Although not immediately apparent, the discipline of behavioral finance is rapidly adopting an implicit prescriptive agenda. Behavioral finance does not merely describe financial market reality, it shapes it. Economic rationality is taken as the ideal toward to which individuals 'should' strive.
In this paper I show that, as a behavioral ideal, economic rationality is unjustified both from a strictly economic perspective, and from a moral perspective. In short, there is nothing inherently 'wrong' with economically irrational participants in the business environment. Indeed such participants will actually enhance the efficiency, and the ethicality, of business.
"rationality itself, whether theoretical or practical, is a concept with a history: indeed, since there are a diversity of traditions of enquiry, with histories, there are ... rationalities rather than rationality" (Alasdair MacIntyre, Whose Justice, Which rationality, 1988, p. 9).
The rapidly growing discipline of beha
vioral finance is generally viewed as a value-free descriptive subject that makes no pronouncements on how agents 'should' behave. Behavioral finance, most academics and practitioners would argue, attempts merely to describe and account for how individuals and groups actually behave in financial environments. In other words, the general consensus is that 'behavioral finance' implies no particular moral or ethical agenda.
On closer inspection, however, behavioral finance does espouse a prescriptive ideal of how economic agents 'should' behave. Consider the following statement in a recent behavioral finance article that appeared in the Financial Analysts Journal: "The way the world should be (the rational economic paradigm) and the way the world is (behavioral tendencies) will always be in tension, but the introduction of psychological antecedents into the analysis of financial anomalies is not a negation of the rational economic paradigm." (Raghubir and Das, 1999, p. 56, my emphasis). Note the view that the way individuals 'should' behave in financial markets is in a manner consistent with the rational economic paradigm. The authors compound this implication by referring to behavior that is inconsistent with economic rationality as "errant" (p. 56) behavior.
Many other financial economists who write about behavioral finance seem to think it natural to set up a dichotomy between actual observed behavior on the one hand, versus some behavioral ideal on the other; where the behavioral ideal comes from financial-economic theory's concept of rationality. Financial economists often refer to irrational behavior as behavior 'off the equilibrium path', as if those individuals who behave irrationally are in some way straying or deviating from an ideal route.
Even in the formative stages of the discipline, therefore, behavioral finance has adopted a normative (i.e. prescriptive) agenda. Behavioral finance is not merely about the application of the theories and methodology of psychology in an attempt to explain behavior. Albeit implicitly, behavioral finance is also about prescribing how agents should behave: agents should behave rationally, where rationality is defined strictly in terms of financial economic theory.
In this paper I analyze behavioral finance's implicit normative agenda. Specifically, I argue that it is unjustified and injustifiable from both an economic and a moral perspective to espouse financial-economic rationality as a behavioral ideal. In short, there is no meaningful way in which we can say that investors, managers, brokers, or anyone else for that matter 'should' behave in a way consistent with economic rationality.
The remainder of the paper is split into three parts. First, I describe exactly what is meant by financial-economic rationality. Second, I show why such a rationality concept is unjustified as a normative ideal from a strictly economic perspective. Third, I show why such a rationality concept is injustifiable as a normative ideal from a strictly moral perspective.
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