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Rational Behavior

What is 'Rational Behavior'

A rational behavior decision-making process is based on making choices that result in the most optimal level of benefit or utility for the individual. Most conventional economic theories are created and used under the assumption all individuals taking part in an action/activity are behaving rationally. Rational behavior does not necessarily always involve receiving the most monetary or material benefit because the satisfaction received could be purely emotional.

Explaining 'Rational Behavior'

While it is likely more financially lucrative for an executive to stay on at a company rather than retire early, it is still considered rational behavior for her to seek an early retirement if she feels the benefits of retired life outweigh the utility from the paycheck she receives.

Behavioral Finance

While most models assume rational behavior on the part of consumers and investors, behavioral finance also substitutes the idea of “normal” people for perfectly rational ones. It allows for issues of psychology and emotion, understanding these factors alter the actions of the investors, leading to decisions that may not be entirely rational or logical in nature.

Rational and Irrational Decision-Making

For a choice to be deemed rational, it must often remove any and all emotional components from the decision-making process and focus solely on the facts as they are presented. Even with emotion removed, more than one determination for a situation may be deemed rational as long as it can be logically explained. One such decision could involve whether to place funds in one bond or another if they both hold similar rates of return and have similar maturity dates.


Further Reading


… asset allocation under mean-reverting returns, stochastic interest rates, and inflation uncertainty: are popular recommendations consistent with rational behavior?
www.sciencedirect.com [PDF]
… implications of the rationality assumptions underlying economics, (2) to assess the importance of evidence documenting violations of rational behavior for the development of both theoretical and applied economics, and (3) to provide a mechanism whereby both economists and …

Behavioral corporate financeBehavioral corporate finance
onlinelibrary.wiley.com [PDF]
… implications of the rationality assumptions underlying economics, (2) to assess the importance of evidence documenting violations of rational behavior for the development of both theoretical and applied economics, and (3) to provide a mechanism whereby both economists and …

Rational herding in financial economicsRational herding in financial economics
www.sciencedirect.com [PDF]
… implications of the rationality assumptions underlying economics, (2) to assess the importance of evidence documenting violations of rational behavior for the development of both theoretical and applied economics, and (3) to provide a mechanism whereby both economists and …

Toward a theory of behavioral operationsToward a theory of behavioral operations
pubsonline.informs.org [PDF]
… implications of the rationality assumptions underlying economics, (2) to assess the importance of evidence documenting violations of rational behavior for the development of both theoretical and applied economics, and (3) to provide a mechanism whereby both economists and …

Behavioral rationality in finance: The case of dividendsBehavioral rationality in finance: The case of dividends
www.jstor.org [PDF]
… implications of the rationality assumptions underlying economics, (2) to assess the importance of evidence documenting violations of rational behavior for the development of both theoretical and applied economics, and (3) to provide a mechanism whereby both economists and …

Behavioral corporate financeBehavioral corporate finance
www.sciencedirect.com [PDF]
… implications of the rationality assumptions underlying economics, (2) to assess the importance of evidence documenting violations of rational behavior for the development of both theoretical and applied economics, and (3) to provide a mechanism whereby both economists and …



Q&A About Rational Behavior


How are conventional economic theories created and used under the assumption all individuals taking part in an action activity are behaving rationally?

Conventional economic theories are created and used under the assumption all individuals taking part in an action activity are behaving rationally.

What do behavioral finance models substitute for perfectly rational ones?

Behavioral finance models substitute for perfectly rational ones by allowing for issues of psychology and emotion, understanding these factors alter the actions of investors leading to decisions that may not be entirely rational or logical in nature.

What does rational behavior not necessarily always involve?

Rational behavior does not necessarily always involve receiving the most monetary or material benefit because the satisfaction received could be purely emotional.

What is rational behavior?

Rational behavior is a decision-making process based on making choices that result in the most optimal level of benefit or utility for the individual.

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