpretation of probability weighting as being irrational, especially in the behavioural economics literature, has limited the operational application in financial decision-making. A recently emerging literature, however, views probability weighting through the lens of information-processing and cognitive costs. The presentation suggests an information-theoretic approach to treat inverse S-shaped probability weighting problems. The fundamental idea is that decision makers maximize uncertainty given observed datasets. The inverse S-shaped probability weighting can be viewed as being ecologically rational and such a behaviour is called the maximum entropy heuristic. The approach provides a bridge between decision theory, behavioural economics and economics models in general. This method and interpretation opens the door to operational and managerial approaches in financial economics and potentially new approaches to understand the finance industry.
Hybrid Talk: https://arc.mpib-berlin.mpg.de/public-with-recording/
Meeting-ID: 666 9084 1856
Passcode: 779007