The document discusses the rise of behavioral economics (BE) and its applications in financial services, emphasizing how it provides insights into consumer decision-making that traditional economic theories fail to account for. It explores evidence of behavioral biases such as loss aversion, status quo bias, and heuristics, which influence judgments and choices in predictable ways. Additionally, the implications of BE on competition law and regulation are examined, highlighting the need for regulators to consider these biases to effectively address market competition and ensure fair outcomes.

1. Behavioural Economics in Financial Services:
Perspectives and Prospects
A Seminar for Eversheds LLP
• Jim Devlin
• Director: Centre for Risk, Banking and Financial
Services
• Professor of Financial Decision Making: Marketing
Division
• Nottingham University Business School

2. • The rise and rise of behavioural
economics
• What are the main principles of
behavioural economics?
• How do we know this stuff works?
Some evidence
• Introduction to applications; A
useful tool for policymakers and
firms?
• Is there a potential dark side to
behavioural economics?
Structure

3. • Arguably, 10 years ago BE was almost exclusively
the preserve of nerdy, academic types mainly
working in the area of economic psychology
• Now, the Government has a whole unit focussed
on using BE to cure just about any problem one
cares to name
• Policymakers are busy working out how to apply
BE to their particular area of responsibility (not
least the FCA)
Behavioural Economics: The Rise
and Rise

4. • Just about every consultancy has a specialist division
in the area
• Companies are busy working out what it all means
and how to make money by using it
• Countless seminars are taking place on a weekly
basis 
• And of course, many of the aforesaid nerdy,
academic types are now academic “rock stars” and
have written books on the subject that have sold
many, many copies
• Why?
Behavioural Economics: The Rise
and Rise

5. • Only natural that things become fashionable at a
certain point
• But, as we will come on to see, evidence of BE’s
power and potential to influence consumer decision
making is strong and consistent
• But that alone does not account for BE’s rise in
popularity
• Other factors at play
Behavioural Economics: The Rise
and Rise: Why?

6. • For instance, economists tend to be very well
represented in policymaking circles
• Therefore, traditional economic theory and
assumptions have tended to dominate policy
approaches
• For instance, the recently disbanded Financial Services
Authority and its approach….more information and more
consumer education making “informed, more rational
choice” more straightforward and more likely
• But experience has shown that such approaches do
not tend to work
Behavioural Economics: The Rise
and Rise: Why?

7. Behavioural Economics: The Rise
and Rise: Why?
• Important to understand that BE exists as a
counter-point to traditional economic theory
• And the assumption we are essentially rational
beings that act as “homo-economicus” (self
interested and vested with immense information
processing powers)
• A very neat model………but does it account for how
we actually behave?
• Increasing realisation that it does not
• Hence alternative approaches required to
understand judgments and decision making

8. Behavioural Economics: The Rise
and Rise: Why?
• There is a large body of evidence showing
persistent and consistent violations of rationality:
As Dan Ariely puts it neatly in the title of his book,
we are Predictably Irrational
• This evidence is sizable and robust enough that
such departures from rationality cannot be
dismissed as mere aberrations
• Hence Behavioural Economics, a relatively recent,
multi-disciplinary approach that attempts to explain
departures from rationality and actual observed
behaviour

9. Behavioural Economics: What is
it all about?
• There are many inconsistencies in our judgments
and decision making (known as biases) and these
biases are predictable
• We are generally lazy in our thinking and like to
take mental short cuts and employ “rules of thumb”
(but that sounds too simple so they are known as
heuristics in academic work)
• How information and choices are presented to us
can have a large impact on our decisions (this is
known as framing effects)

10. Behavioural Economics: What is
it all about?
• But just how new is all of this? Not to most
marketing practitioners, for instance
• Have been accusations that behavioural economics
is little more than glorified common sense and that
it merely states the obvious
• But strong evidence base from the research
provides depth
• And simplicity does not take away from the
potentially profound implications

11. The evidence: Bias against
losses
• We hate losing things roughly twice as much as we
like gaining things (known as Loss Aversion)
• “Losses loom larger than gains”
• And we use a reference point to evaluate our gains
and losses.
• Underpins many important phenomena in
behavioural economics
• The Mug Experiment is just one of many studies
that provides empirical backing

12. The evidence: Bias against
losses: The Mug Experiment
Reported in Kahneman, D (2011) Thinking Fast
and Slow
• In student classes; random half class given given
mugs with University insignia; other half nothing
• People then offered the chance to trade, but buyers
had to use their own money
• People had to “name their price”
• Consistently, price required to sell is TWICE that of
price buyers are willing to pay
• More of an issue with losing the mug than gaining
it!

13. The evidence: Bias against
losses: The Mug Experiment
Reported in Kahneman, D (2011) Thinking Fast
and Slow
• Third group added who don’t name a price for
buying and selling, but can choose either the mug
or an amount of money and state what amount of
money is equally desirable to the mug; results:
• Sellers $7.12, Choosers $3.12, Buyers $2.87
• Gap between sellers and choosers is particularly
remarkable, as either can go home with the mug or
the money and face what should be the same
choice!

14. The evidence: Bias for the status
quo and default option:
• People have a tendency to stick with current
choices/patterns of behaviour
• An exaggerated preference for the status quo
which is really just inertia
• It involves less mental effort
• Colloquially known as the “whatever” phenomenon
• Relatedly, most people also go with the “default
option” rather than make a more considered choice
• These biases are arguably intuitively obvious
• But how do we know that they are so predictable
and prevalent

15. The evidence: Bias for the status
quo and default option:
Reported in Thaler, R and Sunstein, C (2008)
Nudge: Improving Decisions about Health Wealth
and Happiness
• Study conducted in the late 1980s on the pension
plan of many college professors in the US
• After initial asset allocation decision, median
number of changes over a lifetime was ZERO
• In the whole of their working life, more than half of
all scheme members made no changes whatsoever

16. The evidence: Bias for the status
quo and default option:
Reported in Thaler, R and Sunstein, C (2008)
Nudge: Improving Decisions about Health Wealth
and Happiness
• Separate study participants were given a scenario
where they inherited some money as cash and were
given four investment options (moderate risk
company, high risk company, treasury bills, bonds)
• When told that the inherited money was a mixture
of cash and stocks of moderate risk many more
chose to stick with this option and % ending up in
moderate risk assets much higher
• Overall, compelling evidence

17. The evidence: Heuristics
Reported in Kahneman, D (2011) Thinking Fast
and Slow
• Mental shortcuts abound, we can only cover some of
the most important
• Anchoring and Adjustment: our tendency to
make judgements by adjusting from some reference
point, which can even be arbitrary
• Far easier to provide evidence/illustrate than
explain!

18. The evidence: Heuristics
Reported in Kahneman, D (2011) Thinking Fast
and Slow
• Two Professors in the US once rigged a “wheel of
fortune” marked 1-100, but that would only stop at
10 or 65
• Groups of students stood in front of it whilst it was spun
and wrote down the number at which it stopped
• They were then asked “What is your best guess of the % of
African nations in the US?”
• Average estimates for those who saw the wheel stop
at
• The number 10 = 25%
• The number 65 = 45%
• Exposure to a totally irrelevant number influenced
their guess
• One of the most robust and reliable results in
behavioural economics

19. The evidence: Framing Effects
• Framing Effect: we make very different judgments
and decisions on information that is factually the
same depending on how it is put to us
• 90% fat free sounds healthy
• 10% fat not so much so!
• I will receive a 3% commission payment on your
investment of £100,000
• I will receive a £3000 commission payment on your
investment of £100,000
• The latter may well strike more as somewhat
unreasonable for a couple of hours spent form filling

20. The evidence: Framing Effects
• Even professionals influenced by framing
• Some doctors told that an operation was associated
with a 90% survival rate
• Others that the same operation was associated with
a 10% mortality rate
• Former group more likely to recommend the
operation even though outcomes are factually
identical

21. Applications
• Potential commercial applications are numerous:
• (Quoted in Harvard Business Review) A European Rail
Company changes its default booking process to include a
seat reservation at a small charge unless a box is
unchecked
• Previously anybody wanting a reservation had to “opt in”
• Reservations rose from 9% to 47% earning an extra 30
million Euros plus in a year
• Many more
• Policy applications are also apparent:
• Opt-out regime for pensions to take account of status quo
bias
• Ensuring that the framing of performance effects or pricing
does not lead consumers to inappropriate choices
• Many more

22. Parting shots
• Influence on judgments and choice can be profound
• Beneficial if used by entities (such as the state and
its agents) intent on steering people to decisions
considered in the best interests of individuals and
society
• But what about then the techniques of BE are used
by commercial firms to increase revenues and
profitability, such as the rail firm example: ethical?,
desirable?
• Potential to lead to new mis-selling scandals

23. Behavioural Economics and
Competition Law
Implications for Enforcement
Adam Ferguson, Eversheds LLP
6 May 2014

24. Overview
• Is there a role for competition law in addressing
problems created by behavioural biases and
heuristics?
• What impact could behavioural economics have
on competition law enforcement?
• Should regulators design remedies to account for
behavioural biases?
• What are the threats and opportunities for
financial services businesses?

25. What is the relationship between
consumer biases and competition?
Competition between
suppliers to provide
consumers needs as
efficiently as possible
Well-informed and
rational consumers
stimulate competition
between suppliers
Demand-side Supply-side
- cartelisation
- dominance
- mergers
- information asymmetries
- search costs
- switching costs

26. The UK markets regime
• Traditional antitrust tools not designed to
address issues on the demand side...
• However, the Enterprise Act 2002:
– enables the Competition and Markets
Authority (CMA) to intervene where it is
concerned that any feature of a market leads
to an adverse effect on competition (AEC);
and
– if there is an AEC, to remedy it

27. The UK markets regime
• For example, Competition Commission’s Issues
Statement in Payday Lending identifies two
features which may lead to an AEC:
– market concentration
– impediments to switching
• In that context the CMA is considering the role of
present bias and over-confidence

28. Impact of BE: better understanding of
demand-side harms
• For example in relation to tying and bundling
cases:
– when viewed entirely rationally, tying may
appear to create only minimal switching costs
– however, default bias and endowment effects
may make market foreclosure more likely
than might appear to be the case
• Microsoft – Windows/Media Player

29. Impact on selection of cases?
• BE casts light on gravity of demand side phenomena
• For example:
– the risk and gravity of increased search costs
resulting from drip or complex pricing may be
more prevalent because of reference dependence
and/or framing effects
• Therefore, the prevalence of biases may make for a
stronger case for intervention
• Also, the CMA now has the ability to look at features
on cross-market basis

30. What does BE mean for remedies?
• Traditional anti-trust tools identify, punish, deter
and facilitate reparation
• In market investigations, CMA must ensure any
remedy is:
– comprehensive
– effective
– proportionate
• Critical that regulators are aware of behavioural
biases to ensure remedies are effective and have
no unintended consequences

31. What does BE mean for remedies?
• Awareness of BE will affect remedy design
– more information / more choice will not necessarily
enhance competition
– the impact of consumer education may be limited
• Regulators have and will take consumer biases into
account (contrast the Microsoft Media Player and Internet
Explorer cases)
• Need for more intensive remedies stage to allow for input
from behavioural psychologists and test efficacy of
remedies?
• Can this be accommodated in the shorter statutory
timetable for market investigations?

32. Threats and opportunities
• Businesses exploiting consumer biases are at greater
risk of intervention
• Insights of BE are not the sole preserve of regulators
• Businesses must ensure competition authorities:
– do not misapply their consumer regulatory powers
without full rigours of market investigation
– take account of behavioural biases where this
militates against intervention and in formulating
remedies

33. For example…
• Allowance for over-confidence and aggression –
when assessing the weight to attach to evidence
in internal documents
• Could vengeful rather than rational behaviour
counteract attempts to exploit consumers?

34. Conclusions
• There is a role for competition law in addressing
behavioural biases
• BE is already having and will continue to impact
competition law enforcement
• Businesses need to familiarise themselves with the insights
of behavioural economics
– to protect against the risk of intervention
– to better anticipate the outcome of regulatory
intervention
– to ensure regulatory outcomes are fair and
proportionate

35. Are any of us immune?
• Which location is rainier
– Manchester or
– Weston-super-Mare?
• Even regulators are susceptible to biases and
heuristics

36. For more information please contact:
David Saunders
Partner - Financial Institutions sector
T: 0845 497 3647
E: davidsaunders@eversheds.com
or visit:
www.eversheds.com/financialinstitutions
www.twitter.com/EvershedsFI