Naturalistic decision making and modern finance

The root process for decision-making in finance is the use of optimization and the weighing of expected return through alternative scenarios. Quantitative approaches are the hallmark of any business school education as it is related to finance. Probability weights all alternatives and finds the expected value. There has been a general focus on trying to move away from any process that cannot be quantified. As evidenced by the strong research on the problems of heuristics and biases, there has been a movement away from decisions that are not processed-based. 

Behavioral finance is work on what should not be done in decision-making. Better decision-making will be made through minimizing mistakes. The current work on decision-making does not have a focus on what are good or effective practices, yet in the real world, experience tells us that using short-cuts can be helpful and useful. There is a growing alternative to this process-driven decision-making to something that is closer to reality.

A close analysis of real-world decision-making shows that the focus for doers is not on considering all options but on using experience to find what is perceived to be the best course of action. Call it a form of satisficing, but most decision-makers do not conduct a full analysis of choices. This focus on choice and experience can be wrongly classified as simple heuristics by some, but it has been studied and developed as a school of thought referred to as naturalistic decision-making (NDM). Repeated decision-making based on past experiences has been referred to as recognition-primed decision-making (RPD). Gary Klein is an innovative researcher in this area who has studied decision-making by firemen, pilots, and the US Army. In different situations, the focus has to be on what has worked in the past.

RPD focuses on defining the situation, matching it to what has been learned in the past, followed by specific action. It may not be the best decision, but it can be effective given the available evidence and the time constraint that requires action. It combines intuition and real-time analysis. Deliberate analysis may be too slow in an active, rapidly changing environment. Action based on experience and mental simulation is a good choice.

This sounds more like how traders may behave when faced with quick market action. Perhaps there should be more teaching of decision-making based on rules developed from analysis of specific situations. This is a fruitful area of finance which has not been effectively analyzed.