Friday, September 14, 2007

Daniel Kahneman: Master of the imperfect mind

It isn't often that a psychologist helps explain personal finance, but Daniel Kahneman isn't an ordinary psychologist. In 2002 he won a Nobel Prize in economics for his research into how people confront uncertainty.

Raised in France and Israel and formerly a professor at the Hebrew University of Jerusalem, UC-Berkeley and Princeton, Kahneman has spent half a century studying how the human mind works - or fails to.

Just retired at age 73, Kahneman is now writing a book about decision-making in collaboration with Money Magazine's Jason Zweig. The two recently chatted on the record.

Q. Are people rational?

A. Economists argue that people are rational - that they use all available information to make decisions and that those decisions are consistent over time. Psychologists say that is totally unrealistic. Economists think about what people ought to do. Psychologists watch what they actually do.

Q. Such as?

A. How people respond to a risk depends partly on how it is described. An investment said to have an 80% chance of success sounds far more attractive than one with a 20% chance of failure. The mind can't easily recognize that they are the same.

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