Introduction

Abstract

Real life problems are inside a complex environment. They are typically ill-defined problems; that is, the goals are not definite, we don’t know what counts as an alternative and how many alternatives there are, it’s unclear what the consequences might be and how to estimate their probabilities and utilities. Jim Savage dubbed this environment characterized by uncertainty as Large World. Small Worlds instead are in principle predictable and without surprises and they are characterized by the knowledge of all relevant variables, their consequences and probabilities. The conditions of Small World are the requirements of Neoclassical Rationality, as Herbert Simon stressed in his Nobel Lecture. In these worlds the problems may be well-defined but they can also be computationally intractable. As is well known, an example of a computational tractable problem is the dice game. Instead the well-defined problem of the chess game is computationally intractable. In any case the real world is most of the time large and these conditions of knowledge are rarely met. Since they are rarely met, the normative rational requirements of neoclassical economics are unjustified and the application of their theories can easily lead to a disaster. Is Finance an example of Large World? Or are there financial phenomena that may be considered examples of Small Worlds? And in this case may they be dealt with by rational tools such as probabilistic reasoning and utility maximization? And if this is the case, what is the role of financial literacy and education? Is financial literacy sufficient to empower the financial decision making of savers and investors or should it be strengthened by training them also in behavioural finance and “debiasing” techniques? And can financial literacy avoid including risk literacy, which is the technique used to reason easily about probability calculus and statistics?.