As households execute decisions under uncertainty, understanding descriptive and normative analyses of financial decisions may lead to improved choices. Normative theories of rational choice address the decisions anticipated by rational agents. This theory assumes that agents have stable preferences and engage in maximizing behavior. Descriptive theories try to characterize the actual choices implemented; recognizing that agents display biases in their economic decision-making and use heuristics to implement investment decisions (Thaler, 2000).
Implementing an asset allocation plan is a way households can benefit from normative analyses and properly diversify their retirement portfolios, yet a significant number of Americans have the majority of their …show more content…
Descriptive analysis recognizes the availability heuristic that influences some investors as they focus on unlikely events recurring, such as the stock market crash of 1929. Investors have a tendency to overestimate the probabilities of an unlikely event which leads to making decisions based on the unlikely event (Kahneman, 2013). On the contrary, normative theory assumes the accuracy of investor predictions and that proper analysis of all available information dictated decisions.
As investors seek to execute informed financial decisions, being aware of the descriptive and normative theories may lead to better financial decisions. The dual-system theory developed by psychologist Daniel Kahneman aligns System 1 with descriptive theory, as System 1 is influenced by heuristics and System 2 aligns with normative theory, as System 2 examines heuristics and rationalizes ideas. Kahneman (2013) stated that the way to block errors that originate in our System 1 way of thinking is to recognize the signs that you are in a cognitive minefield, slow down, and ask for reinforcement from System
Implementing an asset allocation plan is a way households can benefit from normative analyses and properly diversify their retirement portfolios, yet a significant number of Americans have the majority of their …show more content…
Descriptive analysis recognizes the availability heuristic that influences some investors as they focus on unlikely events recurring, such as the stock market crash of 1929. Investors have a tendency to overestimate the probabilities of an unlikely event which leads to making decisions based on the unlikely event (Kahneman, 2013). On the contrary, normative theory assumes the accuracy of investor predictions and that proper analysis of all available information dictated decisions.
As investors seek to execute informed financial decisions, being aware of the descriptive and normative theories may lead to better financial decisions. The dual-system theory developed by psychologist Daniel Kahneman aligns System 1 with descriptive theory, as System 1 is influenced by heuristics and System 2 aligns with normative theory, as System 2 examines heuristics and rationalizes ideas. Kahneman (2013) stated that the way to block errors that originate in our System 1 way of thinking is to recognize the signs that you are in a cognitive minefield, slow down, and ask for reinforcement from System