Episode Summary
Executive Summary: In a live Masters in Business episode at the New York Economic Club, Richard Thaler and Alex Emis discuss their updated book 'The Winner's Curse.' They explore how cognitive biases (endowment effect, winner's curse, beauty contest game) persist in real markets like NFL drafts, oil leases, and stock trading. Thaler recounts his 'corruption of youth' strategy via anomalies columns and highlights how learning from feedback is slow even for professionals (e.g., traders selling worse than random). Key implications: defaults (automatic 401k enrollment) significantly boost savings and behavioral economics tools (nudge units) improve tax compliance.
Main Topics: Behavioral economics anomalies still replicate in field settings (Priority: 5/5): How cognitive biases (endowment effect, winner's curse, beauty contest, confirmation bias) persist in real-world markets like NFL drafts, oil leases, and stock trading – despite professionals having decades of experience. The winner's curse explains overbidding in auctions and sports (Priority: 5/5): The surprising persistence of the winner's curse (oil leases, sports free agents, auctions) – winners systematically overpay because they ignore that they won by bidding highest among equally informed bidders. Professionals do learn but slowly – feedback loops are broken (Priority: 4/5): Professionals (fund managers, scouts) fail to learn from feedback because they don't systematically analyze past mistakes (e.g., cutting winning too early, never studying scouting reports). Nudge theory works in practice (retirement savings, tax compliance) (Priority: 4/5): Nudges (automatic enrollment, save more tomorrow, improved tax letters) significantly improve outcomes by changing defaults or making the right action easy – costless implementation. Technology magnifies behavioral biases (Robinhood, sports betting) (Priority: 4/5): Technology amplifies biases: Robinhood options trading causes retail investors to lose billions; single-day options and sports gambling are new 'behavioral traps'. Origins of behavioral economics: anomalies columns, Kahneman & Tversky (Priority: 3/5): The 'anomalies' approach (from Kahneman & Tversky) combined with market analysis distinguishes behavioral economics from pure psychology – focusing on market aggregation of biases. Sports and finance: slow adoption of evidence-based decision-making (Priority: 3/5): The failure to apply analytic thinking in sports (three-point shot, fourth-down decisions) and finance (value of picks, selling decisions) shows system-wide suboptimal decisions persist.
Key Arguments: Human decision-making under uncertainty is systematically biased, not irrational – biases replicate in real-world markets (NFL draft, portfolios). Winner's curse explains overbidding where winners overpay due to ignoring competition (oil leases, free agents). Endowment effect causes sellers (and traders) to overvalue what they own; professionals suffer this too (selling decisions worse than random). Learning from feedback is slow because people avoid disconfirming evidence and don't analyze past mistakes (e.g., scouting reports never studied). Nudges can cost-effectively improve outcomes (tax compliance letters, retirement savings defaults) by making the right action easy.
Data Points: US 401k market size: $4.7 trillion - Market size impacted by behavioral economics nudge via 401k defaults Percentage of 401k assets defaulted to cash historically: 40% - Historical impact of poor default choices on retirement savings Estimated increased retirement savings due to automatic enrollment: Double what it would have been without - Economic value created through nudge-based default changes NFL draft pick discount rate (trading future picks): 137% - Performance of average investor behavior Winner's curse overpayment (average vs winning bid in auction for jar of coins): Winning bid always above actual value - Impact of auction behavior on decision-making Performance of selling decisions relative to random: Worse than random - Underperformance of professional traders in selling decisions Losses from options trading on platforms like Robinhood: $6 billion over two years - Impact of Robinhood trading on retail investors Increase in participation due to automatic enrollment: Thousands of new savers - Savings impact of automatic enrollment in 401k plans Result of automatic contribution increases: Gradual increase over time - Effectiveness of automatic escalation (Save More Tomorrow)
Pivotal Quotes: "The only way you can learn anything is feedback. And most of us don't bother." — Richard Thaler: Thaler explains why behavioral anomalies persist: professionals don't learn because they don't study their own past mistakes. "In economics, an anomaly is something that cannot easily be explained using the standard assumptions that people are really smart, unemotional, selfish, no self-control problems, basically not like anybody you know." — Richard Thaler: Thaler describes how his anomaly columns originated and why they focus on big effects that replicate. "They did worse than random... selling is not really an investment decision. And I'm like, all right, I told my friends at the University of Chicago Finance Department, they were very surprised that selling wasn't an investment decision." — Alex Imis: Imis explains how expert traders can be worse than random at selling stocks, highlighting the discontinuity between buying and selling skills.
Implications: Key takeaway: Behavioral economics demonstrates systematic errors in human decision-making under uncertainty. Nudges (like automatic enrollment) can dramatically improve financial outcomes. For professionals – overcoming blind spots requires rigorous feedback mechanisms. Future: technology amplifies biases (e.g., Robinhood options losses) unless intentionally designed wisely.
From the Transcript
Well, we talked about this last time we discussed this issue. The buys are very quantitative and rigorous. The sells are just squishy, and every emotional bias that comes in. Oh, this is starting to falter. It's not doing what I expected. Something else shiny comes along and it catches their attention. They need to make room in the portfolio. You mentioned blind spots. Your friend Danny Kahneman used to talk. About, I used to ask him on occasion, how do you avoid all of these biases we all succumb to? And he's like, I'm subject to every one of them. We all have a bias blind spot. There's no getting away from it. Is there hope for us? Well, the only way you can learn anything is feedback. And most of us don't bother. So we don't get the feedback. And You know, when my friend Cade, my former student that I did the football paper with, we were hired for a while by one of the NFL teams. And they're showing us around their facility. And we go, and there's some room about the size of this full of file cabinets. And we say, what's in there? Oh, old scouting.
I had a friend, I have a friend named Hal Varian, who has been the chief economist at Google. He was a mere professor at the time and on the advisory board of this journal. And they were planning some pieces that would appear in every issue, which is once a quarter. And Hal and I cooked up the idea of having a feature on anomalies. So, what's an anomaly? In economics, an anomaly is something that cannot easily be explained using the standard assumptions that people are really smart, unemotional, selfish, no self-control problems, basically not like anybody you know. And so, as a result of that, there were lots of anomalies. And I did this for almost four years. When it looked like a pile of them, looked like a book. I stapled them together, and that was the original version of The Winner's Curse, published in 1992.
Look, we want to give these guys a large benefit of the doubt. We don't know what their conditions are. So we're just going to compare them to a very, very easy counterfactual. I don't know what they're facing. I'm just going to throw a dart in their portfolio and sell that instead. And they did worse than random. And basically, what we found is that they weren't spending a lot of time on the selling decisions. We interviewed them and we said, what are you guys doing? It's like, ah, selling is not really that important. It's not really an investment decision. And I'm like, you know, all right. I told my friends at the University of Chicago Finance Department, they were very surprised that selling wasn't an investment decision. And so they were just not really paying attention to it. So they were just selling the things that were very, very salient on their screens and the things that they were least attached to. So going back to the endowment effect, they were selling the things that they had recently bought. But if you're good at buying, that's not what you should be selling.
About Masters in Business
Barry Ritholtz speaks with the people that shape markets, investing and business.