Economics and Psychology. Perfect Rationality versus Bounded Rationality

Classical mathematical algorithms often fail to identify in time when the international financial crises occur although, as the classical theory of choice would suggest, the economic agents are rational and the markets are or should be efficient and behave also rationally. This contribution does not pretend to give a complete answer to these questions, but it will highlight some well-known limits of the classical theory of rational choice and compare this theory of choice with the approach that seeks to combine economics and psychology, focusing on Herbert Simon’s notion of bounded rationality. The work also makes some references to the literature of behavioral finance which has given important contributions in explaining the behavior and the anomalies of financial markets. Finally, following the approach of Simon, the paper proposes an analytical model to describe the behaviour of agents which are rationally bounded, risk averse and loss averse, emphasizing the relationship between psychology and economics which helps to explain the crises in financial markets.