Ideas from behavioral economics such as prospect theory have enlightened us to our reactions to gains and losses over varying time periods, but I have yet to come across research discussing what I am calling ‘rationally irrational’ decisions. Let me attempt to explain.
Our decisions are influenced by rewards, potential or actual. These rewards can create habits that lead to the continuation of a specific behaviour. But since rewards are felt by chemicals in our brains, something that is unhealthy for our minds and bodies – getting high on hard drugs, smoking cigarettes, or drinking excessive amounts of alcohol – may be felt of as a reward which could lead to future cravings.
Often it is the case that the individual knows fully well the impacts of his or her decision, and sometimes in fact craves these effects. Think of the masochist who gets off on the pain, or the dieter who wants to improve their body image yet craves unhealthy foods. Most people want the fitness physique, yet also want to eat all the cakes.
In terms of finance this could translate to a rogue trader gambling deeper and deeper into the red, or an institution plotting to cheat and steal from clients. Of course, there have been many cases of both.
As I am planning to create a basic model of a complex economical system, I am looking to model one of the most important aspect of the system, the participants. And of course, I need to include their irrationality. If anybody has any research that I may have overlooked in regards to reward mechanisms, please let me know.