The Behavioral Paradox: Why Investor Irrationality Calls for Lighter and Simpler Financial Regulation

It is widely believed that behavioral economics justifies more intrusive regulation of financial markets, because people are not fully rational and need to be protected from their quirks. This Article challenges that belief. Firstly, insofar as people can be helped to make better choices, that goal can usually be achieved through light-touch regulations. Secondly, faulty perceptions about markets seem to be best corrected through market-based solutions. Thirdly, increasing regulation does not seem to solve problems caused by lack of market discipline, pricing inefficiencies, and financial innovation; better results may be achieved with freer markets and simpler rules. Fourthly, regulatory rule makers are subject to imperfect rationality, which tends to reduce the quality of regulatory intervention. Finally, regulatory complexity exacerbates the harmful effects of bounded rationality, whereas simple and stable rules give rise to positive learning effects

Regulating Complacency: Human Limitations and Legal Efficacy

This Article examines how insights into limited human rationality can improve financial regulation. The Article identifies four categories of limitations—herd behavior, cognitive biases, overreliance on heuristics, and a proclivity to panic—that undermine the perfect-market regulatory assumptions that parties have full information and will act in their rational self-interest. The Article then analyzes how insights into these limitations can be used to correct resulting market failures. Requiring more robust disclosure and due diligence, for example, can help to reduce reliance on misleading information cascades that motivate herd behavior. Debiasing through law, such as requiring more specific, poignant, and concrete disclosure of risks and their consequences, can help to correct cognitive biases. Requiring firms to engage in more self-aware operational risk management and reporting can reduce the likelihood that parties will over-rely on heuristics. And legislating backstop market liquidity and other stabilizing controls can help to minimize panics. Regulation, however, can only partly overcome these limitations. Effective financial regulation should therefore be designed not only to address these limitations but also to try to mitigate the harm of inevitable financial failures

Regulating Complacency: Human Limitations and Legal Efficacy

This Article examines how insights into limited human rationality can improve financial regulation. The Article identifies four categories of limitations—herd behavior, cognitive biases, overreliance on heuristics, and a proclivity to panic—that undermine the perfect-market regulatory assumptions that parties have full information and will act in their rational self-interest. The Article then analyzes how insights into these limitations can be used to correct resulting market failures. Requiring more robust disclosure and due diligence, for example, can help to reduce reliance on misleading information cascades that motivate herd behavior. Debiasing through law, such as requiring more specific, poignant, and concrete disclosure of risks and their consequences, can help to correct cognitive biases. Requiring firms to engage in more self-aware operational risk management and reporting can reduce the likelihood that parties will over-rely on heuristics. And legislating backstop market liquidity and other stabilizing controls can help to minimize panics. Regulation, however, can only partly overcome these limitations. Effective financial regulation should therefore be designed not only to address these limitations but also to try to mitigate the harm of inevitable financial failures

Statistical Inferences for Polarity Identification in Natural Language

Information forms the basis for all human behavior, including the ubiquitous decision-making that people constantly perform in their every day lives. It is thus the mission of researchers to understand how humans process information to reach decisions. In order to facilitate this task, this work proposes a novel method of studying the reception of granular expressions in natural language. The approach utilizes LASSO regularization as a statistical tool to extract decisive words from textual content and draw statistical inferences based on the correspondence between the occurrences of words and an exogenous response variable. Accordingly, the method immediately suggests significant implications for social sciences and Information Systems research: everyone can now identify text segments and word choices that are statistically relevant to authors or readers and, based on this knowledge, test hypotheses from behavioral research. We demonstrate the contribution of our method by examining how authors communicate subjective information through narrative materials. This allows us to answer the question of which words to choose when communicating negative information. On the other hand, we show that investors trade not only upon facts in financial disclosures but are distracted by filler words and non-informative language. Practitioners - for example those in the fields of investor communications or marketing - can exploit our insights to enhance their writings based on the true perception of word choice

More than a Feeling: Emotion and the First Amendment

First Amendment law has generally been leery of government attempts to change the marketplace of emotions—except when it has not been. Scientific evidence indicates that emotion and rationality are not opposed, as the law often presumes, but rather inextricably linked. There is no judgment, whether moral or otherwise, without emotions to guide our choices. Judicial failure to grapple with this reality has produced some puzzles in the law. Part I of this Symposium contribution examines the intersection of private law, the First Amendment, and attempts to manipulate and control emotions. Only false factual statements can defame, not mere derogatory opinions. Yet trademark law allows exactly the kind of control over nonfactual, emotional appeals that modern defamation law precludes. These two bodies of law thus stand in contrast, one constrained by the First Amendment to cover only facts and the other allowed to reach much further into the dark heart of emotional manipulation. Part II turns to compelled speech, and again finds two contrasting regulations united by their emotional mechanisms, but divided by their constitutional fates. Courts have struck down mandatory smoking warnings in visual form, but have approved mandatory abortion disclosures and ultrasound requirements that operate in the same emotional register. Regardless of whether the regulation involves a direct government mandate or private parties claiming competing rights to influence the audience’s emotional state, then, current First Amendment law doesn’t have a consistent account of the proper role of emotion in speech regulation. Part III suggests that the contradictions of current doctrine could be ameliorated by less distrust of emotion and more acceptance that where information is being conveyed, emotion will regularly follow. Our focus then should not be on whether deployment of emotion is “manipulative,” but whether it is part of a discriminatory or factually misleading regulation. When the government can otherwise constitutionally mandate disclosure, the fact that these disclosures have emotional resonance is not an independent constitutional barrier

Judging Myopia in Hindsight: Bivens Actions, National Security Decisions, and the Rule of Law

Liability in national security matters hinges on curbing both official myopia and hindsight bias. The Framers knew that officials could be short-sighted, prioritizing expedience over abiding values. Judicial review emerged as an antidote to myopia of this kind. However, the Framers recognized that ubiquitous second-guessing of government decisions would also breed instability. Balancing these conflicting impulses has produced judicial oscillation between intervention and deference. Recent decisions on Bivens claims in the war on terror have defined extremes of deference or intervention. Cases like Ashcroft v. Iqbal and Arar v. Ashcroft display a categorical deference that rewards officials\u27 myopia. On the other hand, courts in Padilla v. Yoo and al-Kidd v. Ashcroft manifest an equally categorical interventionism that institutionalizes hindsight bias. To break with the categorical cast of both deferential and interventionist decisions, this Article proposes an innovation-eliciting approach. Inspired by remedies for cognitive bias and regulatory failure, it gives officials a stake in developing alternatives to both overreaching and abdication. Officials who can demonstrate they have implemented alternatives in other contexts that are both proportional and proximate in time to the instant case buy flexibility and dismissal of the lawsuit before the qualified immunity phase. By leveraging officials\u27 experiences and expertise, the innovation-eliciting approach tames the pendular swings in policy that Justice Kennedy in Boumediene v. Bush viewed as undermining both liberty and security

The Role of Heuristics in Information Security Decision Making

Inadvertent human errors (e.g., clicking on phishing emails or falling for a spoofed website) have been the primary cause of security breaches in recent years. To understand the root cause of these errors and examine practical solutions for users to overcome them, we applied the theory of bounded rationality and explored the role of heuristics (i.e., short mental processes) in security decision making. Interviews with 27 participants revealed that users rely on various heuristics to simplify their decision making in the information security context. Specifically, users rely on experts’ comments (i.e., expertise heuristic), information at hand, such as recent events (i.e., availability heuristic), and security-representative visual cues (i.e., representativeness heuristic). Findings also showed the use of other heuristics, including affect, brand, and anchoring, to a lesser degree. The results have practical and theoretical significance. In particular, they extend the literature by integrating bounded rationality concepts and elaborating “how” users simplify their security decision making by relying on cognitive heuristics

Behavioral Economics and the SEC

Not all investors are rational. Quite apart from the obvious examples of credulity in the face of the latest Ponzi scheme, there is no shortage of evidence that many investors\u27 decisions are influenced by systematic biases that impair their abilities to maximize their investment returns. For example, investors will often hold onto poorly performing stocks longer than warranted, hoping to recoup their losses. Other investors will engage in speculative trading, dissipating their returns by paying larger commissions than more passive investors. And we are not just talking about widows and orphans here. There is evidence that supposedly sophisticated institutional investors-mutual funds, pension funds, insurance companies-suffer from similar biases that impair their decisions. These biases are not merely isolated quirks, rather, they are consistent, deep-rooted, and systematic behavioral patterns. Apparently even the considerable sums at stake in the securities markets are not enough to induce market participants to overcome these cognitive defects on a consistent basis

Open Doors, Trap Doors, and the Law

Accordingly, the term open door will be used to refer to situations in which an individual can exercise, ex post, a right to rescind or withdraw from (and thus reverse) an ex ante commitment or decision. More specifically, within the realm of contract theory, this article focuses on implications for contract formation interpretation and the design of contractual default rules