"Their pioneering work addressed money illusion and other psychological foibles, such as our tendency to feel sadder about losing, say, $1,000 than feeling happy about gaining that same amount."
Its about expectations for the future. If I think I can make back 1k in the future no sweat. The future is uncertain and i would be upset over that 1k
I've heard this guy Dan Ariely who is an economist looking into the whole "rational actor " argument, and he makes the pretty compelling general thesis that we are rational actors, but that we aren't motivated by the same financially utilitarian factors that Bentham (or von Mises) would claim. This is a transcript of the most recent interview I heard. I know a lot of folks here rag on Marketplace, and they are late/slow to a lot of stories, but I think their coverage of this sort of story is very interesting and quality - it beats listening to Jim Cramer pound a stage desk.
Mises was discredited, run out of Nazi Germany, lost his professorship and died without much. His writing and theories have found a growing audience and acceptance. The Mises Institute is located in Auburn U. (Alabama of all places).
The article posted, and the work done to 'explain' is not very substantive to me. But then, what do I know? I sell advertising.
These individuals appear to assign a higher value to losing $1000, than gaining the same amount.
Well, yeah. The way you've stated it, it seems to be a 50/50 proposition. Now if I were risking 1,000 to gain 10,000,...I might listen. I need to either have a margin of safety or a "feeling" that I can control the outcome (whether that is really the case or not.)
Alan Greenspan. A persistent cheerleader for the notion of efficient markets, he told a congressional committee in October 2008: “Those of us who looked to the self-interest of lending institutions to protect shareholder’s equity, myself especially, are in a state of shocked disbelief.”
Hmmm, is it possible that an institution, while legally a "person", actually has no self-interest? That the decisions are made by real people that do have self-interests that are not aligned with the best interests of that corporation?
"I've argued before that many buyers during the late stages of the bubble acted rationally."
Other factors were much less bullish, ie. home prices at historical multiples of wages and rents, mortgage products that were historically extremely risky (option pay arms, 0 down loans, no income loans}. Those borrowers you discuss above were mostly unsopisticated borrowers that new mortage products brought into the market, which is, I suppose, another argument against the "Efficient Market Hypothesis" now generally discredited.
“When all mortgages were of the 30-year, fixed-rate variety, choosing the best one was simple—just pick the lowest interest rate,” Thaler says. “Now with variable rates, teaser rates, balloon payments, prepayment penalties, and so forth, choosing the best mortgages requires a Ph.D. in finance.”
Perhaps instead of looking for what a Phd considers the "best" mortgage, we just look for one we can handle? That is, one that we can pay consistently? When looking at the array of confusing alternatives, we need to step back and think," Why are they confusing? Who does it benefit to confuse me?" and then we can proceed with, "Why don't I pick the alternative that I actually understand."
Even "animal spirits" as often described isn't the core of the bubble making psychology, exactly. It's a related psychology which is less about "trust" or a background expectation of a numerical financial outcome (which indeed matters to another part of the brain which gives an "OK" to this particular impulse). In other words, not an "animal spirit" of trust in rising prices, realtors, etc., but, this kind of "spirit": Finding the Dream: Field of Dreams (updated)
The rational investor should not care whether she has $10 million and then loses $8 million or, alternatively, whether she has nothing and ends up with $2 million. In either case, the end result is the same.
God, I love this article, so rich! The rational person should not care whether they fall eight stories from a ten story building or walk up two flights of stairs, the end result is the same.
Things were odd in 2005 and 2006.You could rent a 1 bedroom for $1200 a month in Petaluma in an ok neighborhood,and pay first and last ($2400) or you could buy a $1MM dollar house for $250 out of pocket for the appraiser and get a NINJA POA loan for the rest,rent a few rooms,and make the minimum payment with ease.All you needed was a 720 credit score and proof you were at least 18.
One group that does not value perceived losses differently than gains are individuals with autism, a disorder characterized by problems with social interaction. When tested, autistics often demonstrate strict logic when balancing gains and losses, but this seeming rationality may itself denote abnormal behavior.
Rather than assume autism is a rational logical epitome for economic behavior, maybe we should look at the assumption that what we're calling rational behavior may not incorporate all the salient facts. Lord Kelvin proved the sun could not burn for billions of years because all the combustible products would have been used up. It wasn't until we discovered the hydrogen fusion process that there was any model for the sun to be still shining.
"Hmmm, is it possible that an institution, while legally a "person", actually has no self-interest? That the decisions are made by real people that do have self-interests that are not aligned with the best interests of that corporation?"
It has high degree of self -interest. One problem, there is often a conflict of interest between managers and shareholders within any given institution. The other huge and mostly unnoticed problem, there is often a conflict of interest between a short run and long run business strategies within most of corporations. Unfortunately humans tend to focus on the short term and ignore the long term implications. Just look at us, we demand from the government a quick and fast solution. And look at our government, it potentially puts our future into jeopardy by trying to bailout everyone and everything right now without considering long term consequences.
How can it be that these banks are not just swimming in cash. Borrow at 0% and loan at 5-8% is just like printing money.
Could the green shoots be in trouble. Unemployment still out of control and unfortunately we do not have anything that even resembles a jobs plan from our wonderful leaders. Bailouts, tarp, health plans but no jobs.
We need jobs, jobs, jobs and I know I sound like a broken record but that should be priority one. Washington's not getting it. Now things are sliding downhill, and no one in the Congress has any stomach to pass another stimulus bill. It would take 25% unemployment (on the record 25%) for the public to be willing to take on any more debt. So we are stuck.
"These individuals appear to assign a higher value to losing $1000, than gaining the same amount. " -- CR
CR, I'd like to respectfully disagree with your implication: that losing $1000 has the same "value" (negative but same magnitude) as gaining $1000.
If a single person has a finite amount of reserves, let's say $2000, they should definitely be more scared oif losing $1000 than eager to gain $1000. That's because if they lose $1000, their reserves have been substantially depleted, and it will be more difficult to "gain" their way back to their $2000 starting point. In fact, if reserves ever go to 0, party's over because they have nothing more to invest!
There is a real asymmetry between gaining and losing when finite reserves are involved. I think for that the good analysis would use a utility function to value the amount of money at each of your ensemble outcomes. This utility function attempts to capture the asymmetry.
For a simple example you could use a log function, such that your money value is the log of your money (plus some bias to stay away from log().
These individuals appear to assign a higher value to losing $1000, than gaining the same amount.
Perhaps I'm not understanding something, but this appears to make perfect sense to me unless you are so rich that $1,000 is like pennies. Take an average American family living paycheck to paycheck with some debt. Doesn't it make sense that they're going to be much more emotionally and financially impacted by losing $1,000 than by gaining $1,000? Losing $1,000 is going to put them further behind on payments, cause interest rates to go up, result in more bill collectors calling, etc. Gaining $1,000 does what, exactly? Add some security? Pay down some debt? Get spent on some shiny consumer electronic thingamajig?
Unlike what the article says these are not Behavioral Psychologists, but Cognitive (and increasingly Cognitive Neuro) Psychologists. Behaviorists do not believe that you can look inside the black-box to investigate the machinery of thought, whereas the Cognitive folks believe that that is fair game (as long as you follow the scientific method).
Although I haven't read these in over a decade, some of my favs were Descartes' Error, Inevitable Illusions, and then some of the papers by Kahneman and Tversky.
They blow huge wholes in many economics theories, which is one of the reasons they are so fun to read.
read Mises and learn more about it
CR Its all Relative
"Their pioneering work addressed money illusion and other psychological foibles, such as our tendency to feel sadder about losing, say, $1,000 than feeling happy about gaining that same amount."
Its about expectations for the future. If I think I can make back 1k in the future no sweat. The future is uncertain and i would be upset over that 1k
I am reading the "Animal Spirits" by Shiller, it's pretty good.
OK I misread.
CR I believe you are talking about "cutting losses" Yes that is hard unless you have a detailed plan for the future.
The pigs are flying in here.
I've heard this guy Dan Ariely who is an economist looking into the whole "rational actor " argument, and he makes the pretty compelling general thesis that we are rational actors, but that we aren't motivated by the same financially utilitarian factors that Bentham (or von Mises) would claim. This is a transcript of the most recent interview I heard. I know a lot of folks here rag on Marketplace, and they are late/slow to a lot of stories, but I think their coverage of this sort of story is very interesting and quality - it beats listening to Jim Cramer pound a stage desk.
Oh Noes! PIgged!
Behavioral Economics? - Tibor R. Machan - Mises Institute
Mises was discredited, run out of Nazi Germany, lost his professorship and died without much. His writing and theories have found a growing audience and acceptance. The Mises Institute is located in Auburn U. (Alabama of all places).
The article posted, and the work done to 'explain' is not very substantive to me. But then, what do I know? I sell advertising.
@ Volker
YouTube - Bill Hicks on Marketing
only in jest.
These individuals appear to assign a higher value to losing $1000, than gaining the same amount.
Well, yeah. The way you've stated it, it seems to be a 50/50 proposition. Now if I were risking 1,000 to gain 10,000,...I might listen. I need to either have a margin of safety or a "feeling" that I can control the outcome (whether that is really the case or not.)
I got one of those super fancy new and improved "Public/Private Investment Partnership" things and I don't worry about losing anything...
loved Bill Hicks, died too soon
BTW: heard Billy Mays had a rough plane landing last night, hit his head, woke up dead.
Alan Greenspan. A persistent cheerleader for the notion of efficient markets, he told a congressional committee in October 2008: “Those of us who looked to the self-interest of lending institutions to protect shareholder’s equity, myself especially, are in a state of shocked disbelief.”
Hmmm, is it possible that an institution, while legally a "person", actually has no self-interest? That the decisions are made by real people that do have self-interests that are not aligned with the best interests of that corporation?
CR,
"I've argued before that many buyers during the late stages of the bubble acted rationally."
Other factors were much less bullish, ie. home prices at historical multiples of wages and rents, mortgage products that were historically extremely risky (option pay arms, 0 down loans, no income loans}. Those borrowers you discuss above were mostly unsopisticated borrowers that new mortage products brought into the market, which is, I suppose, another argument against the "Efficient Market Hypothesis" now generally discredited.
“When all mortgages were of the 30-year, fixed-rate variety, choosing the best one was simple—just pick the lowest interest rate,” Thaler says. “Now with variable rates, teaser rates, balloon payments, prepayment penalties, and so forth, choosing the best mortgages requires a Ph.D. in finance.”
Perhaps instead of looking for what a Phd considers the "best" mortgage, we just look for one we can handle? That is, one that we can pay consistently? When looking at the array of confusing alternatives, we need to step back and think," Why are they confusing? Who does it benefit to confuse me?" and then we can proceed with, "Why don't I pick the alternative that I actually understand."
Even "animal spirits" as often described isn't the core of the bubble making psychology, exactly. It's a related psychology which is less about "trust" or a background expectation of a numerical financial outcome (which indeed matters to another part of the brain which gives an "OK" to this particular impulse). In other words, not an "animal spirit" of trust in rising prices, realtors, etc., but, this kind of "spirit": Finding the Dream: Field of Dreams (updated)
The rational investor should not care whether she has $10 million and then loses $8 million or, alternatively, whether she has nothing and ends up with $2 million. In either case, the end result is the same.
God, I love this article, so rich! The rational person should not care whether they fall eight stories from a ten story building or walk up two flights of stairs, the end result is the same.
minus a limiting authority, greed trumps all
Things were odd in 2005 and 2006.You could rent a 1 bedroom for $1200 a month in Petaluma in an ok neighborhood,and pay first and last ($2400) or you could buy a $1MM dollar house for $250 out of pocket for the appraiser and get a NINJA POA loan for the rest,rent a few rooms,and make the minimum payment with ease.All you needed was a 720 credit score and proof you were at least 18.
One group that does not value perceived losses differently than gains are individuals with autism, a disorder characterized by problems with social interaction. When tested, autistics often demonstrate strict logic when balancing gains and losses, but this seeming rationality may itself denote abnormal behavior.
Rather than assume autism is a rational logical epitome for economic behavior, maybe we should look at the assumption that what we're calling rational behavior may not incorporate all the salient facts. Lord Kelvin proved the sun could not burn for billions of years because all the combustible products would have been used up. It wasn't until we discovered the hydrogen fusion process that there was any model for the sun to be still shining.
"Hmmm, is it possible that an institution, while legally a "person", actually has no self-interest? That the decisions are made by real people that do have self-interests that are not aligned with the best interests of that corporation?"
It has high degree of self -interest. One problem, there is often a conflict of interest between managers and shareholders within any given institution. The other huge and mostly unnoticed problem, there is often a conflict of interest between a short run and long run business strategies within most of corporations. Unfortunately humans tend to focus on the short term and ignore the long term implications. Just look at us, we demand from the government a quick and fast solution. And look at our government, it potentially puts our future into jeopardy by trying to bailout everyone and everything right now without considering long term consequences.
How can it be that these banks are not just swimming in cash. Borrow at 0% and loan at 5-8% is just like printing money.
Could the green shoots be in trouble. Unemployment still out of control and unfortunately we do not have anything that even resembles a jobs plan from our wonderful leaders. Bailouts, tarp, health plans but no jobs.
hat tip to: Financial Opinions Updated Daily iamned.com for the good articles
We need jobs, jobs, jobs and I know I sound like a broken record but that should be priority one. Washington's not getting it. Now things are sliding downhill, and no one in the Congress has any stomach to pass another stimulus bill. It would take 25% unemployment (on the record 25%) for the public to be willing to take on any more debt. So we are stuck.
"These individuals appear to assign a higher value to losing $1000, than gaining the same amount. " -- CR
CR, I'd like to respectfully disagree with your implication: that losing $1000 has the same "value" (negative but same magnitude) as gaining $1000.
If a single person has a finite amount of reserves, let's say $2000, they should definitely be more scared oif losing $1000 than eager to gain $1000. That's because if they lose $1000, their reserves have been substantially depleted, and it will be more difficult to "gain" their way back to their $2000 starting point. In fact, if reserves ever go to 0, party's over because they have nothing more to invest!
There is a real asymmetry between gaining and losing when finite reserves are involved. I think for that the good analysis would use a utility function to value the amount of money at each of your ensemble outcomes. This utility function attempts to capture the asymmetry.
For a simple example you could use a log function, such that your money value is the log of your money (plus some bias to stay away from log(
).
These individuals appear to assign a higher value to losing $1000, than gaining the same amount.
Perhaps I'm not understanding something, but this appears to make perfect sense to me unless you are so rich that $1,000 is like pennies. Take an average American family living paycheck to paycheck with some debt. Doesn't it make sense that they're going to be much more emotionally and financially impacted by losing $1,000 than by gaining $1,000? Losing $1,000 is going to put them further behind on payments, cause interest rates to go up, result in more bill collectors calling, etc. Gaining $1,000 does what, exactly? Add some security? Pay down some debt? Get spent on some shiny consumer electronic thingamajig?
he's right: it isn't what you make, it's what you don't lose.
Unlike what the article says these are not Behavioral Psychologists, but Cognitive (and increasingly Cognitive Neuro) Psychologists. Behaviorists do not believe that you can look inside the black-box to investigate the machinery of thought, whereas the Cognitive folks believe that that is fair game (as long as you follow the scientific method).
Sounds like the boys are trying to invent psychohistory. Isiac Asimov would certainly approve.
The cognitive science stuff is great.
Although I haven't read these in over a decade, some of my favs were Descartes' Error, Inevitable Illusions, and then some of the papers by Kahneman and Tversky.
They blow huge wholes in many economics theories, which is one of the reasons they are so fun to read.