Rationality is based on having appropriate data, models, and goals given one's context. Behavioral economics often assumes behaviors are irrational without considering individuals' perspectives. The document argues that what appears irrational may be rational for that person given their information and aims. It says rationality varies situationally and is better defined as consistency with one's reasons and optimal decisions given their constraints. Overall, rationality is a complex, relative concept rather than an absolute measure of behavior.

1. “Running an Agile Fortune 500 Company”
Aditya Yadav, aditya.yadav@gmail.com
http://www.adityayadav.com
*

2. *
*A Typical Global Company
*Fortune 500/1000
*200 Divisions
*40 Countries
*25000 Employees

3. @ Acme Inc.
*

4. *
*Original Question “How do we implement
principles of Behavioral Finance/Economics in
our Business?”
*The Correct Question - “What you really need
to do is to understand the fundamental
principles of Rationality and then start from
there.”

5. And The Philosophy Behind The Answer
*

6. *
*Anchoring
*Mental Accounting
*Confirmation & Hindsight Bias
*Gambler’s Fallacy
*Herd Behavior
*Overconfidence
*Overreaction & Availability Bias
*Prospect Theory

7. *
* Rationality is the quality or state of being reasonable, based on facts or reason.
* Rationality implies the conformity of one's beliefs with one's reasons to believe, or of
one's actions with one's reasons for action.
* A rational decision is one that is not just reasoned, but is also optimal for achieving a
goal or solving a problem.
* Determining optimality for rational behaviour requires a quantifiable formulation of
the problem, and making several key assumptions. When the goal or problem involves
making a decision, rationality factors in how much information is available (e.g.
complete or incomplete knowledge). Collectively, the formulation and background
assumptions are the model within which rationality applies. Illustrating the relativity of
rationality: if one accepts a model in which benefitting oneself is optimal, then
rationality is equated with behaviour that is self-interested to the point of being
selfish; whereas if one accepts a model in which benefiting the group is optimal, then
purely selfish behaviour is deemed irrational.
* It is thus meaningless to assert rationality without also specifying the background
model assumptions describing how the problem is framed and formulated.
Ref: Wikipedia

8. *
Rationality
(Reasoned
& Optimal)
Data/Info/Knowledge
Model/Techniques
Context/Purpose

9. *
* Not everybody has the same data, information and knowledge… That
DOESN’T make them inherently irrational… => they are rational ‘within’
what they have with them
* Not everyone has the ‘Education’ or ‘Experience’ to have the same models
and techniques at their disposal… even that doesn’t make them inherently
irrational… => they are rational ‘within’ what they have with them
* Not everyone’s context or purpose is the same… even that doesn’t make
everyone inherently irrational… => they are rational ‘within’ what they
have with them
* So what defines as irrational?
* Going back to slide #7… Irrationality is…
* Inconsistency of Actions/Decisions/Choices from their ‘own’ Purpose
* Sub-Optimal Actions/Decisions/Choices even within the ‘Scope’ of what
they have at their disposal
* Deficiency in Logic & Reasoning within the bounds of their ‘own’ purpose,
context, info & model’s

10. *
*Take my word that the Entire practice of
Behavioural Finance & Economics is based on
‘Behavioural Psychology’
*The foundation of ‘Behavioural Psychology’ is based
on very little information, primitive techniques and
behaviours… and NO – Purpose!!!
*Human brains are far more complex and they evolve
complicated ‘purpose’s’ in different situations…
*Human’s learn, adapt and think (Hopefully !!!) ;-)
*Behavioural Psychology lost favour long ago and
Cognitive Psychology is more suited to Human
Behaviour.

11. *
* Scene 1: Time 8am
* X – The ‘real’ price is $500 but we will give it to you for $250
* Y – Sounds good I will take it!
* Scene 2: Time 9am
* X – The ‘real’ price is $300 but we will give it to you for $150
* Y – I guess I will take it
* Scene 3: Time 10am
* X – The ‘real’ price is $4000 but we will give it to you for $2000
* Y – I will probably benefit $1500 from it… give it to me for $750 and I
will take it or else I will pass.
* Note: Even within hours the entire Anchoring Bias theory is rubbished
in Human Experiments. Humans will collect more data, learn and
evolve models and techniques and shift between purpose…

12. *
* Weak Theorem
* If someone uses ‘n’ pieces of information to take a rational decision… he
is Rational To The Degree ‘n’ in ‘His Context’
* What happens when someone takes a Non-Optimal/Non-Rational decision
of Degree ‘m’? He is simply Rational in Degree ‘k’ where some k<m
* Degree 0 => Implies Randomness
* Infinite Degree => God Himself!!!
* Degree of Rationality can be…
* In Spontaneous Bursts
* Temporal
* Situational
* Long-Term… etc.
* Augmented from Peers
* Degraded at any ‘Moment’ (e.g. Emotional Outbreaks, Alcohol,
Stress/Exhaustion, Sleep Deprivation etc.)

13. *
*Every piece of Information+Technique+Purpose
has a price associated with it. This can be
calculated from 2 decision trees, first without
the Information+Technique+Purpose of the
individual and probably rather that of the
market or normative in some sense, and the
second with that of the individual and taking
the difference of the two.
*Someone always pays the Price of Irrationality.
Either individuals, society, businesses,
industries, economy, world, humanity (future
humans, human race…), or nature.

14. *
*Everyone has different Data, Models and
Purpose…
*So the best definition of Rationality boils down
to – If you can [reasonably] model it … it is
rational
*If you can increasingly model it… it is
increasingly rational

15. *
*Heuristics: People often make decisions based
on approximate rules of thumb and not strict
logic.
*Framing: The collection of anecdotes and
stereotypes that make up the mental
emotional filters individuals rely on to
understand and respond to events.
*Market inefficiencies: These include mis-
pricings and non-rational decision making.
*** Ref: Wikipedia

16. *
*The Problem with Behavioural Finance & Economics
is Two Folds
*First -> They are based Entirely on Behavioural
Psychology
*Second -> They naively say “If its not Optimal
according to Financial or Economic Theory it is
irrational”… they have no concepts of the interplay
between data, models and (especially) purpose…
*Rationality is a bigger concept… which needs to be
rethought to be applied correctly.

17. *
* Rationality normally increases with Time
* It’s a Given: Rationality increases with increase in
information, models and purpose
* Consumer behaviour is becoming increasingly
modelable/rational
* As irrationality declines => Brands are becoming increasingly
irrelevant as a major factor in the value proposition
* Degree of Rationality is an Indicator not a Measure of
Rationality
* Multi-Model Thinkers have way higher degree of rationality than
Uni-Model Thinkers
* In an Ecosystem, groups with varying degrees of rationality are
in a sort of Markov Process Equilibrium

18. *
* The Equilibrium shifts slowly to higher and higher degrees of rationality
* Every market has Asymmetry. Either (i) data/information/knowledge or (ii) models/techniques
or (iii) purpose. defined as the Power of Actors in the market.
* Even if you start with complete Equity (But asymmetry exists in the market). Powerful actors
make higher gains and loose lesser compared to less powerful people resulting in Complete
Inequity eventually. The proportions of gains and losses are also in a Equilibrium at that
instant.
* The gains and losses accumulate over time at the rate of exchange in the Market or the Speed
Of The World. This is defined as the Compounding of Inequity. The phenomenon of Rich
getting Richer and the Poor getting Poorer.
* Universal Equity Establishing Interventions don’t work, they just seem to work at the instant
but as the system churns it goes back to the Markov Equilibrium of Inequity. Equilibrium might
take time but Inequity will be established and will prevail.
* Further the degree of Rationality for each Actor depends on each context he acts in… e.g.
someone might have a degree of 7 with finance, 3 with driving, 2 with entertainment and so
on.
* Golden Rule: Analysts will fall in love with NetLogo ;-)
* The most irrational concept in the world is (probably) LOVE ;-)

19. *
Aditya!!!