Before I get into the heart of a comprehensive model of market participant behavior, I would like to put the concept of prescription into context amid economic theory.
Traditional economists offer normative theories. That is, they model how markets ought to behave in a world where all the participants are rational actors and always behave in accordance with expected utility theory. One need only look at a ten year chart of the SPX to see that these guys are delusional.
Behavioral economists offer descriptive theories. That is, they model how markets really behave and account for irrational market and participant behaviors that are not in accordance with expected utility theory. This is a wonderful step forward from normative models because markets do not occur without the people who make them. Phenomena occur predictably which are not fully rational such as limits to arbitrage (at the market level) and disposition effects (at the participant level).
The shortcoming though of the behavioral economic models is that, while they have assimilated experimental and social psychological models into economic theory, they have neglected clinical psychological models which offer rich and comprehensive models of how humans experience as well as how to effectively promote adaptive change.
They are missing two critical components to the fuller integration of psychology and economics – prescription and personality theory.
Behavioral economics needs to begin integrating prescriptive psychological models into its framework in order to be able to enact adaptive behavioral change in markets and among market participants. I have already outlined why their current attempts to go beyond description are inadequate and in future posts I will begin to outline how this can be accomplished.
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