Trust, Emotions, Thresholds , Herding and Contagion

1. Trust, Emotions, Thresholds, Herding and Contagion Alan Kirman Presentationat the THEfoDA discussion forum Mallorca May 9th 2013 Presentation at the THEfoDA discussion forum Mallorca May 9th 2013

2. Bob Shiller • Of course, the problemwitheconomicsisthatthere are often as manyinterpretations of anycrisis as there are economists. An economyis a remarkablycomplex structure, and fathomingitdepends on understandingitslaws, regulations, business practices and customs, and balance sheets, amongmanyotherdetails. Presentation at the THEfoDA discussion forum Mallorca May 9th 2013

3. Bob Shiller • Yetitislikelythat one daywewill know much more about how economieswork – or fail to work – by understandingbetter the physical structures thatunderliebrainfunctioning. Those structures – networks of neuronsthatcommunicatewitheachother via axons and dendrites – underlie the familiaranalogy of the brain to a computer – networks of transistors thatcommunicatewitheachother via electricwires. The economyis the nextanalogy: a network of people whocommunicatewitheachother via electronic and other connections. Presentation at the THEfoDA discussion forum Mallorca May 9th 2013

4. Bob Shiller The brain, the computer, and the economy: all three are deviceswhosepurposeis to solvefundamental information problems in coordinating the activities of individualunits – the neurons, the transistors, or individual people. As weimproveourunderstanding of the problemsthatany one of thesedevicessolves – and how itovercomes obstacles in doingso – welearnsomethingvaluable about all three. http://www.project-syndicate.org/commentary/the-neuroeconomics-revolution#01DugqtByVO8W50F.99 Presentation at the THEfoDA discussion forum Mallorca May 9th 2013

5. Hume: Reason and Passions • “Reason is and ought only to be the slave of the passions, and never pretend to any other office than to serve and obey them.” Treatise bk 2 pt 3 “Never literary attempt was more unfortunate than my Treatise on Human Nature. It fell dead-born from the press” My Own Life, ch 1 Presentation at the THEfoDA discussion forum Mallorca May 9th 2013

6. Empathy and affection • Empathywasoriginallydefined to be the capacity to put oneself in the other’s place and thiswastypicallywith respect to emotions. • Adam Smith’sexamples deal with the case of somebodywatchingsomeoneelsehaving a painfulexperience. Presentation at the THEfoDA discussion forum Mallorca May 9th 2013

7. A More Cognitive Approach • « Your corn is ripe today, mine willbesotomorrow. ‘Tis profitable for us boththat I should labour withyoutoday, and thatyoushouldaid me tomorrow, I have no kindness for you and know you have as little for me. I will not, therefore, takeany pains uponyouraccount; and should I labour withyouuponmyownaccount, in expectation of a return, I know I shouldbedisappointed, and that I should in vain dependuponyour gratitude. Here, then I leaveyou to labour alone. You treat me in the samemanner. The seasons change and both of us loseourharvest for want of mutual confidence and security ». Hume, 2000: 520–1 Presentation at the THEfoDA discussion forum Mallorca May 9th 2013

8. Empathy: Understanding or Feeling? Presentation at the THEfoDA discussion forum Mallorca May 9th 2013

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10. Mirror Neurons • These have received a great deal of attention though they have not been shown to exist in humans?? • The idea is that the observation of the movements or gestures of others triggers the same actions in the observer but this is not conscious. • There has been a lot of incautious extension of this idea to cognitive activities in humans. Presentation at the THEfoDA discussion forum Mallorca May 9th 2013

11. Mentalising and Intentionality • The mentalising idea is intimately linked with the notion of understanding the intentions of others. This, it is argued is a uniquely human attribute. • Yet in macaque monkeys, grabbing reflexes are activated when a monkey sees another monkey grabbing for food, whilst no such activation occurs if the same gesture is made when there is no food and the monkey grabs an object to put it elsewhere. • Thus, at least in the immediate present, the intentionality of gestures may be interpreted Presentation at the THEfoDA discussion forum Mallorca May 9th 2013

12. Common Knowledge • By thisismeantthat not only do people know whatothers know but they know how all the participants in the game or economicactivityreason and itisthisthatallowsthem to reachequilibria. Presentation at the THEfoDA discussion forum Mallorca May 9th 2013

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25. Behaviour in Groups Optimising or Learning ? Presentation at the THEfoDA discussion forum Mallorca May 9th 2013

26. A curiosity • Hume argues at one point that it is difficult to predict the behaviour of an individual whereas the behaviour of groups, particularly large groups is much more predictable. • The basis for such an argument now would be some sort of independence of the behaviour of the individuals. • Yet often Hume argues that it is the interaction between individuals that is an important determinant of their behaviour. Presentation at the THEfoDA discussion forum Mallorca May 9th 2013

27. Isaac Newton « I cancalculate the motion of heavenly bodies, but not the madness of people » Presentation at the THEfoDA discussion forum Mallorca May 9th 2013

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29. Past and Present • This brings us to the argument about the uniqueness of humans which invokes our capacity to invoke the past and to use it to influence or predict what will happen in the future. • This problem goes back at least to Hobbes and was discussed by Hume (1740) who was perhaps the first to make explicit reference to the role of mutual knowledge in coordination. In his account of convention in A Treatise of Human Nature, Hume argued that a necessary condition for coordinated activity was that agents all know what behavior to expect from one another. But, he does not argue that by so doing they will reach a good outcome. • Yet ants and bees convey information about sources of food that they found in the past in order to induce others to use this information in the future. Presentation at the THEfoDA discussion forum Mallorca May 9th 2013

30. Expectations • « A verynaturalnextstep for economicsis to maintainexpectations in the strategic position they have come to occupy, but to build an empiricallyvalidatedtheoryof how attention is in factdirectedwithin a social system, and how expectations are, in fact, formed. Takingthatnextstep, requiresthatempiricalwork in economicstake a new direction, the direction of micro-level investigation proposed by Behavioralism.» HerbSimon (1984) PerhapsBIG DATA can help in conjunctionwith the sort of experimentspresented by Cars. Presentation at the THEfoDA discussion forum Mallorca May 9th 2013

31. Consistency of forecasts • Surveys indicate a considerable difference in individual forecasts of economic variables • We know that even expert forecasters differ widely in their forecasts even though (luckily) their forecasts tend to converge as the forecast horizon approaches. • Efforts to explain the fact that the forecasts do not seem to be consistent with rational expectations have taken several forms. • One idea is to concentrate on forecast revisions and for this, in particular “sticky information”(Mankiw) or “noisy information” (Woodford) models have been proposed. • But given the dispersion of forecasts none of these alternatives can, alone, account for the differences Presentation at the THEfoDA discussion forum Mallorca May 9th 2013

32. Lessonsfrom Social Insects • Social insectsachieve a great deal of coordination • Theirbehaviour on close inspection is far from optimal • Theycanhardlybesaid to have rational expectations • Theyact on local information and follow simple rules • Are wenearer to them or to peoplewho are rationaloptimisers? Presentation at the THEfoDA discussion forum Mallorca May 9th 2013

33. Lessonfrom 6000 yearsago • "Look to the ant, thou sluggard. Consider her ways and be wise. Without chief or ruler or overseer she gathers her harvest in the fall to save for the winter." Book of Proverbs, The Old Testament Presentation at the THEfoDA discussion forum Mallorca May 9th 2013

34. The Phenomenon • The basic mystery about ant colonies is that there is no management. A functioning organization with no one in charge is so unlike the way humans operate as to be virtually inconceivable. No insect issues commands to another or instructs it to do things in a certain way. No individual is aware what must be done to complete any colony task. Each ant scratches and prods its way through the tiny world of its immediate surroundings. Ants meet each other, separate, go about their business. Somehow these small events create a pattern that drives the coordinated behavior of colonies. Deborah Gordon Ants at Work Presentation at the THEfoDA discussion forum Mallorca May 9th 2013

35. Ants • Antslearn in an environment of whichthey have onlyverylimited and local knowledge. • Yettheyproducequitesophisticatedaggregatebehaviour. Presentation at the THEfoDA discussion forum Mallorca May 9th 2013

36. Antslearn to find the route to food • Ants communicate with each other • either through a pheromone trail • or by tandem recruiting.

37. Bees and theirsophisticatedaggregatebehaviour Presentation at the THEfoDA discussion forum Mallorca May 9th 2013

38. Antslearn to find the route to food • Antscommunicatewitheachother • eitherthrough a pheromonetrail • or by tandem recruiting

41. Self Organisation This idea that markets self organise was espoused by Hayek This has been used as a justification for not interfering with markets. Markets do clearly self organise but we have no reason to believe that this is a stable process nor one which leads to optimal outcomes. As the actors within them modify their rules new norms appear and these can gently lead the system to major “phase transitions”. Presentation at the THEfoDA discussion forum Mallorca May 9th 2013

42. The Efficient MarketsHypothesis • This isvery simple • All relevant information iscontained in pricesthereforethereis no need to look anywhereelse: paradox • This basic argument comesfrom the work of Bachelier but histhesisadvisersaid… Presentation at the THEfoDA discussion forum Mallorca May 9th 2013

43. No panic ! Presentation at the THEfoDA discussion forum Mallorca May 9th 2013

44. Un Avertissement • Quand des hommes sont rapprochés, ils ne se décident plus au hasard et indépendamment les uns des autres ; ils réagissent les uns sur les autres. Des causes multiples entrent en action, et elles troublent les hommes, les entraînent à droite et à gauche, mais il y a une chose qu'elles ne peuvent détruire, ce sont leurs habitudes de moutons de Panurge. Et c'est cela qui se conserve Henri PoincaréReport on Bachelier’s thesis 1900 Presentation at the THEfoDA discussion forum Mallorca May 9th 2013

45. Wheredoes the efficient marketshypothesis go wrong? • Remember Poincaré’s warning • Individuals do not only look at their own information they also observe the actions of others and infer information from those actions. Presentation at the THEfoDA discussion forum Mallorca May 9th 2013

46. Looking into the sky quickly gets passers-by to follow. Presentation at the THEfoDA discussion forum Mallorca May 9th 2013

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48. SuddenAggregate Changes Presentation at the THEfoDA discussion forum Mallorca May 9th 2013

49. The Dow Jones 1990-1999 Presentation at the THEfoDA discussion forum Mallorca May 9th 2013

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