The O.G.’s of Behavioral Finance

Behavioral finance, a field that blends psychology with economics, has transformed how we understand decision-making in markets. But long before the term was coined, the roots of this discipline were laid by some unexpected figures—the true O.G.s of finance. (For my beloved baby boomers, “O.G.” or “Original Gangstas” in modern usage refers to someone who is an original member of a group or movement.)

Traditional finance assumes that individuals make decisions purely based on math and logic. Behavioral finance, however, recognizes that psychological factors often drive financial choices, explaining why people sometimes act irrationally in markets. Many prominent thinkers, including Daniel Kahneman, Richard Thaler, James Montier, and Daniel Crosby, have contributed to this growing field. Both Kahneman and Thaler have won Nobel Prizes in Economic Sciences for their groundbreaking work.

While many consider this the beginning of the field, its roots go much deeper. Some may think the O.G. of behavioral finance was Benjamin Graham, whose book The Intelligent Investor (1949) introduced key ideas, but that’s not quite right. Others might point to Adam Smith, whose book The Theory of Moral Sentiments (1759) explored how emotions influence economic decisions. Yet even this isn’t the earliest example.

The true O.G.s of behavioral finance can be traced back to the Talmud, a text with origins over 3,300 years ago. Divided into 63 tractates, several sections focus on law, finance, and, as we’ll see, behavioral finance.

1. Risk Aversion and Loss Aversion

The Talmud discusses laws related to custodians, who safeguard others’ property. These laws vary based on whether the custodian is paid, reflecting different levels of responsibility and risk aversion tied to compensation. This parallels modern risk aversion theory, which states that people are more willing to take risks if they are compensated. The Tosafos, a group of Talmudic commentators from the 12th and 13th centuries, explain in Bava Metzia 42a that an unpaid custodian takes fewer risks due to a greater fear of personal loss compared to a paid custodian, who has some form of “buffer” or protection.

2. Diminishing Sensitivity

In Bava Metzia 21a, the Talmud discusses when a lost item can be kept by a finder. A key principle is whether the owner gives up hope of recovering the lost item, as well as the effort the owner must exert to retrieve it versus the value of the item. The sages discuss the distinction between a kav (volume) of grain spread over four amos (space) and a half-kav spread over two amos. This can be understood through the concept of diminishing sensitivity. In the case of the kav scattered over four amos, the owner may perceive the loss as too large and spread out to be worth retrieving, leading to giving up hope of recovery. In contrast, the half-kav scattered over two amos feels more recoverable, as the loss is smaller and more concentrated. The psychological impact of losing that smaller portion is more significant.

This reflects diminishing sensitivity: the owner feels less emotional impact from each part of the kav as the overall size of the loss increases, making them more willing to abandon efforts to recover it, whereas a smaller, more focused loss feels more manageable and worth pursuing.

3. Anchoring

In Bava Batra 90b, the Talmud discusses fair pricing and market regulation, including how much profit a merchant is allowed to make. It sets limits on overcharging, which aligns with the anchoring effect—where the first price presented (the “anchor”) influences subsequent negotiations and perceptions of value. By establishing legal guidelines for fair pricing, the Talmud acknowledges how people are influenced by their initial perception of value.

4. Present Bias & Hyperbolic Discounting

In Ketubot 102b, the Talmud addresses the marriage contract and how certain payments can be deferred or structured over time to the ex-wife. This reflects present bias, where people prefer immediate rewards over larger, delayed ones—a concept known as hyperbolic discounting in behavioral finance. The Talmud’s legal guidelines aim to mitigate this short-sightedness by offering protections for both immediate and deferred payments.

5. Mental Accounting

The Talmud in Ketubot 50a covers the ethical importance of charity and the laws of tithing. Setting aside a specific portion of one’s income for charity can be viewed through the lens of mental accounting, where people divide money into different categories (e.g., charity, savings, spending), affecting their financial behavior. Tithing creates a “mental account” for charitable giving, promoting responsible financial behavior by framing charity as a separate financial obligation.

The examples I shared are just a small sample from this vast topic. So, no offense to my respected contemporaries and those from the past few hundred years for their contributions to the field of behavioral finance, but the true O.G.s of behavioral finance are found in the ancient text of the Talmud.