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NISM Professor

Richard Thaler

The 2017 Nobel laureate the workbook credits, alongside Daniel Kahneman, with founding behavioural finance — named for mental accounting (1999) and for a pension-enrolment nudge that overcame status quo bias.

In plain language

Richard Thaler is one of two people the workbook names as bringing behavioural finance into the mainstream. The other is Daniel Kahneman.

Thaler's own contributions, as the workbook presents them, are about how ordinary people actually handle money — not how a textbook says they should.

How it works

Two contributions, both credited to Thaler by name.

1. Nobel Prize, 2017. The workbook lists Kahneman (2002) and Thaler (2017) together as the Nobel laureates behind behavioural finance.

2. Mental accounting, 1999. Thaler developed the idea that people treat one sum of money differently from another, equal-sized sum, depending on which mental account it sits in — a bonus, a salary, a lottery win — even though money is, in reality, completely fungible. Thaler's own recommendation is to treat all money as fungible, whatever its source.

3. The nudge, illustrated through pension enrolment. The workbook credits "a simple nudge, as explained by Richard Thaler," with getting more employees to enrol in pension plans that otherwise had poor take-up, because status quo bias kept people out even when enrolling was clearly in their own interest.

A worked example

Illustrative application. Mr Verma gets an annual bonus of Rs 2,00,000 and treats it as "fun money," spending it on a holiday, while he is careful with his monthly salary over the same two months.

Thaler's mental accounting explains this exactly. Mr Verma treats two equal sums of money differently only because of the mental account — bonus versus salary — each one sits in, even though a rupee from either source buys exactly the same thing. An adviser familiar with Thaler's work would point out that both sums are part of the same household wealth, and encourage Mr Verma to spend the bonus with the same discipline as his salary.

Why NISM asks about it

Chapter 16 (Basics of Behavioural Finance), section 16.1, names Thaler as a 2017 Nobel laureate alongside Kahneman. Section 16.3.2 credits him by name with mental accounting (1999) and with the pension-enrolment nudge under status quo bias. Expect a question naming Thaler's Nobel year, or asking which named bias his pension example illustrates.

Common exam traps

  • Thaler's Nobel year is 2017; Kahneman's is 2002 — the two years are a common distractor swap.
  • Mental accounting (1999) is Thaler's contribution, not Kahneman and Tversky's. Prospect Theory (1979) belongs to the other pair.
  • The pension nudge illustrates status quo bias, not mental accounting. Thaler is cited in the workbook for both, but they are separate ideas in separate places in the chapter.

Check yourself

  1. 1.Who identified the disposition effect, and in which year?

    1. a)Shefrin and Statman, in 1985
    2. b)Kahneman and Tversky, in 1979
    3. c)Herbert Simon, in 1978
    4. d)Richard Thaler, in 1999
    Show the answer

    Answer: (a) Shefrin and Statman, in 1985

    Shefrin and Statman (1985) extended the analysis of loss aversion to the investing field and identified the disposition effect — the tendency to hold the losers too long and sell the winners too early.

    Keep the attributions apart: loss aversion bias is Kahneman and Tversky (1979), arising from their work on prospect theory. Bounded rationality is Herbert Simon (1978). Mental accounting is Richard Thaler (1999).

  2. 2.The workbook footnote defines fungibility as which of the following?

    1. a)The fact that all money is interchangeable and has no labels
    2. b)The ability of an asset to be converted into cash quickly
    3. c)The tendency of investors to allocate money to separate goal buckets
    4. d)The rate at which money loses purchasing power over time
    Show the answer

    Answer: (a) The fact that all money is interchangeable and has no labels

    Fungibility is the fact that all money is interchangeable and has no labels. The workbook notes that people treat money less fungible than it really is.

    This is the property violated by mental accounting bias, developed by Richard Thaler (1999) — an information processing bias in which people treat one sum of money differently from another equal-sized sum based on which mental account it is kept in.

    Thaler suggests to consider money as fungible and treat all money the same, regardless of its origin or use. Option 2 describes liquidity, which is a different property.

  3. 3.Which statement about status quo bias and regret is correct?

    1. a)Regret is more intense for bad outcomes resulting from actions taken than for bad consequences of inaction
    2. b)Regret is more intense for bad consequences of inaction than for bad outcomes resulting from actions taken
    3. c)Regret is felt equally for errors of commission and errors of omission
    4. d)Regret aversion is a cognitive error rather than an emotional bias
    Show the answer

    Answer: (a) Regret is more intense for bad outcomes resulting from actions taken than for bad consequences of inaction

    People feel greater regret for the bad outcomes that result from new actions taken (error of commission) than for the bad consequences of inaction (error of omission).

    This asymmetry is what produces status quo bias, an emotional bias closely linked with regret aversion and endowment bias, in which people prefer to keep things the way they are and do nothing.

    Richard Thaler showed the bias can be used positively through the nudge: if the default option is set as enrolment in the pension scheme, employees continue with it instead of opting out.

Where this is taught

Free preparation for NISM Series X-B

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