Daniel Kahneman / Amos Tversky

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pages: 336 words: 113,519

The Undoing Project: A Friendship That Changed Our Minds by Michael Lewis

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Albert Einstein, availability heuristic, Cass Sunstein, choice architecture, complexity theory, Daniel Kahneman / Amos Tversky, Donald Trump, Douglas Hofstadter, endowment effect, feminist movement, framing effect, hindsight bias, John von Neumann, Kenneth Arrow, loss aversion, medical residency, Menlo Park, Murray Gell-Mann, Nate Silver, New Journalism, Paul Samuelson, Richard Thaler, Saturday Night Live, statistical model, the new new thing, Thomas Bayes, Walter Mischel, Yom Kippur War

“The Neurobiological Origins of Psychoanalytic Dream Theory.” American Journal of Psychiatry 134, no. 11 (1978): 1211–21. Kahneman, Daniel. “The Psychology of Possible Worlds.” Katz-Newcomb Lecture, April 1979. Kahneman, Daniel, and Amos Tversky. “The Simulation Heuristic.” In Judgment under Uncertainty: Heuristics and Biases, edited by Daniel Kahneman, Paul Slovic, and Amos Tversky, 3–22. Cambridge: Cambridge University Press, 1982. LeCompte, Tom. “The Disorient Express.” Air & Space, September 2008, 38–43. http://www.airspacemag.com/military-aviation/the-disorient-express-474780/. Tversky, Amos, and Daniel Kahneman. “The Framing of Decisions and the Psychology of Choice.” Science 211, no. 4481 (1981): 453–58. CHAPTER 12: THIS CLOUD OF POSSIBILITY Cohen, L. Jonathan. “On the Psychology of Prediction: Whose Is the Fallacy?”

Psychological Bulletin 57, no. 2 (1960): 116–31. Kahneman, Daniel, and Amos Tversky. “Subjective Probability: A Judgment of Representativeness.” Cognitive Psychology 3 (1972): 430–54. Meehl, Paul E. “Causes and Effects of My Disturbing Little Book.” Journal of Personality Assessment 50, no. 3 (1986): 370–75. Tversky, Amos, and Daniel Kahneman. “Availability: A Heuristic for Judging Frequency and Probability.” Cognitive Psychology 5, no. 2 (1973): 207–32. CHAPTER 7: THE RULES OF PREDICTION Fischhoff, Baruch. “An Early History of Hindsight Research.” Social Cognition 25, no. 1 (2007): 10–13. Howard, R. A., J. E. Matheson, and D. W. North. “The Decision to Seed Hurricanes.” Science 176 (1972): 1191–1202. http://www.warnernorth.net/hurricanes.pdf. Kahneman, Daniel, and Amos Tversky. “On the Psychology of Prediction.”

Minneapolis: University of Minnesota Press, 1973. CHAPTER 8: GOING VIRAL Redelmeier, Donald A., Joel Katz, and Daniel Kahneman. “Memories of Colonoscopy: A Randomized Trial,” Pain 104, nos. 1–2 (2003): 187–94. Redelmeier, Donald A., and Amos Tversky. “Discrepancy between Medical Decisions for Individual Patients and for Groups.” New England Journal of Medicine 322 (1990): 1162–64. ——— . Letter to the editor. New England Journal of Medicine 323 (1990): 923. http://www.nejm.org/doi/pdf/10.1056/NEJM199009273231320. ——— . “On the Belief That Arthritis Pain Is Related to the Weather.” Proceedings of the National Academy of Sciences 93, no. 7 (1996): 2895–96. http://www.pnas.org/content/93/7/2895.full.pdf. Tversky, Amos, and Daniel Kahneman. “Judgment under Uncertainty: Heuristics and Biases.” Science 185 (1974): 1124–31.


pages: 519 words: 104,396

Priceless: The Myth of Fair Value (And How to Take Advantage of It) by William Poundstone

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availability heuristic, Cass Sunstein, collective bargaining, Daniel Kahneman / Amos Tversky, delayed gratification, Donald Trump, East Village, en.wikipedia.org, endowment effect, equal pay for equal work, experimental economics, experimental subject, feminist movement, game design, German hyperinflation, Henri Poincaré, high net worth, index card, invisible hand, John von Neumann, Kenneth Arrow, laissez-faire capitalism, Landlord’s Game, loss aversion, market bubble, mental accounting, meta analysis, meta-analysis, Nash equilibrium, new economy, Paul Samuelson, payday loans, Philip Mirowski, Potemkin village, price anchoring, price discrimination, psychological pricing, Ralph Waldo Emerson, RAND corporation, random walk, RFID, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, rolodex, Steve Jobs, The Chicago School, The Wealth of Nations by Adam Smith, ultimatum game, working poor

“Shared Outrage and Erratic Awards: The Psychology of Punitive Damages.” Journal of Risk and Uncertainty 16, 49–86. ———, and Eldar Shafir. “Amos Tversky (1937–1996).” American Psychologist 53, 793–94. ———, Paul Slovic, and Amos Tversky (1982). Judgment Under Uncertainty: Heuristics and Biases. Cambridge: Cambridge University Press. ———, and Amos Tversky (1973). “On the Psychology of Prediction.” Psychological Review 80, 237–51. ———, and Amos Tversky (1979). “Prospect Theory: An Analysis of Decision Under Risk.” Econometrica 47, 263–92. ———, and Amos Tversky (1984). “Choices, Values and Frames.” American Psychologist 39, 341–50. ———, and Amos Tversky (1996). “On the Reality of Cognitive Illusions.” Psychological Review 103, 582–91. Kay, Aaron C., S. Christian Wheeler, John A. Bargh, and Lee Ross (2004).

As far back as the late 1960s, psychologists Sarah Lichtenstein and Paul Slovic demonstrated the deep ambiguity of prices. In their experiments, subjects were unable to set prices consistent with what they wanted or the choices they made. Psychologists have been working out the consequences ever since. In the new view, internal prices are “constructed” as needed from hints in the environment. One demonstration of how that works is the “United Nations” experiment of Amos Tversky and Daniel Kahneman. Tversky and Kahneman are a legendary team of Israeli American psychologists. Kahneman, now in his mid-seventies, is a very active senior scholar at Princeton’s Woodrow Wilson School. Tversky, the younger man by three years, died of melanoma in 1996, at the age of fifty-nine. In 2002, Kahneman shared the Nobel Prize in Economic Sciences with American economist Vernon Smith. Tversky was cheated of that honor only by his early death.

Hoffman’s recommendations are credited with keeping the towers standing long enough for more than 14,000 people to escape to safety. Today the Oregon Research Institute (ORI) is revered as a cradle of behavioral decision theory. ORI was the longtime professional home of Sarah Lichtenstein and Paul Slovic, the first to demonstrate clearly just how clueless people are about prices and decisions based on them. For one productive year, ORI was also home to Amos Tversky and Daniel Kahneman, perhaps the most influential psychologists of their age. Before getting to this illustrious group, it’s necessary to say something about their predecessors, and about the peculiar science of psychophysics. Well into the twentieth century, psychologists had a case of physics envy. There was agonizing over whether psychology was a science at all. In a quest to make their field more quantitative, psychologists collected reams of numbers.


pages: 654 words: 191,864

Thinking, Fast and Slow by Daniel Kahneman

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Albert Einstein, Atul Gawande, availability heuristic, Bayesian statistics, Black Swan, Cass Sunstein, Checklist Manifesto, choice architecture, cognitive bias, complexity theory, correlation coefficient, correlation does not imply causation, Daniel Kahneman / Amos Tversky, delayed gratification, demand response, endowment effect, experimental economics, experimental subject, Exxon Valdez, feminist movement, framing effect, hindsight bias, index card, information asymmetry, job satisfaction, John von Neumann, Kenneth Arrow, libertarian paternalism, loss aversion, medical residency, mental accounting, meta analysis, meta-analysis, nudge unit, pattern recognition, Paul Samuelson, pre–internet, price anchoring, quantitative trading / quantitative finance, random walk, Richard Thaler, risk tolerance, Robert Metcalfe, Ronald Reagan, The Chicago School, The Wisdom of Crowds, Thomas Bayes, transaction costs, union organizing, Walter Mischel, Yom Kippur War

liking of dolphins: There is evidence that questions about the emotional appeal of species and the willingness to contribute to their protection yield the same rankings: Daniel Kahneman and Ilana Ritov, “Determinants of Stated Willingness to Pay for Public Goods: A Study in the Headline Method,” Journal of Risk and Uncertainty 9 (1994): 5–38. superior on this attribute: Hsee, “Attribute Evaluability.” “requisite record-keeping”: Cass R. Sunstein, Daniel Kahneman, David Schkade, and Ilana Ritov, “Predictably Incoherent Judgments,” Stanford Law Review 54 (2002): 1190. 34: Frames and Reality unjustified influences of formulation: Amos Tversky and Daniel Kahneman, “The Framing of Decisions and the Psychology of Choice,” Science 211 (1981): 453–58. paid with cash or on credit: Thaler, “Toward a Positive Theory of Consumer Choice.” 10% mortality is frightening: Barbara McNeil, Stephen G. Pauker, Harold C. Sox Jr., and Amos Tversky, “On the Elicitation of Preferences for Alternative Therapies,” New England Journal of Medicine 306 (1982): 1259–62.

Numerous authors believed that the correct terms were “insider view” and “outsider view,” which are not even close to what we had in mind. very different answers: Dan Lovallo and Daniel Kahneman, “Timid Choices and Bold Forecasts: A Cognitive Perspective on Risk Taking,” Management Science 39 (1993): 17–31. Daniel Kahneman and Dan Lovallo, “Delusions of Success: How Optimism Undermines Executives’ Decisions,” Harvard Business Review 81 (2003): 56–63. “Pallid” statistical information: Richard E. Nisbett and Lee D. Ross, Human Inference: Strategies and Shortcomings of Social Judgment (Englewood Cliffs, NJ: Prentice-Hall, 1980). impersonality of procedures: Fo {i>How Doctors Think (New York: Mariner Books, 2008), 6. planning fallacy: Daniel Kahneman and Amos Tversky, “Intuitive Prediction: Biases and Corrective Procedures,” Management Science 12 (1979): 313–27. Scottish Parliament building: Rt.

The same event can be compared to either a personal norm or the norm of other people, leading to different counterfactuals, different causal attributions, and different emotions (regret or blame): Herbert L. A. Hart and Tony Honoré, Causation in the Law (New York: Oxford University Press, 1985), 33. remarkably uniform: Daniel Kahneman and Amos Tversky, “The Simulation Heuristic,” in Judgment Under Uncertainty: Heuristics and Biases, ed. Daniel Kahneman, Paul Slovic, and Amos Tversky (New York: Cambridge University Press, 1982), 160–73. applies to blame: Janet Landman, “Regret and Elation Following Action and Inaction: Affective Responses to Positive Versus Negative Outcomes,” Personality and Social Psychology Bulletin 13 (1987): 524–36. Faith Gleicher et al., “The Role of Counterfactual Thinking in Judgment of Affect,” Personality and Social Psychology Bulletin 16 (1990): 284–95.


pages: 317 words: 100,414

Superforecasting: The Art and Science of Prediction by Philip Tetlock, Dan Gardner

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Affordable Care Act / Obamacare, Any sufficiently advanced technology is indistinguishable from magic, availability heuristic, Black Swan, butterfly effect, cloud computing, cuban missile crisis, Daniel Kahneman / Amos Tversky, desegregation, drone strike, Edward Lorenz: Chaos theory, forward guidance, Freestyle chess, fundamental attribution error, germ theory of disease, hindsight bias, index fund, Jane Jacobs, Jeff Bezos, Kenneth Arrow, Mikhail Gorbachev, Mohammed Bouazizi, Nash equilibrium, Nate Silver, obamacare, pattern recognition, performance metric, Pierre-Simon Laplace, place-making, placebo effect, prediction markets, quantitative easing, random walk, randomized controlled trial, Richard Feynman, Richard Feynman, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Reagan, Saturday Night Live, Silicon Valley, Skype, statistical model, stem cell, Steve Ballmer, Steve Jobs, Steven Pinker, the scientific method, The Signal and the Noise by Nate Silver, The Wisdom of Crowds, Thomas Bayes, Watson beat the top human players on Jeopardy!

Snap judgments are sometimes essential. As Daniel Kahneman puts it, “System 1 is designed to jump to conclusions from little evidence.”13 So what about that shadow in the long grass? Should you worry? Well, can you recall a lion emerging from the grass and pouncing on someone? If that memory comes to you easily—it is not the sort of thing people tend to forget—you will conclude lion attacks are common. And then start to worry. Spelling out this process makes it sound ponderous, slow, and calculating but it can happen entirely within System 1—making it automatic, fast, and complete within a few tenths of a second. You see the shadow. Snap! You are frightened—and running. That’s the “availability heuristic,” one of many System 1 operations—or heuristics—discovered by Daniel Kahneman, his collaborator Amos Tversky, and other researchers in the fast-growing science of judgment and choice.

Popular books often draw a dichotomy between intuition and analysis—“blink” versus “think”—and pick one or the other as the way to go. I am more of a thinker than a blinker, but blink-think is another false dichotomy. The choice isn’t either/or, it is how to blend them in evolving situations. That conclusion is not as inspiring as a simple exhortation to take one path or the other, but it has the advantage of being true, as the pioneering researchers behind both perspectives came to understand. While Daniel Kahneman and Amos Tversky were documenting System 1’s failings, another psychologist, Gary Klein, was examining decision making among professionals like the commanders of firefighting teams, and discovering that snap judgments can work astonishingly well. One commander told Klein about going to a routine kitchen fire and ordering his men to stand in the living room and hose down the flames. The fire subsided at first but roared back.

Unfortunately, no, it probably wouldn’t. The reason is a basic psychological concept called anchoring. When we make estimates, we tend to start with some number and adjust. The number we start with is called the anchor. It’s important because we typically underadjust, which means a bad anchor can easily produce a bad estimate. And it’s astonishingly easy to settle on a bad anchor. In classic experiments, Daniel Kahneman and Amos Tversky showed you could influence people’s judgment merely by exposing them to a number—any number, even one that is obviously meaningless, like one randomly selected by the spin of a wheel.10 So a forecaster who starts by diving into the inside view risks being swayed by a number that may have little or no meaning. But if she starts with the outside view, her analysis will begin with an anchor that is meaningful.


pages: 461 words: 128,421

The Myth of the Rational Market: A History of Risk, Reward, and Delusion on Wall Street by Justin Fox

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activist fund / activist shareholder / activist investor, Albert Einstein, Andrei Shleifer, asset allocation, asset-backed security, bank run, beat the dealer, Benoit Mandelbrot, Black-Scholes formula, Bretton Woods, Brownian motion, capital asset pricing model, card file, Cass Sunstein, collateralized debt obligation, complexity theory, corporate governance, corporate raider, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, discovery of the americas, diversification, diversified portfolio, Edward Glaeser, Edward Thorp, endowment effect, Eugene Fama: efficient market hypothesis, experimental economics, financial innovation, Financial Instability Hypothesis, fixed income, floating exchange rates, George Akerlof, Henri Poincaré, Hyman Minsky, implied volatility, impulse control, index arbitrage, index card, index fund, information asymmetry, invisible hand, Isaac Newton, John Meriwether, John Nash: game theory, John von Neumann, joint-stock company, Joseph Schumpeter, Kenneth Arrow, libertarian paternalism, linear programming, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, market bubble, market design, Myron Scholes, New Journalism, Nikolai Kondratiev, Paul Lévy, Paul Samuelson, pension reform, performance metric, Ponzi scheme, prediction markets, pushing on a string, quantitative trading / quantitative finance, Ralph Nader, RAND corporation, random walk, Richard Thaler, risk/return, road to serfdom, Robert Bork, Robert Shiller, Robert Shiller, rolodex, Ronald Reagan, shareholder value, Sharpe ratio, short selling, side project, Silicon Valley, South Sea Bubble, statistical model, The Chicago School, The Myth of the Rational Market, The Predators' Ball, the scientific method, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Thomas Kuhn: the structure of scientific revolutions, Thomas L Friedman, Thorstein Veblen, Tobin tax, transaction costs, tulip mania, value at risk, Vanguard fund, Vilfredo Pareto, volatility smile, Yogi Berra

Most of the information and all of the quotes in the foregoing paragraphs are from Kahneman’s autobiography, Les Prix Nobel 2002 (Stockholm: Nobel Foundation, 2003); also available at www.nobelprize.org. 4. I would repeat some of the questions Tversky asked, but they’re phrased in the arcane language of statistics. Amos Tversky and Daniel Kahneman, “Belief in the Law of Small Numbers,” Psychological Bulletin 2 (1971): 105–10. Reprinted in Daniel Kahneman, Paul Slovic, and Amos Tversky, Judgment Under Uncertainty: Heuristics and Biases (Cambridge, UK: Cambridge University Press, 1982), 23–31. 5. Herbert A. Simon, Models of My Life (New York: Basic Books, 1991), 144. 6. John F. Muth, “Rational Expectations and the Theory of Price Movements,” Econometrica (July 1961): 315–35. The paper was first presented at an Econometric Society meeting in 1959. 7.

In flight training—or in investing, or in all manner of other endeavors clouded by statistical noise—that’s not the case at all, which is what Daniel Kahneman had suddenly realized.1 Decades later, after he had won a Nobel Prize in Economics for his work, Kahneman described this moment with the flight instructors as “the most satisfying Eureka experience of my career.” It was not an experience that he knew immediately what to do with. His own psychological research focused not on decision making but on technical matters like the dilation of people’s pupils as they memorized long numbers. It wasn’t until one day during the 1968–69 academic year, when Kahneman invited a younger colleague named Amos Tversky to speak to his students, that he began to figure out what to do with his insight. Tversky was an almost-direct link to the ideas about decision making that had captivated economists in the late 1940s and early 1950s.

Kenneth Arrow was the responsible party, having campaigned to get Simon elected a fellow of the American Economic Association that year. This post gave Simon a prominent speaking slot at the AEA’s annual meeting, which he used to talk about rationality and its limits. That presumably helped lead to his winning the next year’s Nobel Prize in Economics, “for his pioneering research into the decision-making process within economic organizations.”14 A year later, Daniel Kahneman and Amos Tversky built upon Simon’s ideas and their experiments to launch their first head-on attack on economics and its reliance on von Neumann and Morgenstern’s version of decision making under uncertainty. How do people really assess uncertain prospects? Kahneman and Tversky asked. First, they attach much importance to where things stand now, treating reductions in their current wealth significantly differently from reductions in future gains.


pages: 542 words: 132,010

The Science of Fear: How the Culture of Fear Manipulates Your Brain by Daniel Gardner

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Atul Gawande, availability heuristic, Black Swan, Cass Sunstein, citizen journalism, cognitive bias, cognitive dissonance, Columbine, correlation does not imply causation, Daniel Kahneman / Amos Tversky, David Brooks, Doomsday Clock, feminist movement, haute couture, hindsight bias, illegal immigration, Intergovernmental Panel on Climate Change (IPCC), mandatory minimum, medical residency, Mikhail Gorbachev, millennium bug, moral panic, mutually assured destruction, nuclear winter, placebo effect, Ralph Nader, RAND corporation, Ronald Reagan, Stephen Hawking, Steven Levy, Steven Pinker, the scientific method, Tunguska event, uranium enrichment, Y2K, young professional

See Eurobarometer/nVision, 2006. CHAPTER TWO 22: There is only the brain. 25: “Psychologists found that when they asked students to eat a piece of fudge. . . .” Like many of the references to the work of psychologists in this chapter and others that follow, this is drawn from Heuristics and Biases, edited by Thomas Gilovich, Dale Griffin, and Daniel Kahneman. Along with the earlier edition of the same work—edited by Paul Slovic, Amos Tversky, and Daniel Kahneman—it is the definitive text on the subject. 30: “. . . if you give it some careful thought . . . .” The answer is five cents. CHAPTER THREE 35: “Those who heard the higher number, guessed higher.” For the record, both groups were way off. Gandhi was 79 when he died. 38: “. . . produced an average answer almost 150 percent greater than a low number.”

And for a parent, the thought of 10,000 pedophiles hunting children online at each and every moment is pretty damned scary. Congratulations. You have a new customer. The Anchoring Rule, as influential as it is, is only a small part of a much wider scientific breakthrough with vast implications. As always in science, there are many authors and origins of this burgeoning field, but two who stand out are psychologists Daniel Kahneman and Amos Tversky. Four decades ago, Kahneman and Tversky collaborated on research that looked at how people form judgments when they’re uncertain of the facts. That may sound like a modest little backwater of academic work, but it is actually one of the most basic aspects of how people think and act. For academics, it shapes the answers to core questions in fields as diverse as economics, law, health, and public policy.

It lasted for decades, but Kahneman and Tversky ultimately prevailed. The idea of “bounded rationality” is now widely accepted, and its insights are fueling research throughout the social sciences. Even economists are increasingly accepting that Homo sapiens is not Homo economicus, and a dynamic new field called “behavioral economics” is devoted to bringing the insights of psychology to economics. Amos Tversky died in 1996. In 2002, Daniel Kahneman experienced the academic equivalent of a conquering general’s triumphal parade: He was awarded the Prize in Economic Sciences in Memory of Alfred Nobel. He is probably the only winner in the history of the prize who never took so much as a single class in economics. The amazing thing is that the Science article, which sent shock waves out in every direction, is such a modest thing on its face.


pages: 121 words: 31,813

The Art of Execution by Lee Freeman-Shor

Black Swan, cognitive bias, collapse of Lehman Brothers, credit crunch, Daniel Kahneman / Amos Tversky, diversified portfolio, family office, I think there is a world market for maybe five computers, index fund, Isaac Newton, Jeff Bezos, Long Term Capital Management, loss aversion, price anchoring, Richard Thaler, Robert Shiller, Robert Shiller, rolodex, Skype, South Sea Bubble, Steve Jobs, technology bubble, The Wisdom of Crowds, too big to fail, tulip mania, zero-sum game

Available at SSRN: ssrn.com/abstract=1424076 25 Lynch (2000). 26 ‘Prospect Theory: An Analysis of Decision Under Risk’, Econometrica, by Daniel Kahneman and Amos Tversky (1979). 27 ‘The disposition effect and underreaction to news,’ The Journal of Finance, by A. Frazzini (2006). 28 Extract from Warren Buffett’s annual letter to the shareholders of Berkshire Hathaway, (1993). 29 Pabrai (2007). 30 In nominal terms. In real terms after inflation you would hope that this has retained and hopefully increased the purchasing power of the $1,000 invested over that period of time. 31 ‘Evershed: New Star Property ad campaign lost investors millions’, Investment Week (2011). 32 ‘Subjective probability: A judgment of representativeness’, by Daniel Kahneman and Amos Tversky in Judgement Under Uncertainty by Kahneman, Slovic, Tversky (1972). 33 ‘Bystander intervention in emergencies: Diffusion of responsibility’, Journal of Personality and Social Psychology, J.

Unfashionable insects One of the most important influences on the Rabbits is what I call NaFF-Bee – or narrative fallacy framing bias. I have to admit that every time I think of this term my mind conjures up an image of an insect with poor fashion sense, but it’s actually a very important concept. It is a condition that was alluded to in 1974 by two brilliant Israeli academics, Amos Tversky and his Nobel-Prize-winning collaborator Daniel Kahneman.3 (Their ideas will crop up throughout these points.) Tversky and Kahneman suggested that people’s decision making is influenced by a cognitive condition they referred to as a framing bias or anchoring heuristic. In other words, when people make decisions they tend to reach a conclusion based on the way a problem has been presented. One of the Rabbits’ mistakes was allowing their favourite types of investment to dominate how they looked at a stock.

A more forward-thinking approach would see resources just as much – if not more – focused on helping the fund manager execute the investments well. I find it bizarre that top athletes and sportsmen and women have coaches but the majority of investment professionals do not. How can they expect to improve their game if they do not have constructive feedback? * * * 3 ‘Judgment under uncertainty: Heuristics and biases’, Science, by Amos Tversky and Daniel Kahneman (1974). 4 Free Radicals: The Secret Anarchy of Science, by Michael Brooks (2011). 5 The General Theory of Employment, Interest and Money, by John Maynard Keynes (1936). 6 How We Decide, by Johan Lehrer (2009). 7 ‘Money: A Bias for the Whole’, Journal of Consumer Research, by Himanshu Mishra, Arul Mishra and Dhananjay Nayakankuppam (2006). 8 ‘Denomination Effect’, Journal of Consumer Research, Priya Raghubir and Joydeep Srivastava (2009). 9 One Up on Wall Street, by Peter Lynch and John Rothchild (2000). 10 The Dhandho Investor, by Mohnish Pabrai (2007). 11 Quote attributed to Donald Rumsfeld. 12 Being Right or Making Money, by Ned Davis (2000). 13 Ibid. 14 Fortune’s Formula, by William Poundstone (2006). 15 blog.asmartbear.com/ignoring-the-wisdom-of-crowds.html 16 The Little Book of Behavioural Investing, by James Montier (2010). 17 An Astronaut’s Guide to Life on Earth, by Col.


pages: 266 words: 86,324

The Drunkard's Walk: How Randomness Rules Our Lives by Leonard Mlodinow

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Albert Einstein, Alfred Russel Wallace, Antoine Gombaud: Chevalier de Méré, Atul Gawande, Brownian motion, butterfly effect, correlation coefficient, Daniel Kahneman / Amos Tversky, Donald Trump, feminist movement, forensic accounting, Gerolamo Cardano, Henri Poincaré, index fund, Isaac Newton, law of one price, pattern recognition, Paul Erdős, probability theory / Blaise Pascal / Pierre de Fermat, RAND corporation, random walk, Richard Feynman, Richard Feynman, Ronald Reagan, Stephen Hawking, Steve Jobs, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Thomas Bayes, V2 rocket, Watson beat the top human players on Jeopardy!

Chapter 2: The Laws of Truths and Half-Truths 1. Daniel Kahneman, Paul Slovic, and Amos Tversky, eds., Judgment under Uncertainty: Heuristics and Biases (Cambridge: Cambridge University Press, 1982), pp. 90–98. 2. Amos Tversky and Daniel Kahneman, “Extensional versus Intuitive Reasoning: The Conjunction Fallacy in Probability Judgment,” Psychological Review 90, no. 4 (October 1983): 293–315. 3. Craig R. Fox and Richard Birke, “Forecasting Trial Outcomes: Lawyers Assign Higher Probabilities to Possibilities That Are Described in Greater Detail,” Law and Human Behavior 26, no. 2 (April 2002): 159–73. 4. Plato, The Dialogues of Plato, trans. Benjamin Jowett (Boston: Colonial Press, 1899), p. 116. 5. Plato, Theaetetus (Whitefish, Mont.: Kessinger, 2004), p. 25. 6. Amos Tversky and Daniel Kahneman, “Availability: A Heuristic for Judging Frequency and Probability,” Cognitive Psychology 5 (1973): 207–32. 7.

But physics assures us that the greenness of grass, the hardness of stones, and the coldness of snow are not the greenness of grass, the hardness of stones, and the coldness of snow that we know in our own experience, but something very different.4 In what follows we will peer at life through the eyepiece of randomness and see that many of the events of our lives, too, are not quite what they seem but rather something very different. IN 2002 THE NOBEL COMMITTEE awarded the Nobel Prize in Economics to a scientist named Daniel Kahneman. Economists do all sorts of things these days—they explain why teachers are paid so little, why football teams are worth so much, and why bodily functions help set a limit on the size of hog farms (a hog excretes three to five times as much as a human, so a farm with thousands of hogs on it often produces more waste than the neighboring cities).5 Despite all the great research generated by economists, the 2002 Nobel Prize was notable because Kahneman is not an economist. He is a psychologist, and for decades, with the late Amos Tversky, Kahneman studied and clarified the kinds of misperceptions of randomness that fuel many of the common fallacies I will talk about in this book.

What it takes to understand randomness and overcome our misconceptions is both experience and a lot of careful thinking. And so we begin our tour with some of the basic laws of probability and the challenges involved in uncovering, understanding, and applying them. One of the classic explorations of people’s intuition about those laws was an experiment conducted by the pair who did so much to elucidate our misconceptions, Daniel Kahneman and Amos Tversky.1 Feel free to take part—and learn something about your own probabilistic intuition. Imagine a woman named Linda, thirty-one years old, single, outspoken, and very bright. In college she majored in philosophy. While a student she was deeply concerned with discrimination and social justice and participated in antinuclear demonstrations. Tversky and Kahneman presented this description to a group of eighty-eight subjects and asked them to rank the following statements on a scale of 1 to 8 according to their probability, with 1 representing the most probable and 8 the least.


pages: 401 words: 119,488

Smarter Faster Better: The Secrets of Being Productive in Life and Business by Charles Duhigg

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Air France Flight 447, Asperger Syndrome, Atul Gawande, Black Swan, cognitive dissonance, Daniel Kahneman / Amos Tversky, David Brooks, digital map, epigenetics, Erik Brynjolfsson, framing effect, hiring and firing, index card, John von Neumann, knowledge worker, Lean Startup, Malcom McLean invented shipping containers, meta analysis, meta-analysis, new economy, Saturday Night Live, Silicon Valley, Silicon Valley startup, statistical model, Steve Jobs, the scientific method, theory of mind, Toyota Production System, William Langewiesche, Yom Kippur War

bought lottery tickets Amos Tversky and Daniel Kahneman, “Availability: A Heuristic for Judging Frequency and Probability,” Cognitive Psychology 5, no. 2 (1973): 207–32; Daniel Kahneman and Amos Tversky, “Prospect Theory: An Analysis of Decision Under Risk,” Econometrica: Journal of the Econometric Society 47, no. 2 (1979): 263–91; Amos Tversky and Daniel Kahneman, “Judgment Under Uncertainty: Heuristics and Biases,” Science 185, no. 4157 (1974): 1124–31; Amos Tversky and Daniel Kahneman, “The Framing of Decisions and the Psychology of Choice,” Science 211, no. 4481 (1981): 453–58; Daniel Kahneman and Amos Tversky, “Choices, Values, and Frames,” American Psychologist 39, no. 4 (1984): 341; Daniel Kahneman, Thinking, Fast and Slow (New York: Farrar, Straus and Giroux, 2011); Daniel Kahneman and Amos Tversky, “On the Psychology of Prediction,” Psychological Review 80, no. 4 (1973): 237.

Gaeth, “All Frames Are Not Created Equal: A Typology and Critical Analysis of Framing Effects,” Organizational Behavior and Human Decision Processes 76, no. 2 (1998): 149–88; Hilary A. Llewellyn-Thomas, M. June McGreal, and Elaine C. Thiel, “Cancer Patients’ Decision Making and Trial-Entry Preferences: The Effects of ‘Framing’ Information About Short-Term Toxicity and Long-Term Survival,” Medical Decision Making 15, no. 1 (1995): 4–12; David E. Bell, Howard Raiffa, and Amos Tversky, Decision Making: Descriptive, Normative, and Prescriptive Interactions (Cambridge: Cambridge University Press, 1988); Amos Tversky and Daniel Kahneman, “Rational Choice and the Framing of Decisions,” The Journal of Business 59, no. 4, part 2 (1986): S251–78. “inside their heads” In response to a fact-checking email, Johnson wrote: “The idea is that we think of a subset of the relevant information.” program named “Gen-1” Lekan Oguntoyinbo, “Hall Sweet Home,” Diverse Issues in Higher Education 27, no. 25 (2011): 8; Dana Jennings, “Second Home for First Gens,” The New York Times, July 20, 2009.

., “The Challenge of Poker,” Artificial Intelligence 134, no. 1 (2002): 201–40; Kevin B. Korb, Ann E. Nicholson, and Nathalie Jitnah, “Bayesian Poker,” Proceedings of the Fifteenth Conference on Uncertainty in Artificial Intelligence (San Francisco: Morgan Kaufmann, 1999). she was going to win Gerald Hanks, “Poker Math and Probability,” Pokerology, http://www.pokerology.com/lessons/math-and-probability/. win a Nobel Prize Daniel Kahneman and Amos Tversky, “Prospect Theory: An Analysis of Decision Under Risk,” Econometrica: Journal of the Econometric Society 47, no. 2 (1979): 263–91. a million television viewers The tournament drew an estimated 1.5 million viewers. She’s not sure Annie, in a phone call to check facts in this chapter, expanded upon her thinking: “If Greg had jacks or better, I was in a bad situation. I was very undecided about the hand he could be holding, and I was in a situation where I really did have to create more certainty for myself.


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Predictably Irrational, Revised and Expanded Edition: The Hidden Forces That Shape Our Decisions by Dan Ariely

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air freight, Al Roth, Bernie Madoff, Burning Man, butterfly effect, Cass Sunstein, collateralized debt obligation, computer vision, corporate governance, credit crunch, Daniel Kahneman / Amos Tversky, David Brooks, delayed gratification, endowment effect, financial innovation, fudge factor, Gordon Gekko, greed is good, housing crisis, invisible hand, lake wobegon effect, late fees, loss aversion, market bubble, Murray Gell-Mann, payday loans, placebo effect, price anchoring, Richard Thaler, second-price auction, Silicon Valley, Skype, The Wealth of Nations by Adam Smith, Upton Sinclair

RELATED READINGS Cass R. Sunstein, Daniel Kahneman, David Schkade, and Ilana Ritov, “Predictably Incoherent Judgments,” Stanford Law Review (2002). Uri Simonsohn, “New Yorkers Commute More Everywhere: Contrast Effects in the Field,” Review of Economics and Statistics (2006). Uri Simonsohn and George Loewenstein, “Mistake #37: The Impact of Previously Faced Prices on Housing Demand,” Economic Journal (2006). Chapter 3: The Cost of Zero Cost BASED ON Kristina Shampanier, Nina Mazar, and Dan Ariely, “How Small Is Zero Price? The True Value of Free Products,” Marketing Science (2007). RELATED READINGS Daniel Kahneman and Amos Tversky, “Prospect Theory: An Analysis of Decision under Risk,” Econometrica (1979). Eldar Shafir, Itamar Simonson, and Amos Tversky, “Reason-Based Choice,” Cognition (1993).

Introduction RELATED READINGS Daniel Kahneman, Barbara L. Fredrickson, Charles A. Schreiber, and Donald A. Redelmeier, “When More Pain Is Preferred to Less: Adding a Better End,” Psychological Science (1993). Donald A. Redelmeier and Daniel Kahneman, “Patient’s Memories of Painful Medical Treatments—Real-Time and Retrospective Evaluations of Two Minimally Invasive Procedures,” Pain (1996). Dan Ariely, “Combining Experiences over Time: The Effects of Duration, Intensity Changes, and On-Line Measurements on Retrospective Pain Evaluations,” Journal of Behavioral Decision Making (1998). Dan Ariely and Ziv Carmon, “Gestalt Characteristics of Experienced Profiles,” Journal of Behavioral Decision Making (2000). Chapter 1: The Truth about Relativity RELATED READINGS Amos Tversky, “Features of Similarity,” Psychological Review, Vol. 84 (1977).

Chapter 1: The Truth about Relativity RELATED READINGS Amos Tversky, “Features of Similarity,” Psychological Review, Vol. 84 (1977). Amos Tversky and Daniel Kahneman, “The Framing of Decisions and the Psychology of Choice,” Science (1981). Joel Huber, John Payne, and Chris Puto, “Adding Asymmetrically Dominated Alternatives: Violations of Regularity and the Similarity Hypothesis,” Journal of Consumer Research (1982). Itamar Simonson, “Choice Based on Reasons: The Case of Attraction and Compromise Effects,” Journal of Consumer Research (1989). Amos Tversky and Itamar Simonson, “Context-Dependent Preferences,” Management Science (1993). Dan Ariely and Tom Wallsten, “Seeking Subjective Dominance in Multidimensional Space: An Explanation of the Asymmetric Dominance Effect,” Organizational Behavior and Human Decision Processes (1995). Constantine Sedikides, Dan Ariely, and Nils Olsen, “Contextual and Procedural Determinants of Partner Selection: On Asymmetric Dominance and Prominence,” Social Cognition (1999).


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Against the Gods: The Remarkable Story of Risk by Peter L. Bernstein

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Albert Einstein, Alvin Roth, Andrew Wiles, Antoine Gombaud: Chevalier de Méré, Bayesian statistics, Big bang: deregulation of the City of London, Bretton Woods, buttonwood tree, capital asset pricing model, cognitive dissonance, computerized trading, Daniel Kahneman / Amos Tversky, diversified portfolio, double entry bookkeeping, Edmond Halley, Edward Lloyd's coffeehouse, endowment effect, experimental economics, fear of failure, Fellow of the Royal Society, Fermat's Last Theorem, financial deregulation, financial innovation, full employment, index fund, invention of movable type, Isaac Newton, John Nash: game theory, John von Neumann, Kenneth Arrow, linear programming, loss aversion, Louis Bachelier, mental accounting, moral hazard, Myron Scholes, Nash equilibrium, Paul Samuelson, Philip Mirowski, probability theory / Blaise Pascal / Pierre de Fermat, random walk, Richard Thaler, Robert Shiller, Robert Shiller, spectrum auction, statistical model, The Bell Curve by Richard Herrnstein and Charles Murray, The Wealth of Nations by Adam Smith, Thomas Bayes, trade route, transaction costs, tulip mania, Vanguard fund, zero-sum game

The following people also made significant contributions to my work and warrant my deepest appreciation: Kenneth Arrow, Gilbert Bassett, William Baumol, Zalmon Bernstein, Doris Bullard, Paul Davidson, Donald Dewey, David Durand, Barbara Fotinatos, James Fraser, Greg Hayt, Roger Hertog, Victor Howe, Bertrand Jacquillat, Daniel Kahneman, Mary Kentouris, Mario Laserna, Dean LeBaron, Michelle Lee, Harry Markowitz, Morton Meyers, James Norris, Todd Petzel, Paul Samuelson, Robert Shiller, Charles Smithson, Robert Solow, Meir Statman, Marta Steele, Richard Thaler, James Tinsley, Frank Trainer, Amos Tversky,* and Marina von N. Whitman. Eight people generously undertook to read the manuscript in its entirety and to give me the benefit of their expert criticisms and suggestions. Each of them, in his own way, deserves major credit for the quality of the content and style of the book, without bearing any responsibility for the shortcomings it contains.

The classical models of rationality-the model on which game theory and most of Markowitz's concepts are based-specifies how people should make decisions in the face of risk and what the world would be like if people did in fact behave as specified. Extensive research and experimentation, however, reveal that departures from that model occur more frequently than most of us admit. You will discover yourself in many of the examples that follow. The most influential research into how people manage risk and uncertainty has been conducted by two Israeli psychologists, Daniel Kahneman and Amos Tversky. Although they now live in the United States-one at Princeton and the other at Stanford-both served in the Israeli armed forces during the 1950s. Kahneman developed a psychological screening system for evaluating Israeli army recruits that is still in use. Tversky served as a paratroop captain and earned a citation for bravery. The two have been collaborating for nearly thirty years and now command an enthusiastic following among both scholars and practitioners in the field of finance and investing, where uncertainty influences every decision.'

Jones, Charles P., and Jack W. Wilson, 1995. "Probability Estimates of Returns from Common Stock Investing." Journal of Portfolio Management, Vol. 22, No. 1 (Fall), pp. 21-32. Kagel, John H., and Alvin E. Roth, eds., 1995. The Handbook of Experimental Economics. Princeton, New Jersey: Princeton University Press. Kahneman, Daniel, and Amos Tversky, 1979. "Prospect Theory: An Analysis of Decision under Risk." Econometrica, Vol. 47, No. 2, pp. 263-291.` Kahneman, Daniel, and Amos Tversky, 1984. "Choices, Values, and Frames." American Psychologist, Vol. 39, No. 4 (April), pp. 342-347. Kahneman, Daniel, Jack L. Knetsch, and Richard H. Thaler, 1990. "Experimental Tests of the Endowment Effect and the Coase Theorem." Journal of Political Economy, Vol. 98, No. 6, pp. 1325-1348. Kaplan, Gilbert Edmund, and Chris Welles, eds. 1969.


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The Irrational Economist: Making Decisions in a Dangerous World by Erwann Michel-Kerjan, Paul Slovic

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Andrei Shleifer, availability heuristic, bank run, Black Swan, Cass Sunstein, clean water, cognitive dissonance, collateralized debt obligation, complexity theory, conceptual framework, corporate social responsibility, Credit Default Swap, credit default swaps / collateralized debt obligations, cross-subsidies, Daniel Kahneman / Amos Tversky, endowment effect, experimental economics, financial innovation, Fractional reserve banking, George Akerlof, hindsight bias, incomplete markets, information asymmetry, Intergovernmental Panel on Climate Change (IPCC), invisible hand, Isaac Newton, iterative process, Kenneth Arrow, Loma Prieta earthquake, London Interbank Offered Rate, market bubble, market clearing, money market fund, moral hazard, mortgage debt, Pareto efficiency, Paul Samuelson, placebo effect, price discrimination, price stability, RAND corporation, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Reagan, source of truth, statistical model, stochastic process, The Wealth of Nations by Adam Smith, Thomas Bayes, Thomas Kuhn: the structure of scientific revolutions, too big to fail, transaction costs, ultimatum game, University of East Anglia, urban planning, Vilfredo Pareto

Our luggage didn’t arrive. On checking out of our hotel five days later, we needed to verify the date of our arrival. It turned out to have been Friday the thirteenth! RECOMMENDED READING Kahneman, Daniel, Paul Slovic, and Amos Tversky, eds. (1982). Judgment Under Uncertainty: Heuristics and Biases. Cambridge: Cambridge University Press, 1982. Kahneman, Daniel, and Amos Tversky, eds. (2000). Choices, Values, and Frames. Cambridge: Cambridge University Press, 2000. Langer, Ellen J. (1982). “The Illusion of Control.” In Daniel Kahneman, Paul Slovic, and Amos Tversky, eds. Judgment Under Uncertainty: Heuristics and Biases. Cambridge: Cambridge University Press. Schelling, Thomas (1996). “Coping Rationally with Lapses from Rationality,” Eastern Economic Journal (Summer): 251-269. Reprinted in Thomas Schelling, Strategies of Commitment and Other Essays (Cambridge, MA: Harvard University Press, 2006.) 2 Berserk Weather Forecasters, Beauty Contests, and Delicious Apples on Wall Street GEORGE A.

At the same time, and despite very important advances in economic theory that were made possible by the traditional view of economic man,7 there was a growing sense of unease among the general public and other social scientists as well as among policy makers that many economists had been unrealistic in their attempts to always rationalize how people, enterprises, and markets function. Fortunately, the story did not stop there. Stimulated by creative conceptual, methodological, and empirical work by the more senior authors in The Irrational Economist and many others, including Amos Tversky, Daniel Kahneman, and Richard Thaler, the trickle of studies challenging traditional economic assumptions of rationality became a torrent. Nobel prizes in economics awarded to Herbert Simon in 1978, to George Akerlof in 2001, and to Daniel Kahneman and Vernon Smith in 2002 for their contributions toward understanding the behavioral dynamics of economic decisions further contributed to what has become a revolution in thinking. Today, young scholars, and even those not so young, have become convinced that the secret to improving economic decision making lies in the careful empirical study of how we actually make decisions.

I think the same goes for driving without one’s license: “That’s the day I’d get stopped by a cop!” (Maybe it is not a truly superstitious belief that if I drive without a license I’ll be stopped by an officer. It may be that if I drive without a license I cannot stop thinking I have no license, and cannot stop looking in the mirror for a police car. It’s my imagination I cannot control, not my logic.) We’ve been taught by psychologists Daniel Kahneman and Amos Tversky that many people are innocent of statistical sampling, that many get “anchored” by a randomly produced number, that many are seduced by “representativeness,” and many don’t understand “regression to the mean.” You walk into a public library in the suburb of a large city and see a man, dressed in tie and jacket, reading Thucydides; you have already learned that he is either a concert violinist or a truck driver.


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Fooled by Randomness: The Hidden Role of Chance in Life and in the Markets by Nassim Nicholas Taleb

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Antoine Gombaud: Chevalier de Méré, availability heuristic, backtesting, Benoit Mandelbrot, Black Swan, commoditize, complexity theory, corporate governance, corporate raider, currency peg, Daniel Kahneman / Amos Tversky, discounted cash flows, diversified portfolio, endowment effect, equity premium, fixed income, global village, hindsight bias, Kenneth Arrow, Long Term Capital Management, loss aversion, mandelbrot fractal, mental accounting, meta analysis, meta-analysis, Myron Scholes, Paul Samuelson, quantitative trading / quantitative finance, QWERTY keyboard, random walk, Richard Feynman, Richard Feynman, road to serfdom, Robert Shiller, Robert Shiller, selection bias, shareholder value, Sharpe ratio, Steven Pinker, stochastic process, survivorship bias, too big to fail, Turing test, Yogi Berra

During much of the rewriting of this book I was under the energizing influence of two intense dinner conversations in Italy with Daniel Kahneman, which had the effect of “pushing” me to the next critical point of intellectual drive, after I saw that his work went so much deeper than mere rational choice under uncertainty. I am certain that his influence on economics (including the Nobel medal) focused people away from the breadth and depth and the general applicability of his discoveries. Economics is boring stuff, but His work matters I kept telling myself, not just because he is an empiricist, not just because of the contrast of the relevance of his work (and personality) with those of the other recent Nobel economists, but because of its far-reaching implications on far worthier questions: (a) He and Amos Tversky helped stand on its head the notion of man that we owe to the dogmatic rationalism of the Hellenistic age and which held for twenty-three centuries, with all the damaging consequences that we know of now; (b) Kahneman’s important work is on utility theory (in its different stages) with consequences on such significant things as happiness.

On the other hand there is the Tragic Vision of humankind that believes in the existence of inherent limitations and flaws in the way we think and act and requires an acknowledgment of this fact as a basis for any individual and collective action. This category of people includes Karl Popper (falsificationism and distrust of intellectual “answers,” actually of anyone who is confident that he knows anything with certainty), Friedrich Hayek and Milton Friedman (suspicion of governments), Adam Smith (intention of man), Herbert Simon (bounded rationality), Amos Tversky and Daniel Kahneman (heuristics and biases), the speculator George Soros, etc. The most neglected one is the misunderstood philosopher Charles Sanders Peirce, who was born a hundred years too early (he coined the term scientific “fallibilism” in opposition to Papal infallibility). Needless to say that the ideas of this book fall squarely into the Tragic category: We are faulty and there is no need to bother trying to correct our flaws.

Go to the airport and ask travelers en route to some remote destination how much they would pay for an insurance policy paying, say, a million tugrits (the currency of Mongolia) if they died during the trip (for any reason).Then ask another collection of travelers how much they would pay for insurance that pays the same in the event of death from a terrorist act (and only a terrorist act). Guess which one would command a higher price? Odds are that people would rather pay for the second policy (although the former includes death from terrorism). The psychologists Daniel Kahneman and Amos Tversky figured this out several decades ago. The irony is that one of the sampled populations did not include people on the street, but professional predictors attending some society of forecasters’ annual meeting. In a now famous experiment they found that the majority of people, whether predictors or nonpredictors, will judge a deadly flood (causing thousands of deaths) caused by a California earthquake to be more likely than a fatal flood (causing thousands of deaths) occurring somewhere in North America (which happens to include California).


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Nudge: Improving Decisions About Health, Wealth, and Happiness by Richard H. Thaler, Cass R. Sunstein

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Al Roth, Albert Einstein, asset allocation, availability heuristic, call centre, Cass Sunstein, choice architecture, continuous integration, Daniel Kahneman / Amos Tversky, desegregation, diversification, diversified portfolio, endowment effect, equity premium, feminist movement, fixed income, framing effect, full employment, George Akerlof, index fund, invisible hand, late fees, libertarian paternalism, loss aversion, Mahatma Gandhi, Mason jar, medical malpractice, medical residency, mental accounting, meta analysis, meta-analysis, Milgram experiment, money market fund, pension reform, presumed consent, profit maximization, rent-seeking, Richard Thaler, Right to Buy, risk tolerance, Robert Shiller, Robert Shiller, Saturday Night Live, school choice, school vouchers, transaction costs, Vanguard fund, Zipcar

“Ten people will raise the temperature of an average size room by one degree per hour.” And one to which we will return: “No more than 25 percent of the guests at a university dinner party can come from the economics department without spoiling the conversation.” BIASES AND BLUNDERS Although rules of thumb can be very helpful, their use can also lead to systematic biases. This insight, first developed decades ago by two Israeli psychologists, Amos Tversky and Daniel Kahneman (1974), has changed the way psychologists (and eventually economists) think about thinking. Their original work identified three heuristics, or rules of thumb—anchoring, availability, and representativeness—and the biases that are associated with each. Their research program has come to be known as the “heuristics and biases” approach to the study of human judgment. More recently, psychologists have come to understand that these heuristics and biases emerge from the interplay between the Automatic System and the Reflective System.

Cambridge: Cambridge University Press, 2000. Gilovich, Thomas. How We Know What Isn’t So: The Fallibility of Human Reason in Everyday Life. New York: Free Press, 1991. Gilovich, Thomas, Dale Gri¤n, and Daniel Kahneman. Heurisitics and Biases: The Psychology of Intuitive Judgment. Cambridge: Cambridge University Press, 2002. Gilovich, Thomas, Victoria H. Medvec, and Kenneth Savitsky. “The Spotlight Effect in Social Judgment: An Egocentric Bias in Estimates of the Salience of One’s Own Actions and Appearance.” Journal of Personality and Social Psychology 78 (2000): 211–22. Gilovich, Thomas, Robert Vallone, and Amos Tversky. “The Hot Hand in Basketball: On the Misperception of Random Sequences.” Cognitive Psychology 17 (1985): 295– 314. Glaeser, Edward L. “Paternalism and Psychology.” University of Chicago Law Review 73 (2006): 133–56.

Science 311 (2006): 854–56. Samuelson, William, and Richard J. Zeckhauser. “Status Quo Bias in Decision Making.” Journal of Risk and Uncertainty 1 (1988): 7–59. Schkade, David A., and Daniel Kahneman. “Does Living in California Make People Happy? A Focusing Illusion in Judgments of Life Satisfaction.” Psychological Science 9 (1998): 340–46. Schkade, David, Cass R. Sunstein, and Daniel Kahneman. “Deliberating About Dollars: The Severity Shift.” Columbia Law Review 100 (2000): 1139–76. Schneider, Carl E. The Practice of Autonomy: Patients, Doctors, and Medical Decisions. Oxford: Oxford University Press, 1998. Schreiber, Charles A., and Daniel Kahneman. “Determinants of the Remembered Wel- BIBLIOGRAPHY fare of Aversive Sounds.” Journal of Experimental Psychology: General 129 (2000): 27–42. Schultz, P. Wesley, Jessica M.


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Mindware: Tools for Smart Thinking by Richard E. Nisbett

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affirmative action, Albert Einstein, availability heuristic, big-box store, Cass Sunstein, choice architecture, cognitive dissonance, correlation coefficient, correlation does not imply causation, cosmological constant, Daniel Kahneman / Amos Tversky, dark matter, endowment effect, experimental subject, feminist movement, fixed income, fundamental attribution error, glass ceiling, Henri Poincaré, Intergovernmental Panel on Climate Change (IPCC), Isaac Newton, job satisfaction, lake wobegon effect, libertarian paternalism, loss aversion, low skilled workers, Menlo Park, meta analysis, meta-analysis, quantitative easing, Richard Thaler, Ronald Reagan, selection bias, Socratic dialogue, Steve Jobs, Steven Levy, the scientific method, The Wealth of Nations by Adam Smith, Thomas Kuhn: the structure of scientific revolutions, William of Occam, Zipcar

The research has also convinced some students of the law that self-reports about motives and goals can be highly unreliable—not for reasons of self-enhancement or self-protection, but because so much of mental life is inaccessible. The errors discovered in self-reports led me to a concern with the accuracy of our inferences in everyday life in general. Following the cognitive psychologists Amos Tversky and Daniel Kahneman, I compared people’s reasoning to scientific, statistical, and logical standards and found large classes of judgments to be systematically mistaken. Inferences frequently violate principles of statistics, economics, logic, and basic scientific methodology. Work by psychologists on these questions has influenced philosophers, economists, and policy makers. Finally, I’ve done research showing that East Asians and Westerners sometimes make inferences about the world in fundamentally different ways.

A familiarity heuristic causes Americans to estimate that Marseille has a bigger population than Nice and Nice has a bigger population than Toulouse. Such heuristics are helpful guides for judgment—they’ll often give us the right answer and normally beat a stab in the dark, often by a long shot. Marseille does indeed have a bigger population than Nice. But Toulouse has a bigger population than Nice. Several important heuristics were identified by the Israeli cognitive psychologists Amos Tversky and Daniel Kahneman. The most important of their heuristics is the representativeness heuristic.22 This rule of thumb leans heavily on judgments of similarity. Events are judged as more likely if they’re similar to the prototype of the event than if they’re less similar. The heuristic is undoubtedly helpful more often than not. Homicide is a more representative cause of death than is asthma or suicide, so homicides seem more likely causes than asthma or suicide.

Jencks, Christopher, M. Smith, H. Acland, M. J. Bane, D. Cohen, H. Gintis, B. Heyns, and S. Mitchelson. Inequality: A Reassessment of the Effects of Family and Schooling in America. New York: Harper and Row, 1972. Jennings, Dennis, Teresa M. Amabile, and Lee Ross. “Informal Covariation Assessment: Data-Based Vs. Theory-Based Judgments.” In Judgment Under Uncertainty: Heuristics and Biases, edited by Amos Tversky and Daniel Kahneman. New York: Cambridge University Press, 1980. Ji, Li-Jun, Yanjie Su, and Richard E. Nisbett. “Culture, Change and Prediction.” Psychological Science 12 (2001): 450–56. Ji, Li-Jun, Zhiyong Zhang, and Tieyuan Guo. “To Buy or to Sell: Cultural Differences in Stock Market Decisions Based on Stock Price Trends.” Journal of Behavioral Decision Making 21 (2008): 399–413. Jones, Edward E., and Victor A.


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Misbehaving: The Making of Behavioral Economics by Richard H. Thaler

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3Com Palm IPO, Albert Einstein, Alvin Roth, Amazon Mechanical Turk, Andrei Shleifer, Apple's 1984 Super Bowl advert, Atul Gawande, Berlin Wall, Bernie Madoff, Black-Scholes formula, capital asset pricing model, Cass Sunstein, Checklist Manifesto, choice architecture, clean water, cognitive dissonance, conceptual framework, constrained optimization, Daniel Kahneman / Amos Tversky, delayed gratification, diversification, diversified portfolio, Edward Glaeser, endowment effect, equity premium, Eugene Fama: efficient market hypothesis, experimental economics, Fall of the Berlin Wall, George Akerlof, hindsight bias, Home mortgage interest deduction, impulse control, index fund, information asymmetry, invisible hand, Jean Tirole, John Nash: game theory, John von Neumann, Kenneth Arrow, late fees, law of one price, libertarian paternalism, Long Term Capital Management, loss aversion, market clearing, Mason jar, mental accounting, meta analysis, meta-analysis, money market fund, More Guns, Less Crime, mortgage debt, Myron Scholes, Nash equilibrium, Nate Silver, New Journalism, nudge unit, Paul Samuelson, payday loans, Ponzi scheme, presumed consent, pre–internet, principal–agent problem, prisoner's dilemma, profit maximization, random walk, randomized controlled trial, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Coase, Silicon Valley, South Sea Bubble, statistical model, Steve Jobs, technology bubble, The Chicago School, The Myth of the Rational Market, The Signal and the Noise by Nate Silver, The Wealth of Nations by Adam Smith, Thomas Kuhn: the structure of scientific revolutions, transaction costs, ultimatum game, Vilfredo Pareto, Walter Mischel, zero-sum game

Notes Bibliography List of Figures Acknowledgments Index The foundation of political economy and, in general, of every social science, is evidently psychology. A day may come when we shall be able to deduce the laws of social science from the principles of psychology. —VILFREDO PARETO, 1906 PREFACE Before we get started, here are two stories about my friends and mentors, Amos Tversky and Daniel Kahneman. The stories provide some hints about what to expect in this book. Striving to please Amos Even for those of us who can’t remember where we last put our keys, life offers indelible moments. Some are public events. If you are as old as I am, one may be the day John F. Kennedy was assassinated (freshman in college, playing pickup basketball in the college gym). For anyone old enough to be reading this book, September 11, 2001, is another (just getting up, listening to NPR, trying to make sense of it).

What made the conference special for me were two psychologists who attended: Baruch Fischhoff and Paul Slovic. They both studied how people make decisions. It was like discovering a new species. I had never met anyone in academia with their backgrounds. I ended up giving Fischhoff a ride to the airport. As we drove, Fisch-hoff told me he had completed a PhD in psychology at the Hebrew University in Israel. There he had worked with two guys whose names I had never heard: Daniel Kahneman and Amos Tversky. Baruch told me about his now-famous thesis on “hindsight bias.” The finding is that, after the fact, we think that we always knew the outcome was likely, if not a foregone conclusion. After the virtually unknown African American senator Barack Obama defeated the heavily favored Hillary Clinton for the Democratic Party presidential nomination, many people thought they had seen it coming.

Available at: http://www.nytimes.com/newsgraphics/2013/11/28/fourth-downs/post.html. Buss, Dale. 1986. “Rebate or Loan: Car Buyers Need to Do the Math.” Wall Street Journal, October 1. Camerer, Colin F. 1989. “Bubbles and Fads in Asset Prices.” Journal of Economic Surveys 3, no. 1: 3–41. ———. 1997. “Progress in Behavioral Game Theory.” Journal of Economic Perspectives 11, no. 4: 167–88. ———. 2000. “Prospect Theory in the Wild: Evidence from the Field.” In Daniel Kahneman and Amos Tversky, eds., Choices, Values, and Frames. Cambridge, UK: Cambridge University Press. ———. 2003. Behavioral Game Theory: Experiments in Strategic Interaction. Princeton: Princeton University Press. ———, Teck-Hua Ho, and Juin-Kuan Chong. 2004. “A Cognitive Hierarchy Model of Games.” Quarterly Journal of Economics 119, no. 3: 861–98. ———, Samuel Issacharoff, George Loewenstein, Ted O’Donoghue, and Matthew Rabin. 2003.

Infotopia: How Many Minds Produce Knowledge by Cass R. Sunstein

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affirmative action, Andrei Shleifer, availability heuristic, Build a better mousetrap, c2.com, Cass Sunstein, cognitive bias, cuban missile crisis, Daniel Kahneman / Amos Tversky, Edward Glaeser, en.wikipedia.org, feminist movement, framing effect, hindsight bias, information asymmetry, Isaac Newton, Jean Tirole, jimmy wales, market bubble, market design, minimum wage unemployment, prediction markets, profit motive, rent control, Richard Stallman, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Reagan, slashdot, stem cell, The Wisdom of Crowds, winner-take-all economy

., Behavioral Law and Economics (Cambridge, UK: Cambridge University Press, 2000). 2. See Amos Tversky and Daniel Kahneman, “Availability: A Heuristic for Judging Frequency and Probability,” Cognitive Psychology 5 (1973): 208 (discussing availability heuristic). 3. Paul Slovic, The Perception of Risk (London: Earthscan Publications, 2000), 37–48. Notes to Pages 70–76 / 241 4. Ibid., 40. 5. See Donald A. Redelmeier et al., “Understanding Patients’ Decisions: Cognitive and Emotional Perspectives,” Journal of the American Medical Association 270 (1993): 73 (discussing framing effects in medical context). 6. Amos Tversky and Daniel Kahneman, “Extensional versus Intuitive Reasoning: The Conjunction Fallacy in Probability Judgment,” in Gilovich et al., Heuristics and Biases, 19, 22–25 (discussing representativeness). 7. See Amos Tversky and Daniel Kahneman, “Judgment under Uncertainty: Heuristics and Biases,” in Judgment under Uncertainty: Heuristics and Biases, ed.

See Amos Tversky and Daniel Kahneman, “Judgment under Uncertainty: Heuristics and Biases,” in Judgment under Uncertainty: Heuristics and Biases, ed. Daniel Kahneman, Paul Slovic, and Amos Tversky (Cambridge, UK: Cambridge University Press, 1982), 11–12; Barbara Mellers et al., “Do Frequency Representations Eliminate Conjunction Effects?,” Psychological Science Journal 12 (2001). 8. See Stasser and Dietz-Uhler, “Collective Choice, Judgment, and Problem Solving,” 49–50. Note that when the bias is not widely shared, it may be corrected through deliberation. See ibid. 9. MacCoun, “Comparing Micro and Macro Rationality,” 121–26 (showing amplification of jury bias). 10. Mark F. Stasson et al., “Group Consensus Approaches on Cognitive Bias Tasks: A Social Decision Scheme Approach,” Japanese Psychological Research Journal 30 (1988): 74–75. 11. See Kerr et al., “Bias in Judgment,” 693, 711–12. 12.


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The Paradox of Choice: Why More Is Less by Barry Schwartz

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accounting loophole / creative accounting, attribution theory, Atul Gawande, availability heuristic, Cass Sunstein, Daniel Kahneman / Amos Tversky, endowment effect, framing effect, income per capita, job satisfaction, loss aversion, medical residency, mental accounting, Own Your Own Home, Pareto efficiency, positional goods, price anchoring, psychological pricing, RAND corporation, Richard Thaler, science of happiness, The Wealth of Nations by Adam Smith

Moreover, surveys indicate that these web sites actually influence the health-related decisions of 70 percent of the people who consult them. Evaluating the Information EVEN IF WE CAN ACCURATELY DETERMINE WHAT WE WANT AND THEN find good information, in a quantity we can handle, do we really know how to analyze, sift, weigh, and evaluate it to arrive at the right conclusions and make the right choices? Not always. Spear-headed by psychologists Daniel Kahneman and Amos Tversky, researchers have spent the last thirty years studying how people make decisions. Their work documents the variety of rules of thumb we use that often lead us astray as we try to make wise decisions. Availability IMAGINE THAT YOU’RE IN THE MARKET FOR A NEW CAR AND THAT YOU care about only two things: safety and reliability. You dutifully check out Consumer Reports, which rates Volvo highest for safety and reliability, so you resolve to buy a Volvo.

CASH—$1.45 per GALLON CREDIT—$1.55 per GALLON The other, imposing a surcharge for credit, has a small sign, just above the pumps, that says: Cash—$1.45 per Gallon Credit—$1.55 per Gallon The sign is small, and doesn’t call attention to itself, because people don’t like surcharges. Beyond the difference in presentation, though, there is no difference in the price structure at these two gas stations. A discount for paying cash is, effectively, the same as a surcharge for using credit. Nonetheless, fuel-hungry consumers will have very different subjective responses to the two different propositions. Daniel Kahneman and Amos Tversky call this effect framing. What determines whether a given price represents a discount or a surcharge? Consumers certainly can’t tell from the price itself. In addition to the current price, potential buyers would need to know the standard or “reference” price. If the reference price of gas is $1.55, then those who pay cash are getting a discount. If the reference price is $1.45, then those who use credit are paying a surcharge.

The “hedonic treadmill” and the “satisfaction treadmill” that I discussed in the last chapter explain to a significant degree how real income can increase by a factor of two (in the U.S.) or five (in Japan) without having a measurable effect on the subjective well-being of the members of society. As long as expectations keep pace with realizations, people may live better, but they won’t feel better about how they live. Prospects, Frames, and Evaluation IN CHAPTER 3, I DISCUSSED A VERY IMPORTANT FRAMEWORK FOR understanding how we assess subjective experience. It is called prospect theory, and it was developed by Daniel Kahneman and Amos Tversky. What the theory claims is that evaluations are relative to a baseline. A given experience will feel positive if it’s an improvement on what came before and negative if it’s worse than what came before. To understand how we will judge an experience, it is necessary first to find out where we set our hedonic zero point. In Chapter 3, I emphasized how language can affect the framing of an experience and thus, the setting of the zero point.


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Why Nudge?: The Politics of Libertarian Paternalism by Cass R. Sunstein

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Affordable Care Act / Obamacare, Andrei Shleifer, availability heuristic, Cass Sunstein, choice architecture, clean water, Daniel Kahneman / Amos Tversky, Edward Glaeser, endowment effect, energy security, framing effect, invisible hand, late fees, libertarian paternalism, loss aversion, nudge unit, randomized controlled trial, Richard Thaler

., Tanner Lectures on Human Values and the Design of the Fight Against Poverty (May 2, 2012), http://economics.mit.edu/files/7904. ONE Occasions for Paternalism 1. See generally ADVANCES IN BEHAVIORAL ECONOMICS (Colin F. Camerer et al. eds., 2003) (offering wide range of findings); ADVANCES IN BEHAVIORAL FINANCE, VOLUME II (Richard H. Thaler ed., 2005); CHOICES, VALUES, AND FRAMES (Daniel Kahneman & Amos Tversky eds., 2000) (offering a large number of relevant findings); HEURISTICS AND BIASES: THE PSYCHOLOGY OF INTUITIVE Judgment (Thomas Gilovich et al. eds., 2002) (outlining a variety of empirical findings). 2. DANIEL KAHNEMAN, THINKING, FAST AND SLOW (2011); see also RICHARD H. THALER & CASS R. SUNSTEIN, NUDGE: IMPROVING DECISIONS ABOUT HEALTH, WEALTH, AND HAPPINESS 19–22 (2008) (discussing “Humans” and “Econs”). 3. See THALER & SUNSTEIN, supra note 2. 4. Colin Camerer et al., Neuroeconomics: How Neuroscience Can Inform Economics, 43 J.

Rao, The Good News–Bad News Effect: Asymmetrical Processing of Objective Information About Yourself, 3 AM. ECON. J. MICROECON. 114, 116–17 (2011). 59. See SHAROT ET AL., supra note 50. 60. Id. at 1477. For some compelling evidence of the neural foundations of optimism, and particularly the more ready incorporation of good news than bad news, see SHAROT ET AL., supra note 52. 61. SHAROT ET AL., supra note 50, at 1477. 62. See id. 63. See Amos Tversky & Daniel Kahneman, Availability: A Heuristic for Judging Frequency and Probability, 5 COGNITIVE PSYCHOL. 207, 221 (1973). 64. See Elke U. Weber, Experience-Based and Description-Based Perceptions of Long-Term Risk: Why Global Warming Does Not Scare Us (Yet), 77 CLIMATIC CHANGE 103, 107–8 (2006). 65. See Laurette Dubé-Rioux & J. Edward Russo, An Availability Bias in Professional Judgment, 1 J. BEHAV.

This is the basic argument of SARAH CONLY, AGAINST AUTONOMY: JUSTIFYING COERCIVE PATERNALISM (2012), who emphasizes the need to assess the full set of costs and benefits. 37. See CHRISTOPHER CHABRIS & DANIEL SIMONS, THE INVISIBLE GORILLA: AND OTHER WAYS OUR INTUITIONS DECEIVE US 6–8 (2010). 38. See OREN BAR-GILL, SEDUCTION BY CONTRACT 18–23 (2012). Early work by Daniel Kahneman focused on closely related questions. See DANIEL KAHNEMAN, ATTENTION AND EFFORT (1973). 39. See Victor Stango & Jonathan Zinman, Limited and Varying Consumer Attention: Evidence from Shocks to the Salience of Bank Overdraft Fees 27–28 (Fed. Reserve Bank of Phila., Working Paper No. 11–17, 2011), http://ssrn.com/abstract=1817916. 40. Id. at 25, 27. 41. See Alix Peterson Zwane et al., Being Surveyed Can Change Later Behavior and Related Parameter Estimates, 108 PROC.


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The Irrational Bundle by Dan Ariely

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accounting loophole / creative accounting, air freight, Albert Einstein, Alvin Roth, assortative mating, banking crisis, Bernie Madoff, Black Swan, Broken windows theory, Burning Man, business process, cashless society, Cass Sunstein, clean water, cognitive dissonance, computer vision, corporate governance, credit crunch, Credit Default Swap, Daniel Kahneman / Amos Tversky, delayed gratification, Donald Trump, end world poverty, endowment effect, Exxon Valdez, first-price auction, Frederick Winslow Taylor, fudge factor, George Akerlof, Gordon Gekko, greed is good, happiness index / gross national happiness, Jean Tirole, job satisfaction, Kenneth Arrow, knowledge economy, knowledge worker, lake wobegon effect, late fees, loss aversion, Murray Gell-Mann, new economy, Peter Singer: altruism, placebo effect, price anchoring, Richard Feynman, Richard Feynman, Richard Thaler, Saturday Night Live, Schrödinger's Cat, second-price auction, shareholder value, Silicon Valley, Skype, software as a service, Steve Jobs, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, ultimatum game, Upton Sinclair, Walter Mischel, young professional

RELATED READINGS Cass R. Sunstein, Daniel Kahneman, David Schkade, and Ilana Ritov, “Predictably Incoherent Judgments,” Stanford Law Review (2002). Uri Simonsohn, “New Yorkers Commute More Everywhere: Contrast Effects in the Field,” Review of Economics and Statistics (2006). Uri Simonsohn and George Loewenstein, “Mistake #37: The Impact of Previously Faced Prices on Housing Demand,” Economic Journal (2006). Chapter 3: The Cost of Zero Cost BASED ON Kristina Shampanier, Nina Mazar, and Dan Ariely, “How Small Is Zero Price? The True Value of Free Products,” Marketing Science (2007). RELATED READINGS Daniel Kahneman and Amos Tversky, “Prospect Theory: An Analysis of Decision under Risk,” Econometrica (1979). Eldar Shafir, Itamar Simonson, and Amos Tversky, “Reason-Based Choice,” Cognition (1993).

Introduction RELATED READINGS Daniel Kahneman, Barbara L. Fredrickson, Charles A. Schreiber, and Donald A. Redelmeier, “When More Pain Is Preferred to Less: Adding a Better End,” Psychological Science (1993). Donald A. Redelmeier and Daniel Kahneman, “Patient’s Memories of Painful Medical Treatments—Real-Time and Retrospective Evaluations of Two Minimally Invasive Procedures,” Pain (1996). Dan Ariely, “Combining Experiences over Time: The Effects of Duration, Intensity Changes, and On-Line Measurements on Retrospective Pain Evaluations,” Journal of Behavioral Decision Making (1998). Dan Ariely and Ziv Carmon, “Gestalt Characteristics of Experienced Profiles,” Journal of Behavioral Decision Making (2000). Chapter 1: The Truth about Relativity RELATED READINGS Amos Tversky, “Features of Similarity,” Psychological Review, Vol. 84 (1977).

Chapter 1: The Truth about Relativity RELATED READINGS Amos Tversky, “Features of Similarity,” Psychological Review, Vol. 84 (1977). Amos Tversky and Daniel Kahneman, “The Framing of Decisions and the Psychology of Choice,” Science (1981). Joel Huber, John Payne, and Chris Puto, “Adding Asymmetrically Dominated Alternatives: Violations of Regularity and the Similarity Hypothesis,” Journal of Consumer Research (1982). Itamar Simonson, “Choice Based on Reasons: The Case of Attraction and Compromise Effects,” Journal of Consumer Research (1989). Amos Tversky and Itamar Simonson, “Context-Dependent Preferences,” Management Science (1993). Dan Ariely and Tom Wallsten, “Seeking Subjective Dominance in Multidimensional Space: An Explanation of the Asymmetric Dominance Effect,” Organizational Behavior and Human Decision Processes (1995). Constantine Sedikides, Dan Ariely, and Nils Olsen, “Contextual and Procedural Determinants of Partner Selection: On Asymmetric Dominance and Prominence,” Social Cognition (1999).


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Currency Wars: The Making of the Next Gobal Crisis by James Rickards

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Asian financial crisis, bank run, Benoit Mandelbrot, Berlin Wall, Big bang: deregulation of the City of London, Black Swan, borderless world, Bretton Woods, BRICs, British Empire, business climate, capital controls, Carmen Reinhart, Cass Sunstein, collateralized debt obligation, complexity theory, corporate governance, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, Daniel Kahneman / Amos Tversky, Deng Xiaoping, diversification, diversified portfolio, Fall of the Berlin Wall, family office, financial innovation, floating exchange rates, full employment, game design, German hyperinflation, Gini coefficient, global rebalancing, global reserve currency, high net worth, income inequality, interest rate derivative, John Meriwether, Kenneth Rogoff, labour mobility, laissez-faire capitalism, liquidity trap, Long Term Capital Management, mandelbrot fractal, margin call, market bubble, Mexican peso crisis / tequila crisis, money market fund, money: store of value / unit of account / medium of exchange, Myron Scholes, Network effects, New Journalism, Nixon shock, offshore financial centre, oil shock, one-China policy, open economy, paradox of thrift, Paul Samuelson, price mechanism, price stability, private sector deleveraging, quantitative easing, race to the bottom, RAND corporation, rent-seeking, reserve currency, Ronald Reagan, sovereign wealth fund, special drawing rights, special economic zone, The Myth of the Rational Market, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Thomas Kuhn: the structure of scientific revolutions, time value of money, too big to fail, value at risk, War on Poverty, Washington Consensus, zero-sum game

Chapter 10 197 Robert K. Merton’s most famous contribution . . . Robert K. Merton, “The Self-Fulfilling Prophecy,” The Antioch Review 8, no. 2 (Summer 1948): 193–210. 197 A breakthrough in the impact of social psychology on economics . . . This work on what became the foundation of behavioral economics is contained in two volumes: Daniel Kahneman and Amos Tversky, eds., Choices, Values, and Frames, Cambridge: Cambridge University Press, 2000; and Daniel Kahneman et al., eds., Judgment under Uncertainty: Heuristics and Biases, Cambridge: Cambridge University Press, 1982. 201 If they are diverse they will respond differently to various inputs producing . . . The extended analysis that follows, including elements of diversity, connectedness, interdependence and adaptability, draws on a series of lectures under the title “Understanding Complexity,” delivered in 2009 by Professor Scott E.

From the fields of psychology, sociology and biology came a flood of studies showing that investors are irrational after all, at least from the perspective of wealth maximization. From iconoclastic mathematical genius Benoît Mandelbrot came insights that showed future prices are not independent of the past—that the market had a kind of “memory” that could cause it to react or overreact in disruptive ways, giving rise to alternating periods of boom and bust. Daniel Kahneman and his colleague Amos Tversky demonstrated in a series of simple but brilliantly constructed experiments that individuals were full of irrational biases. The subjects of their experiments were more concerned about avoiding a loss than achieving a gain, even though an economist would say the two outcomes had exactly the same value. This trait, called risk aversion, helps to explain why investors will dump stocks in a panic but be slow to reenter the market once it turns around.

On March 12, 2008, Schwartz told CNBC, “We don’t see any pressure on our liquidity, let alone a liquidity crisis.” Forty-eight hours later Bear Stearns was headed to bankruptcy after frightened Wall Street banks withdrew billions of dollars of credit lines. For Bear Stearns, this was a real-life version of Merton’s thought experiment. A breakthrough in the impact of social psychology on economics came with the work of Daniel Kahneman, Amos Tversky, Paul Slovic and others in a series of experiments conducted in the 1950s and 1960s. In the most famous set of experiments, Kahneman and Tversky showed that subjects, given the choice between two monetary outcomes, would select the one with the greater certainty of being received even though it did not have the highest expected return. A typical version of this is to offer a subject the prospect of winning money structured as a choice between: A) $4,000 with an 80 percent probability of winning, or B) $3,000 with a 100 percent probability of winning.

The Panic Virus: The True Story Behind the Vaccine-Autism Controversy by Seth Mnookin

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Albert Einstein, AltaVista, British Empire, Cass Sunstein, cognitive dissonance, correlation does not imply causation, Daniel Kahneman / Amos Tversky, en.wikipedia.org, illegal immigration, index card, Isaac Newton, loss aversion, meta analysis, meta-analysis, mouse model, neurotypical, pattern recognition, placebo effect, Richard Thaler, Saturday Night Live, selection bias, Solar eclipse in 1919, Stephen Hawking, Steven Pinker, the scientific method, Thomas Kuhn: the structure of scientific revolutions

., August 27, 1993), footnote, 15. 17 “fills me with horror”: Tsouderos, “Autism ‘Miracle’ Called Junk Science.” 17 “If someone like Mark Geier comes up”: Kevin Leitch, interview with author, May 5, 2009. 18 in a series of groundbreaking papers in the 1970s: Daniel Kahneman and Amos Tversky, “Subjective Probability: A Judgment of Representativeness,” Cognitive Psychology 1973;3: 430–54; Daniel Kahneman and Amos Tversky, “Judgment Under Uncertainty: Heuristics and Biases,” Science 1974;185(4157): 1124–31; Daniel Kahneman and Amos Tversky, “Prospect Theory: An Analysis of Decisions Under Risk,” Econometrica March 1979;47(2): 313–27. See also: Preference, Belief, and Similarity—Selected Writings, Amos Tversky, edited by Eldar Shafir (Cambridge: Massachusetts Institute of Technology Press, 2004), Chapter 7, “Belief in the Law of Small Numbers,” 193–202; Chapter 9, “Extensional Versus Intuitive Reasoning: The Conjunction Fallacy in Probability Judgment,” 221–56. 18 A recent Hib outbreak in Minnesota: Centers for Disease Control and Prevention, “Invasive Haemophilus influenzae Type B Disease in Five Young Children—Minnesota, 2008,” Morbidity and Mortality Weekly Report, January 23, 2009;58(Early Release): 1–3. 19 Among those infected was Dana McCaffery: Toni and David McCaffery, interview and e-mails with author, 2009–2010. 19 A decade after the World Health Organization: World Health Organization, “Measles Eradication Still a Long Way Off,” Bulletin of the World Health Organization 2001;79(6), http://www.who.int/mediacentre/ factsheets/fs288/en/index.html. 19 In Great Britain, there’s been more than a thousandfold increase: “Agency Publishes Annual Measles Figures for 2008,” Health Protection Agency (U.K.), February 9, 2009. 19 outbreaks in many of the country’s most populous states: Centers for Disease Control and Prevention, “Update: Measles—United States, January–July 2008,” Morbidity and Mortality Weekly Report, August 22, 2008;57(33): 893–96. 19 “felt safe in making the choice”: “How My Son Spread the Measles,” Time, May 25, 2008. 20 Before the MMR vaccine was introduced: Nancy Shute, “Parents’ Vaccine Safety Fears Mean Big Trouble for Children’s Health,” usnews.com, March 1, 2010. 20 On the fourth morning of Matthew Lacek’s coma: Kelly Lacek, interview with author, May 7, 2009. 20 “We just celebrated [Matthew’s] 7th birthday”: Kelly Lacek, e-mail to author, “Subject: Re: from Seth Mnookin/via Trish at PKids,” April 12, 2010.

A lot of parenting decisions come down to our gut reactions—science can’t tell us what’s an appropriate curfew for a sixteen-year-old or whether it’s better to indulge or resist a child who says he wants to quit violin lessons—and when it comes to vaccines, most of the “commonsense” arguments appear to line up on one side of the equation: Vaccines contain viruses, viruses are dangerous, infants’ immune systems aren’t fully developed, drug companies are interested only in profit, and the government can’t always be trusted. The problem, as psychologist and Nobel laureate Daniel Kahneman and his longtime research partner Amos Tversky demonstrated in a series of groundbreaking papers in the 1970s, is that in many situations regarding risk perception and data processing, “commonsense” arguments are precisely the ones that lead us astray.5 Because the risks associated with foregoing vaccines feel so hypothetical, and because the infinitesimally remote possibility that vaccines could hurt our children is so scary, and because there’s nothing in our daily experience to indicate that a little fluid administered through a needle would protect us from a threat we can’t even see, it’s very hard for parents working by intuition alone to know what’s best for their children in this situation.

Thompson, William W., et al. “Early Thimerosal Exposure and Neuropsychological Outcomes at 7 to 10 Years.” New England Journal of Medicine 2007;357(13): 1281–92. Trevelyan, Barry, et al. “The Spatial Dynamics of Poliomyelitis in the United States: From Epidemic Emergence to Vaccine-Induced Retreat, 1910–1971.” Annals of the Association of American Geographers 2005;95(2): 269–93. Tversky, Amos, and Daniel Kahneman. “Belief in the Law of Small Numbers.” Psychological Bulletin 1971;76(2): 105–10. Uhlmann, V., et al. “Potential Viral Pathogenic Mechanism for New Variant Inflammatory Bowel Disease.” Journal of Clinical Pathology: Molecular Pathology 2002;55(2): 84–90. Van Damme, Wim, et al. “Measles Vaccination and Inflammatory Bowel Disease.” The Lancet 1997;350(9093): 1774–75. Varricchio, F. “Understanding Vaccine Safety Information from the Vaccine Adverse Event Reporting System.”


Adaptive Markets: Financial Evolution at the Speed of Thought by Andrew W. Lo

Albert Einstein, Alfred Russel Wallace, algorithmic trading, Andrei Shleifer, Arthur Eddington, Asian financial crisis, asset allocation, asset-backed security, backtesting, bank run, barriers to entry, Berlin Wall, Bernie Madoff, bitcoin, Bonfire of the Vanities, bonus culture, break the buck, Brownian motion, business process, butterfly effect, capital asset pricing model, Captain Sullenberger Hudson, Carmen Reinhart, Chance favours the prepared mind, collapse of Lehman Brothers, collateralized debt obligation, commoditize, computerized trading, corporate governance, creative destruction, Credit Default Swap, credit default swaps / collateralized debt obligations, cryptocurrency, Daniel Kahneman / Amos Tversky, delayed gratification, Diane Coyle, diversification, diversified portfolio, double helix, easy for humans, difficult for computers, Ernest Rutherford, Eugene Fama: efficient market hypothesis, experimental economics, experimental subject, Fall of the Berlin Wall, financial deregulation, financial innovation, financial intermediation, fixed income, Flash crash, Fractional reserve banking, framing effect, Gordon Gekko, greed is good, Hans Rosling, Henri Poincaré, high net worth, housing crisis, incomplete markets, index fund, interest rate derivative, invention of the telegraph, Isaac Newton, James Watt: steam engine, job satisfaction, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Meriwether, Joseph Schumpeter, Kenneth Rogoff, London Interbank Offered Rate, Long Term Capital Management, loss aversion, Louis Pasteur, mandelbrot fractal, margin call, Mark Zuckerberg, market fundamentalism, martingale, merger arbitrage, meta analysis, meta-analysis, Milgram experiment, money market fund, moral hazard, Myron Scholes, Nick Leeson, old-boy network, out of africa, p-value, paper trading, passive investing, Paul Lévy, Paul Samuelson, Ponzi scheme, predatory finance, prediction markets, price discovery process, profit maximization, profit motive, quantitative hedge fund, quantitative trading / quantitative finance, RAND corporation, random walk, randomized controlled trial, Renaissance Technologies, Richard Feynman, Richard Feynman, Richard Feynman: Challenger O-ring, risk tolerance, Robert Shiller, Robert Shiller, short selling, sovereign wealth fund, statistical arbitrage, Steven Pinker, stochastic process, survivorship bias, The Great Moderation, the scientific method, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, theory of mind, Thomas Malthus, Thorstein Veblen, Tobin tax, too big to fail, transaction costs, Triangle Shirtwaist Factory, ultimatum game, Upton Sinclair, US Airways Flight 1549, Walter Mischel, Watson beat the top human players on Jeopardy!, WikiLeaks, Yogi Berra, zero-sum game

Human nature simply doesn’t allow us to view uncertainty with indifference. Fortune favors the brave, and market prices reflect our innate tendency to avoid uncertainty. 56 • Chapter 2 LOSING HURTS MORE THAN WINNING FEELS GOOD While the distinction between risk and uncertainty might seem subtle at first, even subtler biases are hardwired into our psychology. Two experimental psychologists, Daniel Kahneman and Amos Tversky, both outsiders to economics, made their careers studying these biases, and in so doing, they radically changed how scientists viewed the human decision-making process. Kahneman and Tversky were one of the great scientific partnerships of the modern era. They worked so closely together that they would randomly choose which author would appear first in their publication credits by tossing a coin—a method entirely fitting with their research focus: decision making under uncertainty.

The representativeness heuristic also explains why people believe in winning streaks, from the picks of a hot stock market guru to the “hot hand” on a basketball court. Basketball fans and players alike believe in the hot hand phenomenon—the ability of a player to develop a streak of exceptional performance in sinking baskets—where a mathematician might say it’s due to luck. In 1985, Thomas Gilovich, Robert Vallone, and Amos Tversky (this time without Daniel Kahneman) set out to discover if the hot hand was actually true.27 The researchers had unprecedented access to the Philadelphia 76ers, including the team’s coach, all of whom were convinced that players developed hot hands from time to time. Professional sports are an excellent place to find large quantities of meticulously recorded behavioral data, and in this case, the team statistician for the Philadelphia 76ers had recorded every three-point attempt made by a player during Philadelphia’s home games in the 1980–81 season.

In the bigger picture, if we let our fear instinct drive our reaction to financial crises, we’ll likely regret the responses produced by our amygdalas. This applies not only to investors, but also to regulators and policymakers, whose responses to fear can have much larger consequences on the financial system than any single player in the market. The psychologist Paul Slovic, a colleague of Daniel Kahneman and Amos Tversky, has studied in depth how people perceive risk while experiencing strong emotion. Slovic found a persistent emotional bias that colors our reactions to risk.12 If the potential risks and benefits of a policy are framed in a manner to provoke a negative emotional response, people overweigh the risks and downplay the benefits, while if a policy is framed in a positive manner, people overweigh the benefits and downplay the risks.


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The Organized Mind: Thinking Straight in the Age of Information Overload by Daniel J. Levitin

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airport security, Albert Einstein, Amazon Mechanical Turk, Anton Chekhov, Bayesian statistics, big-box store, business process, call centre, Claude Shannon: information theory, cloud computing, cognitive bias, complexity theory, computer vision, conceptual framework, correlation does not imply causation, crowdsourcing, cuban missile crisis, Daniel Kahneman / Amos Tversky, delayed gratification, Donald Trump, en.wikipedia.org, epigenetics, Eratosthenes, Exxon Valdez, framing effect, friendly fire, fundamental attribution error, Golden Gate Park, Google Glasses, haute cuisine, impulse control, index card, indoor plumbing, information retrieval, invention of writing, iterative process, jimmy wales, job satisfaction, Kickstarter, life extension, meta analysis, meta-analysis, more computing power than Apollo, Network effects, new economy, Nicholas Carr, optical character recognition, Pareto efficiency, pattern recognition, phenotype, placebo effect, pre–internet, profit motive, randomized controlled trial, Rubik’s Cube, Skype, Snapchat, statistical model, Steve Jobs, supply-chain management, the scientific method, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, theory of mind, Thomas Bayes, Turing test, ultimatum game, zero-sum game

I’ve learned a lot from having this fly-on-the-wall view of companies in prosperity and companies in crisis. An organized mind leads effortlessly to good decision-making. As an undergraduate, I had two brilliant professors, Amos Tversky and Lee Ross, both of whom were pioneers in the science of social judgments and decision-making. They sparked a fascination for how we assess others in our social world and how we interact with them, the various biases and misinformation we bring to those relationships, along with how to overcome them. Amos, with his colleague Daniel Kahneman (who won the Nobel Prize for their work together a few years after Amos passed away), uncovered a host of systematic errors in the way the human brain evaluates evidence and processes information. I’ve been teaching these to university undergraduates for twenty years, and my students have helped me to come up with ways to explain these errors so that all of us can easily improve our decision-making.

For many of us, a number of items on our To Do lists require a decision and we feel we don’t have enough information to make the decision. Say that one item on your To Do list was “Make a decision about assisted living facilities for Aunt Rose.” You’ve already visited a few and gathered information, but you haven’t yet made the decision. On a morning scan of your cards, you find you aren’t ready to do it. Take two minutes now to think about what you need in order to make the decision. Daniel Kahneman and Amos Tversky said that the problem with making decisions is that we are often making them under conditions of uncertainty. You’re uncertain of the outcome of putting Rose in a home, and that makes the decision difficult. You also fear regret if you make the wrong decision. If more information will remove that uncertainty, then figure out what that information is and how to obtain it, then—to keep the system working for you—put it on an index card.

We don’t have the time or expertise to do research on every little decision. Instead, we rely on trusted authorities, newspapers, radio, TV, books, sometimes your brother-in-law, the neighbor with the perfect lawn, the cab driver who dropped you at the airport, your memory of a similar experience. . . . Sometimes these authorities are worthy of our trust, sometimes not. My teacher, the Stanford cognitive psychologist Amos Tversky, encapsulates this in “the Volvo story.” A colleague was shopping for a new car and had done a great deal of research. Consumer Reports showed through independent tests that Volvos were among the best built and most reliable cars in their class. Customer satisfaction surveys showed that Volvo owners were far happier with their purchase after several years. The surveys were based on tens of thousands of customers.


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To Sell Is Human: The Surprising Truth About Moving Others by Daniel H. Pink

always be closing, Atul Gawande, barriers to entry, call centre, Cass Sunstein, Checklist Manifesto, choice architecture, complexity theory, Credit Default Swap, Daniel Kahneman / Amos Tversky, disintermediation, future of work, George Akerlof, information asymmetry, Jeff Bezos, Kickstarter, Marc Andreessen, Menlo Park, out of africa, Richard Thaler, rolodex, Ronald Reagan, Steve Jobs, The Market for Lemons, Upton Sinclair, Wall-E, zero-sum game

The Conference Board, Ready to Innovate: Are Educators and Executives Aligned on the Creative Readiness of the U.S. Workforce? Research Report R-1424-08-RR (October 2008), available at http://www.artsusa.org/pdf/information_services/research/policy_roundtable/readytoinnovatefull.pdf. 11. Robert B. Cialdini, Influence: Science and Practice, 5th ed. (Boston: Allyn & Bacon, 2009), 12–16. 12. For a good introduction, see Daniel Kahneman and Amos Tversky, “The Framing of Decisions and the Psychology of Choice,” Science 211 (1981): 453–58; Daniel Kahneman and Amos Tversky, “Rational Choice and the Framing of Decisions,” in Robin M. Hogarth and Melvin W. Reder, eds., Rational Choice: The Contrast Between Economics and Psychology (Chicago: University of Chicago Press, 1987); Erving Goffman, Frame Analysis: An Essay on the Organization of Experience (Cambridge MA: Harvard University Press, 1974). 13.

Hamm, “The Use of Interpersonal Touch in Securing Compliance,” Journal of Nonverbal Behavior 5, no. 5 (September 1980): 49–55. 21. Damien Erceau and Nicolas Guéguen, “Tactile Contact and Evaluation of the Toucher,” Journal of Social Psychology 147, no. 4 (August 2007): 441–44. 22. See also Liam C. Kavanagh, Christopher L. Suhler, Patricia S. Churchland, and Piotr Winkielman, “When It’s an Error to Mirror: The Surprising Reputational Costs of Mimicry,” Psychological Science 22, no. 10 (October 2011): 1274–76. 23. Daniel Kahneman, Ed Diener, and Norbert Schwarz, eds., Well-Being: The Foundations of Hedonic Psychology (New York: Russell Sage Foundation, 1999), 218. 24. P. T. Costa Jr. and R. R. McCrae, NEO PI-R Professional Manual (Odessa, FL: Psychological Assessment Resources, Inc., 1992), 15; Susan Cain, Quiet: The Power of Introverts in a World That Can’t Stop Talking (New York: Crown, 2012). 25. See, for instance, Table 1 in Wendy S.


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Rationality: From AI to Zombies by Eliezer Yudkowsky

Albert Einstein, Alfred Russel Wallace, anthropic principle, anti-pattern, anti-work, Arthur Eddington, artificial general intelligence, availability heuristic, Bayesian statistics, Berlin Wall, Build a better mousetrap, Cass Sunstein, cellular automata, cognitive bias, cognitive dissonance, correlation does not imply causation, cosmological constant, creative destruction, Daniel Kahneman / Amos Tversky, dematerialisation, discovery of DNA, Douglas Hofstadter, Drosophila, effective altruism, experimental subject, Extropian, friendly AI, fundamental attribution error, Gödel, Escher, Bach, hindsight bias, index card, index fund, Isaac Newton, John Conway, John von Neumann, Long Term Capital Management, Louis Pasteur, mental accounting, meta analysis, meta-analysis, money market fund, Nash equilibrium, Necker cube, NP-complete, P = NP, pattern recognition, Paul Graham, Peter Thiel, Pierre-Simon Laplace, placebo effect, planetary scale, prediction markets, random walk, Ray Kurzweil, reversible computing, Richard Feynman, Richard Feynman, risk tolerance, Rubik’s Cube, Saturday Night Live, Schrödinger's Cat, scientific mainstream, sensible shoes, Silicon Valley, Silicon Valley startup, Singularitarianism, Solar eclipse in 1919, speech recognition, statistical model, Steven Pinker, strong AI, technological singularity, The Bell Curve by Richard Herrnstein and Charles Murray, the map is not the territory, the scientific method, Turing complete, Turing machine, ultimatum game, X Prize, Y Combinator, zero-sum game

Where did that specific detail come from? For it is written: If you can lighten your burden you must do so. There is no straw that lacks the power to break your back. * 1. William S. Gilbert and Arthur Sullivan, The Mikado, Opera, 1885. 2. Tversky and Kahneman, “Extensional Versus Intuitive Reasoning.” 3. Amos Tversky and Daniel Kahneman, “Judgments of and by Representativeness,” in Judgment Under Uncertainty: Heuristics and Biases, ed. Daniel Kahneman, Paul Slovic, and Amos Tversky (New York: Cambridge University Press, 1982), 84–98. 7 Planning Fallacy The Denver International Airport opened 16 months late, at a cost overrun of $2 billion. (I’ve also seen $3.1 billion asserted.) The Eurofighter Typhoon, a joint defense project of several European countries, was delivered 54 months late at a cost of $19 billion instead of $7 billion.

West, “Individual Differences in Reasoning: Implications for the Rationality Debate?,” Behavioral and Brain Sciences 23, no. 5 (2000): 645–665, http://journals.cambridge.org/abstract_S0140525X00003435. 6. Timothy D. Wilson, David B. Centerbar, and Nancy Brekke, “Mental Contamination and the Debiasing Problem,” in Heuristics and Biases: The Psychology of Intuitive Judgment, ed. Thomas Gilovich, Dale Griffin, and Daniel Kahneman (Cambridge University Press, 2002). 7. Amos Tversky and Daniel Kahneman, “Extensional Versus Intuitive Reasoning: The Conjunction Fallacy in Probability Judgment,” Psychological Review 90, no. 4 (1983): 293–315, doi:10.1037/0033-295X.90.4.293. 8. Richards J. Heuer, Psychology of Intelligence Analysis (Center for the Study of Intelligence, Central Intelligence Agency, 1999). 9. Wayne Weiten, Psychology: Themes and Variations, Briefer Version, Eighth Edition (Cengage Learning, 2010). 10.

In Cognition and Categorization, edited by Eleanor Rosch and Barbara Lloyd, 79–98. Hillsdale, NJ: Lawrence Erlbaum Associates, Inc., 1978. Tversky, Amos, and Daniel Kahneman. “Extensional Versus Intuitive Reasoning: The Conjunction Fallacy in Probability Judgment.” Psychological Review 90, no. 4 (1983): 293–315. doi:10.1037/0033-295X.90.4.293. ———. “Judgment Under Uncertainty: Heuristics and Biases.” Science 185, no. 4157 (1974): 1124–1131. doi:10.1126/science.185.4157.1124. ———. “Judgments of and by Representativeness.” In Judgment Under Uncertainty: Heuristics and Biases, edited by Daniel Kahneman, Paul Slovic, and Amos Tversky, 84–98. New York: Cambridge University Press, 1982. Tzu, Sun. The Art of War. Cloud Hands, Inc., 2004. Uhlmann, Eric Luis, and Geoffrey L. Cohen. “‘I think it, therefore it’s true’: Effects of Self-perceived Objectivity on Hiring Discrimination.”


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Doing Good Better: How Effective Altruism Can Help You Make a Difference by William MacAskill

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barriers to entry, basic income, Black Swan, Branko Milanovic, Cal Newport, Capital in the Twenty-First Century by Thomas Piketty, carbon footprint, clean water, corporate social responsibility, correlation does not imply causation, Daniel Kahneman / Amos Tversky, David Brooks, effective altruism, en.wikipedia.org, end world poverty, experimental subject, follow your passion, food miles, immigration reform, income inequality, index fund, Intergovernmental Panel on Climate Change (IPCC), Isaac Newton, job automation, job satisfaction, labour mobility, Lean Startup, M-Pesa, mass immigration, meta analysis, meta-analysis, microcredit, Nate Silver, Peter Singer: altruism, purchasing power parity, quantitative trading / quantitative finance, randomized controlled trial, self-driving car, Skype, Stanislav Petrov, Steve Jobs, Steve Wozniak, Steven Pinker, The Future of Employment, The Wealth of Nations by Adam Smith, universal basic income, women in the workforce

Within philosophy, for example, there are about four times as many doctoral candidates as there are tenure-track positions: Carolyn Dicey Jennings, quoted in “To Get a Job in Philosophy,” Philosophy Smoker (blog), April 18, 2012, http://philosophysmoker.blogspot.com.ar/2012/04/to-get-job-in-philosophy.html. within economics the number of people who seek academic employment more closely matches the number of academic jobs: Richard B. Freeman, “It’s Better Being an Economist (But Don’t Tell Anyone),” Journal of Economic Perspectives 13, no. 3 (Summer 1999), 139–45. Daniel Kahneman and Amos Tversky were psychologists who caused a revolution within economics: For an excellent overview of this pathbreaking research, see Daniel Kahneman, Thinking, Fast and Slow (New York: Farrar, Straus and Giroux, 2011). this field has improved our ability to cause desirable behavior change: For examples, see “Poor Behaviour: Behavioural Economics Meets Development Policy,” The Economist, December 6, 2014, and Dean Karlan and Jacob Appel, More Than Good Intentions: How a New Economics Is Helping to Solve Global Poverty (New York: Dutton, 2011).

This, however, shouldn’t deter you if you have some particular interest or expertise within an area of research that is relevant to a particularly high-priority cause area. One good way to have impact within research is to combine fields. There are far more combinations of fields than there are individual fields, and research tends to be influenced by traditional disciplinary distinctions, so research at the intersection of two disciplines is often particularly neglected and can for that reason be very high-impact. For example, Daniel Kahneman and Amos Tversky were psychologists who caused a revolution within economics: they applied methods developed in psychology to test assumptions about rational choice that were prevalent within economics, thereby leading to the new field of “behavioral economics.” By giving us a better understanding of human behavior, this field has improved our ability to cause desirable behavior change, including in development.

Scientists who have clearly had a huge positive effect on the world include Fritz Haber and Carl Bosch, who invented synthetic fertilizer; Karl Landsteiner, who discovered blood groups, thus allowing blood transfusions to be possible; Grace Eldering and Pearl Kendrick, who developed the first whooping cough vaccine; and Françoise Barré-Sinoussi and Luc Montagnier, who discovered HIV. In each of these cases, even after taking into account that these developments would have eventually happened anyway, the good each of these researchers did should be measured in the millions of lives saved. And clearly many other researchers, from Isaac Newton to Daniel Kahneman, have made a huge contribution to human progress even if it’s not easy to quantify their impact in terms of lives saved. Like innovative entrepreneurship, research is an area that is drastically undersupplied by the market because the benefits are open to everyone, and because much of the benefit of research occurs decades into the future. Governments try to fix this problem to some extent through state-funded research, but academic research is very often not as high-impact as it could be—the incentive facing many academics is work on the most theoretically interesting questions rather than the most socially important questions.


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How Markets Fail: The Logic of Economic Calamities by John Cassidy

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Albert Einstein, Andrei Shleifer, anti-communist, asset allocation, asset-backed security, availability heuristic, bank run, banking crisis, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Black-Scholes formula, Bretton Woods, British Empire, capital asset pricing model, centralized clearinghouse, collateralized debt obligation, Columbine, conceptual framework, Corn Laws, corporate raider, correlation coefficient, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, Daniel Kahneman / Amos Tversky, debt deflation, diversification, Elliott wave, Eugene Fama: efficient market hypothesis, financial deregulation, financial innovation, Financial Instability Hypothesis, financial intermediation, full employment, George Akerlof, global supply chain, Gunnar Myrdal, Haight Ashbury, hiring and firing, Hyman Minsky, income per capita, incomplete markets, index fund, information asymmetry, Intergovernmental Panel on Climate Change (IPCC), invisible hand, John Nash: game theory, John von Neumann, Joseph Schumpeter, Kenneth Arrow, laissez-faire capitalism, Landlord’s Game, liquidity trap, London Interbank Offered Rate, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, margin call, market bubble, market clearing, mental accounting, Mikhail Gorbachev, money market fund, Mont Pelerin Society, moral hazard, mortgage debt, Myron Scholes, Naomi Klein, negative equity, Network effects, Nick Leeson, Northern Rock, paradox of thrift, Pareto efficiency, Paul Samuelson, Ponzi scheme, price discrimination, price stability, principal–agent problem, profit maximization, quantitative trading / quantitative finance, race to the bottom, Ralph Nader, RAND corporation, random walk, Renaissance Technologies, rent control, Richard Thaler, risk tolerance, risk-adjusted returns, road to serfdom, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, shareholder value, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, statistical model, technology bubble, The Chicago School, The Great Moderation, The Market for Lemons, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, unorthodox policies, value at risk, Vanguard fund, Vilfredo Pareto, wealth creators, zero-sum game

.”: Smith, Wealth of Nations, Books 1–3, 209–10. 193 “[t]aking the whole kingdom on average . . .”: Ibid., 211. 193 “our telescopic faculty is defective . . .”: Pigou, The Economics of Welfare, 25. 194 “We spent hours each day . . .”: Daniel Kahneman, Nobel Prize autobiography, available at http://nobelprize.org/nobel_prizes/economics/laureates/2002/kahneman-autobio.html. 195 “put too much faith . . .”: Amos Tversky and Daniel Kahneman, “Judgement under Uncertainty: Heuristics and Biases,” Science 185, no. 4157 (1974): 1126. 195 “Steve is very shy . . .”: Ibid., 1124. 196 Hot hand theory: Thomas Gilovich, Robert Vallone, and Amos Tversky, “The Hot Hand in Basketball: On the Misperception of Random Sequences,” Cognitive Psychology 17 (1985): 295–314. 196 “with little or no regard . . .”: Tversky and Kahneman, “Judgement under Uncertainty,” 1126. 197 Likelihood of getting killed in a terrorist attack: See N.

Once you start to think about the world in terms of some of the concepts I outline, such as the beauty contest, disaster myopia, and the market for lemons, you may well wonder how you ever got along without them. The emergence of reality-based economics can be traced to two sources. Within orthodox economics, beginning in the late 1960s, a new generation of researchers began working on a number of topics that didn’t fit easily within the free market model, such as information problems, monopoly power, and herd behavior. At about the same time, two experimental psychologists, Amos Tversky and Daniel Kahneman, were subjecting rational economic man—Homo economicus—to a withering critique. As only an economist would be surprised to discover, humans aren’t supercomputers: we have trouble doing sums, let alone solving the mathematical optimization problems that lie at the heart of many economic theories. When faced with complicated choices, we often rely on rules of thumb, or instinct. And we are greatly influenced by the actions of others.

Arthur Pigou reiterated Smith’s point that people prefer instant satisfaction to deferred pleasure, noting “our telescopic faculty is defective.” It was in the aftermath of World War II that economists began to focus almost exclusively on Homo economicus, elevating rationality to a near-sacred principle. By the 1970s, economists had locked themselves in straitjackets, and it took external help to liberate them. Assistance arrived in the unlikely form of two Israeli experimental psychologists, Daniel Kahneman and Amos Tversky, who were studying how people choose between uncertain outcomes, a subject that most economists regarded as having been settled in the 1940s, when John von Neumann and Oskar Morgenstern, the founders of game theory, put forward the “expected utility hypothesis.” According to this theory, decision-makers weigh possible outcomes according to how likely they are. If a bachelor has to choose between a definite date tonight with his pals for a beer, or a possible but by no means certain movie date tomorrow night with his girlfriend, he will take the sure thing and head for the bar.


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This Will Make You Smarter: 150 New Scientific Concepts to Improve Your Thinking by John Brockman

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23andMe, Albert Einstein, Alfred Russel Wallace, banking crisis, Barry Marshall: ulcers, Benoit Mandelbrot, Berlin Wall, biofilm, Black Swan, butterfly effect, Cass Sunstein, cloud computing, congestion charging, correlation does not imply causation, Daniel Kahneman / Amos Tversky, dark matter, data acquisition, David Brooks, delayed gratification, Emanuel Derman, epigenetics, Exxon Valdez, Flash crash, Flynn Effect, hive mind, impulse control, information retrieval, Intergovernmental Panel on Climate Change (IPCC), Isaac Newton, Jaron Lanier, John von Neumann, Kevin Kelly, lifelogging, mandelbrot fractal, market design, Mars Rover, Marshall McLuhan, microbiome, Murray Gell-Mann, Nicholas Carr, open economy, Pierre-Simon Laplace, place-making, placebo effect, pre–internet, QWERTY keyboard, random walk, randomized controlled trial, rent control, Richard Feynman, Richard Feynman, Richard Feynman: Challenger O-ring, Richard Thaler, Satyajit Das, Schrödinger's Cat, security theater, selection bias, Silicon Valley, stem cell, Steve Jobs, Steven Pinker, Stewart Brand, the scientific method, Thorstein Veblen, Turing complete, Turing machine, Vilfredo Pareto, Walter Mischel, Whole Earth Catalog, zero-sum game

“If there is a vowel on the front of the card, then there is an odd number on the back.” Some considerations about each of these questions: Question 1: If you said that the university should remodel on the grounds that it was expensive to build the old hospital, you have fallen into the “sunk-cost trap” shorthand abstraction (SHA)identified by economists. The money spent on the hospital is irrelevant—it’s sunk—and has no bearing on the present choice. Amos Tversky and Daniel Kahneman pointed out that people’s ability to avoid such traps might be helped by a couple of thought experiments like the following: Imagine that you have two tickets to tonight’s NBA game in your city and that the arena is forty miles away. But it’s begun to snow, and you’ve found out that your team’s star has been injured and won’t be playing. Should you go, or just throw away the money and skip it?

And if this is true, this anecdotalism will give new legs to the tragic misconception that the mentally ill are more dangerous than the rest of us. So maybe when I argue for anecdotalism going into everyone’s cognitive toolkit, I am really arguing for two things to be incorporated: (a) an appreciation of how distortive it can be; and (b) recognition, in a salute to the work of people like Amos Tversky and Daniel Kahneman, of its magnetic pull, its cognitive satisfaction. As social primates complete with a region of the cortex specialized for face recognition, we find that the individual face—whether literal or metaphorical—has a special power. But unappealing, unintuitive patterns of statistics and variation generally teach us much more. You Can Show That Something Is Definitely Dangerous but Not That It’s Definitely Safe Tom Standage Digital editor, The Economist; author, An Edible History of Humanity A wider understanding of the fact that you can’t prove a negative would, in my view, do a great deal to upgrade the public debate around science and technology.

Douglas Rushkoff Technologies Have Biases Our widespread inability to recognize or even acknowledge the biases of the technologies we use renders us incapable of gaining any real agency through them. Gerald Smallberg Bias Is the Nose for the Story Our brains evolved having to make the right bet with limited information. Jonah Lehrer Control Your Spotlight Too often, we assume that willpower is about having strong moral fiber. But that’s wrong. Daniel Kahneman The Focusing Illusion The mismatch in the allocation of attention between thinking about a life condition and actually living it is the cause of the focusing illusion. Carlo Rovelli The Uselessness of Certainty The very foundation of science is to keep the door open to doubt. Lawrence Krauss Uncertainty In the public parlance, uncertainty is a bad thing, implying a lack of rigor and predictability.


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How Not to Network a Nation: The Uneasy History of the Soviet Internet (Information Policy) by Benjamin Peters

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Albert Einstein, Andrei Shleifer, Benoit Mandelbrot, bitcoin, Brownian motion, Claude Shannon: information theory, cloud computing, cognitive dissonance, computer age, conceptual framework, continuation of politics by other means, crony capitalism, crowdsourcing, cuban missile crisis, Daniel Kahneman / Amos Tversky, David Graeber, Dissolution of the Soviet Union, Donald Davies, double helix, Drosophila, Francis Fukuyama: the end of history, From Mathematics to the Technologies of Life and Death, hive mind, index card, informal economy, information asymmetry, invisible hand, Jacquard loom, Jacquard loom, John von Neumann, Kevin Kelly, knowledge economy, knowledge worker, linear programming, mandelbrot fractal, Marshall McLuhan, means of production, Menlo Park, Mikhail Gorbachev, mutually assured destruction, Network effects, Norbert Wiener, packet switching, Pareto efficiency, pattern recognition, Paul Erdős, Peter Thiel, Philip Mirowski, RAND corporation, rent-seeking, road to serfdom, Ronald Coase, scientific mainstream, Steve Jobs, Stewart Brand, stochastic process, technoutopianism, The Structural Transformation of the Public Sphere, transaction costs, Turing machine

Boundary Work among Scientists in the United States and Britain during the Cold War,” in The History and Heritage of Scientific and Technical Information Systems: Proceedings of the 2002 Conference, Chemical Heritage Foundation, ed. W. Boyd Rayward and Mary Ellen Bowden, 15–28 (Medford, NJ: Information Today, 2004). 23. Arturo Rosenblueth, Norbert Wiener, and Julian Bigelow, “Behavior, Purpose, and Teleology,” Philosophy of Science 10 (1943): 18–24. 24. Daniel Kahneman and Amos Tversky, “Prospect Theory: An Analysis of Decisions under Risk,” Econometrica 47 (2) (1979): 263–291. See also Daniel Kahneman and Amos Tversky, eds., Choices, Values and Frames (New York: Cambridge University Press and Russell Sage Foundation, 2000). 25. David Stark, The Sense of Dissonance: Accounts of Worth in Economic Life (Princeton: Princeton University Press, 2009), 1–34. 26. The intellectual history of thought on hierarchy and its critics would fill many shelves.

“Two Specialists in Cybernetics: Stefan Odobleja and Norbert Wiener, Common and Different Features.” Twentieth World Congress of Philosophy (1998), accessed October 11, 2011, http://www.bu.edu/wcp/Papers/Comp/CompJurc.htm. Kahnemann, Daniel. Thinking Fast and Slow. New York: Farrar, Straus, and Giroux, 2011. Kahneman, Daniel and Amos Tversky. “Prospect Theory: An Analysis of Decisions under Risk,” Econometrica 47 (2) (1979): 263–291. Kahneman, Daniel and Amos Tversky, eds., Choices, Values and Frames. New York: Cambridge University Press and Russell Sage Foundation, 2000. Kapitonova, Yulia O., and Aleksandr A. Letichevsky, Paradigmi i idei akademika V. M. Glushkova [Paradigms and ideas of academician V. M. Glushkov]. Kiev: Naukova Dumka, 2003. Kapp, William. The Foundations of Institutional Economics.


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Adapt: Why Success Always Starts With Failure by Tim Harford

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Andrew Wiles, banking crisis, Basel III, Berlin Wall, Bernie Madoff, Black Swan, car-free, carbon footprint, Cass Sunstein, charter city, Clayton Christensen, clean water, cloud computing, cognitive dissonance, complexity theory, corporate governance, correlation does not imply causation, creative destruction, credit crunch, Credit Default Swap, crowdsourcing, cuban missile crisis, Daniel Kahneman / Amos Tversky, Dava Sobel, Deep Water Horizon, Deng Xiaoping, double entry bookkeeping, Edmond Halley, en.wikipedia.org, Erik Brynjolfsson, experimental subject, Fall of the Berlin Wall, Fermat's Last Theorem, Firefox, food miles, Gerolamo Cardano, global supply chain, Intergovernmental Panel on Climate Change (IPCC), Isaac Newton, Jane Jacobs, Jarndyce and Jarndyce, Jarndyce and Jarndyce, John Harrison: Longitude, knowledge worker, loose coupling, Martin Wolf, mass immigration, Menlo Park, Mikhail Gorbachev, mutually assured destruction, Netflix Prize, New Urbanism, Nick Leeson, PageRank, Piper Alpha, profit motive, Richard Florida, Richard Thaler, rolodex, Shenzhen was a fishing village, Silicon Valley, Silicon Valley startup, South China Sea, special economic zone, spectrum auction, Steve Jobs, supply-chain management, the market place, The Wisdom of Crowds, too big to fail, trade route, Tyler Cowen: Great Stagnation, web application, X Prize, zero-sum game

Available at: http://timharford.com/2006/05/the-poker-machine/; and Tim Harford, The Logic of Life (New York: Random House, 2008). 32 The brain refuses to register: Gary Smith, Michael Levere and Robert Kurtzman, ‘Poker Player Behavior after Big Wins and Big Losses’, Management Science, Vol. 55, No. 9 (September 2009), pp. 1547–55. 32 The great economic psychologists Daniel Kahneman and Amos Tversky: Daniel Kahneman and Amos Tversky, ‘Prospect Theory: An Analysis of Decision under Risk’, Econometrica, Vol. 47, No. 2 (1979), p. 287. 33 Found the perfect setting to analyse the way we respond to losses: Thierry Post, Martijn J. Van den Assem, Guido Baltussen and Richard H. Thaler, ‘Deal or No Deal? Decision Making under Risk in a Large-Payoff Game Show’, American Economic Review, Vol. 98, No. 1 (March 2008).

The brain refuses to register that the money has gone. Acknowledging the loss and recalculating one’s strategy would be the right thing to do, but that is too painful. Instead, the player makes crazy bets to rectify what he unconsciously believes is a temporary situation. It isn’t the initial loss that does for him, but the stupid plays he makes in an effort to deny that the loss has happened. The eat economic psychologists Daniel Kahneman and Amos Tversky summarised the behaviour in their classic analysis of the psychology of risk: ‘a person who has not made peace with his losses is likely to accept gambles that would be unacceptable to him otherwise’. Even those of us who aren’t professional poker players know how it feels to chase a loss. A few years ago, my wife and I had booked a romantic weekend in Paris. But she was pregnant, and a couple of hours before we were due to catch the train she began feeling sick.


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How Doctors Think by Jerome Groopman

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affirmative action, Atul Gawande, Daniel Kahneman / Amos Tversky, deliberate practice, fear of failure, framing effect, index card, iterative process, medical malpractice, medical residency, Menlo Park, pattern recognition, placebo effect, stem cell, theory of mind

"Aspirin poisoning, bread-and-butter toxicology," he said, "something that was drilled into me throughout my training. She was an absolutely classic case—the rapid breathing, the shift in her blood electrolytes—and I missed it. I got cavalier." As there are classic clinical maladies, there are classic cognitive errors. Alter's misdiagnosis resulted from such an error, the use of a heuristic called "availability." Amos Tversky and Daniel Kahneman, psychologists from the Hebrew University in Jerusalem, explored this shortcut in a seminal paper more than two decades ago. Kahneman won the Nobel Prize in economics in 2002 for work illuminating the way certain patterns of thinking cause irrational decisions in the marketplace; Tversky certainly would have shared the prize had he not died an untimely death in 1996. "Availability" means the tendency to judge the likelihood of an event by the ease with which relevant examples come to mind.

Ironside, "Iatrogenic contributions to suicide and a report on 37 suicide attempts," New Zealand Medical Journal 69 (1969), p. 207; John Maltsberger and Donald Buie, "Countertransference hate in the treatment of suicidal patients," Archives of General Psychiatry 30 (1974), pp. 625–633. The connections between cognition and emotion are beautifully described in Antonio Damasio's Descartes' Error: Emotion, Reason, and the Human Brain (Itasca, Ill.: Putnam, 1994). 2. Lessons from the Heart Amos Tversky and Daniel Kahneman were the pioneers in categorizing cognitive biases. Kahneman was awarded a Nobel Prize for their work; alas, Tversky died before the Nobel Committee's decision. Valuable articles by these researchers on errors include "Availability: A heuristic for judging frequency and probability," Cognitive Psychology 5 (1973), pp. 207–232, and "Judgment under uncertainty: Heuristics and biases," Science 185 (1974), pp. 1124–1131.

It provides a mental checklist that is readily retrieved from one's memory in an urgent and stressful situation. Its simplicity and comprehensiveness make it a useful aid that can move a doctor away from the far end of the Yerkes-Dodson curve where anxiety impairs performance. I wish that I'd learned these ABCs before my first day of internship when I froze in front of Mr. Morgan. Earlier, I cited the extraordinary insights of Amos Tversky and Daniel Kahneman. Their exploration of availability errors is found in "Availability: A heuristic for judging frequency and probability," Cognitive Psychology 5 (1973), pp. 207–232. Note how incomplete communication and cognitive pitfalls are linked in the case of Blanche Begaye. Once Alter had anchored his assumption that she had a viral infection, he limited his dialogue with her. In revisiting the reasons for missing the diagnosis of aspirin toxicity, he pinpointed that he did not define what "a few" meant.


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Wait: The Art and Science of Delay by Frank Partnoy

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algorithmic trading, Atul Gawande, Bernie Madoff, Black Swan, blood diamonds, Cass Sunstein, Checklist Manifesto, cognitive bias, collapse of Lehman Brothers, collateralized debt obligation, computerized trading, corporate governance, Daniel Kahneman / Amos Tversky, delayed gratification, Flash crash, Frederick Winslow Taylor, George Akerlof, Google Earth, Hernando de Soto, High speed trading, impulse control, income inequality, information asymmetry, Isaac Newton, Long Term Capital Management, Menlo Park, mental accounting, meta analysis, meta-analysis, Nick Leeson, paper trading, Paul Graham, payday loans, Ralph Nader, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, Ronald Reagan, Saturday Night Live, six sigma, Spread Networks laid a new fibre optics cable between New York and Chicago, statistical model, Steve Jobs, The Market for Lemons, the scientific method, The Wealth of Nations by Adam Smith, upwardly mobile, Walter Mischel

For most of the twentieth century, economists assumed that people discount the future at a consistent rate for both the short term and the long term.28 If our discount rate is 10 percent, they assumed, we use that same rate regardless of when we owe money—in a day, a month, or a year.29 Economists also assumed we use the same rate regardless of our level of wealth, or whether we owe or are owed money. The standard economic model assumed that people think about these factors and are consistent about risk and time. Then, in 1979, psychologists began dropping bombs on these assumptions. Daniel Kahneman and Amos Tversky published an article in Econometrica, a prestigious economics journal, arguing that the standard economic model of decisions was wrong. A few economists, particularly Richard Thaler, showed that people’s discount rates vary dramatically depending on how far into the future they are discounting. In 1981 Thaler reported the results of an experiment designed to test what people’s discount rates actually were for different periods of time by asking them a series of questions about whether they would prefer money today or in the future.

It questions the long-held assumptions by financial economists that investors are rational and act in their self-interest, as well as the mathematical equations that purport to show how markets are largely predictable and efficient. A few economists, such as Eugene Fama, one of the founding fathers of efficient market theory, continue to cling to some of these assumptions. But many financial economists are jumping ship. A wave of research, spurred on by Daniel Kahneman, Amos Tversky, and Richard Thaler, has demonstrated that investors have systematic biases. Numerous researchers have documented how we make mistakes in our financial decisions.2 We anchor around certain numbers and concepts, we travel in herds, we overreact, we are overconfident, and we are very, very bad at assessing risk.3 We trade too frequently. We pay too much for those trades. In short, we are unprofessional.

The second rule of Fight Club is: you do not talk about Fight Club!” IMDb, “Memorable Quotes for ‘Fight Club,’” http://www.imdb.com/title/tt0137523/quotes. 5 | BAD CALL Psychologists often say there are two systems of the mind: system 1, which is automatic and involuntary, and system 2, which is effortful and deliberative. They don’t really mean there are two separate physical systems. As Nobel laureate Daniel Kahneman has written, “The two systems do not really exist in the brain or anywhere else.”1 But some scientists find this two-system idea to be a useful metaphor in describing our different mental approaches. So far in this book, we have been looking at what a psychologist would refer to as system 1. As we have seen, timing and delay play an important role even for the kinds of superfast preconscious reactions that psychologists would label as automatic.


pages: 252 words: 70,424

The Self-Made Billionaire Effect: How Extreme Producers Create Massive Value by John Sviokla, Mitch Cohen

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Cass Sunstein, Colonization of Mars, corporate raider, Daniel Kahneman / Amos Tversky, Elon Musk, Frederick Winslow Taylor, game design, global supply chain, James Dyson, Jeff Bezos, John Harrison: Longitude, Jony Ive, loss aversion, Mark Zuckerberg, market design, old-boy network, paper trading, RAND corporation, randomized controlled trial, Richard Thaler, risk tolerance, self-driving car, Silicon Valley, smart meter, Steve Ballmer, Steve Jobs, Steve Wozniak, Tony Hsieh, Toyota Production System, young professional

And now we’ve got these people—we don’t know them—and they’re selling to China? How are we going to be paid? Who are we going to chase?’ 3. http://onlinenevada.org/kirk_kerkorian. 4. Michael Specter, “Branson’s Luck,” New Yorker, May 14, 2007. 5. The original paper was published by Econometrica. See Daniel Kahneman and Amos Tversky, “Prospect Theory: An Analysis of Decision Under Risk,” Econometrica 47, no. 2 (March 1979): 263–91. For a more approachable treatment, see Daniel Kahneman, Thinking Fast and Slow (New York: Farrar, Straus and Giroux, 2011), in which Kahneman revisits that work with thirty years of perspective and corroborating experiments. 6. Quote published at www.womenofchina.cn/html/womenofchina/report/123585-1.htm, accessed February 3, 2014. 7. Richard Thaler and Eric Johnson, “Gambling with the House Money and Trying to Break Even: The Effects of Prior Outcomes on Risky Choice,” Management Science (June 1990): 643–60. 8.

It means instead that the risks they take are not any larger than the risks present in everyday business transactions. More important, the real source of risk resides in other places than the average professional would see them. Risk is a matter of perception. This may seem like an uncontroversial statement, but viewing risk as a subjective rather than objective factor moves against economic orthodoxy—not to mention corporate practice. The Nobel Prize winner Daniel Kahneman and his research partner Amos Tversky first proposed the subjective nature of risk in a 1979 paper in which they describe a series of experiments they conducted to come up with their famous Prospect Theory, a model for human decision making. At its core, Prospect Theory argues that individual perceptions of risk can be influenced by how an opportunity is framed, the context in which it is presented, personal experience, and other factors.


pages: 280 words: 79,029

Smart Money: How High-Stakes Financial Innovation Is Reshaping Our WorldÑFor the Better by Andrew Palmer

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Affordable Care Act / Obamacare, algorithmic trading, Andrei Shleifer, asset-backed security, availability heuristic, bank run, banking crisis, Black-Scholes formula, bonus culture, break the buck, Bretton Woods, call centre, Carmen Reinhart, cloud computing, collapse of Lehman Brothers, collateralized debt obligation, computerized trading, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, David Graeber, diversification, diversified portfolio, Edmond Halley, Edward Glaeser, endogenous growth, Eugene Fama: efficient market hypothesis, eurozone crisis, family office, financial deregulation, financial innovation, fixed income, Flash crash, Google Glasses, Gordon Gekko, high net worth, housing crisis, Hyman Minsky, implied volatility, income inequality, index fund, information asymmetry, Innovator's Dilemma, interest rate swap, Kenneth Rogoff, Kickstarter, late fees, London Interbank Offered Rate, Long Term Capital Management, loss aversion, margin call, Mark Zuckerberg, McMansion, money market fund, mortgage debt, mortgage tax deduction, Myron Scholes, negative equity, Network effects, Northern Rock, obamacare, payday loans, peer-to-peer lending, Peter Thiel, principal–agent problem, profit maximization, quantitative trading / quantitative finance, railway mania, randomized controlled trial, Richard Feynman, Richard Feynman, Richard Thaler, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, short selling, Silicon Valley, Silicon Valley startup, Skype, South Sea Bubble, sovereign wealth fund, statistical model, transaction costs, Tunguska event, unbanked and underbanked, underbanked, Vanguard fund, web application

A control group of recipients received an e-mail reminding them of the matching-contribution rules in their 401(k) retirement plans (whereby employers match employee contributions) and telling them how much money they had put into the plan so far that year. The guinea pigs in the trial got e-mails that included extra sentences designed to act as savings cues.20 The idea was to test another big behavioral quirk: the effect that exposure to arbitrary numbers, or “anchors,” can have on people. The effect was first formally identified by Amos Tversky and Daniel Kahneman, a pair of psychologists whose studies of human decision making laid the foundations for the field of behavioral economics. In a 1974 experiment, they rigged a roulette wheel to stop at either 10 or 65 and then asked people to estimate the percentage of African countries in the United Nations. The subjects were instructed to indicate first whether the roulette-wheel number was higher or lower than their estimate for the proportion of African countries in the UN and then to give their estimate.

Keith Chen, Venkat Lakshminarayanan, and Laurie Santos, “How Basic Are Behavioural Biases? Evidence from Capuchin Monkey Trading Behaviour,” Journal of Political Economy (2006). 19. Shlomo Bernartzi and Richard Thaler, “Behavioural Economics and the Retirement Savings Crisis,” Science (March 8, 2013). 20. James Choi et al., “Small Cues Change Savings Choices” (NBER Working Paper 17843, February 2012). 21. Amos Tversky and Daniel Kahnemann, “Judgment Under Uncertainty: Heuristics and Biases,” Science (September 1974). 22. “Reverse Mortgages: Report to Congress” (Consumer Financial Protection Bureau, June 2012). 23. Esteban Calvo, Kelly Haverstick, and Natalia Zhivan, “Determinants and Consequences of Moving Decisions for Older Americans” (Center for Retirement Research at Boston College, August 2009). 24.

Being able to override heuristics appears to be a trait of the stars of the financial industry. Financial traders do significantly better than other bank employees in classic tests of cognitive reasoning like the following question: “A bat and a ball cost $1.10 in total. The bat costs $1.00 more than the ball. How many cents does the ball cost?” It may well be that the best traders are those who can switch off the rules of thumb and use a more reflective style of thinking—what Daniel Kahneman, a pioneer of behavioral finance, would call using a System 2 process rather than a System 1 process.11 The most recent crisis showed how thin on the ground such stars are. Most investors used fallible heuristics to guide their decision making. Most obviously, home buyers and lenders fell for the rule of thumb that stated house prices in the United States do not fall nationwide. But other heuristics were hard-coded into the financial system by the logic of standardization.


pages: 310 words: 82,592

Never Split the Difference: Negotiating as if Your Life Depended on It by Chris Voss, Tahl Raz

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banking crisis, Black Swan, clean water, cognitive bias, Daniel Kahneman / Amos Tversky, Donald Trump, framing effect, friendly fire, iterative process, loss aversion, market fundamentalism, price anchoring, telemarketer, ultimatum game, uranium enrichment

It was a brilliant, rational, and profound synthesis of the most advanced game theory and legal thinking of the day. For years after that book came out, everybody—including the FBI and the NYPD—focused on a problem-solving approach to bargaining interactions. It just seemed so modern and smart. Halfway across the United States, a pair of professors at the University of Chicago was looking at everything from economics to negotiation from a far different angle. They were the economist Amos Tversky and the psychologist Daniel Kahneman. Together, the two launched the field of behavioral economics—and Kahneman won a Nobel Prize—by showing that man is a very irrational beast. Feeling, they discovered, is a form of thinking. As you’ve seen, when business schools like Harvard’s began teaching negotiation in the 1980s, the process was presented as a straightforward economic analysis. It was a period when the world’s top academic economists declared that we were all “rational actors.”

What I am saying is that while our decisions may be largely irrational, that doesn’t mean there aren’t consistent patterns, principles, and rules behind how we act. And once you know those mental patterns, you start to see ways to influence them. By far the best theory for describing the principles of our irrational decisions is something called Prospect Theory. Created in 1979 by the psychologists Daniel Kahneman and Amos Tversky, prospect theory describes how people choose between options that involve risk, like in a negotiation. The theory argues that people are drawn to sure things over probabilities, even when the probability is a better choice. That’s called the Certainty Effect. And people will take greater risks to avoid losses than to achieve gains. That’s called Loss Aversion. That’s why people who statistically have no need for insurance buy it.

NOTES The pagination of this electronic edition does not match the edition from which it was made. To locate a specific passage, please use the search feature on your e-book reader CHAPTER 1: THE NEW RULES 1.Robert Mnookin, Bargaining with the Devil: When to Negotiate, When to Fight (New York: Simon & Schuster, 2010). 2.Roger Fisher and William Ury, Getting to Yes: Negotiating Agreement Without Giving In (Boston: Houghton Mifflin, 1981). 3.Daniel Kahneman, Thinking, Fast and Slow (New York: Farrar, Straus & Giroux, 2011). 4.Philip B. Heymann and United States Department of Justice, Lessons of Waco: Proposed Changes in Federal Law Enforcement (Washington, DC: U.S. Department of Justice, 1993). CHAPTER 2: BE A MIRROR 1.George A. Miller, “The Magical Number Seven, Plus or Minus Two: Some Limits on Our Capacity for Processing Information,” Psychological Review 63, no. 2 (1956): 81–97.


pages: 410 words: 101,260

Originals: How Non-Conformists Move the World by Adam Grant

Albert Einstein, Apple's 1984 Super Bowl advert, availability heuristic, barriers to entry, business process, business process outsourcing, Cass Sunstein, clean water, cognitive dissonance, creative destruction, cuban missile crisis, Daniel Kahneman / Amos Tversky, Dean Kamen, double helix, Elon Musk, fear of failure, Firefox, George Santayana, Ignaz Semmelweis: hand washing, Jeff Bezos, job satisfaction, job-hopping, Joseph Schumpeter, Kickstarter, Lean Startup, Louis Pasteur, Mahatma Gandhi, Mark Zuckerberg, meta analysis, meta-analysis, minimum viable product, Network effects, pattern recognition, Paul Graham, Peter Thiel, Ralph Waldo Emerson, random walk, risk tolerance, Rosa Parks, Saturday Night Live, Silicon Valley, Skype, Steve Jobs, Steve Wozniak, Steven Pinker, The Wisdom of Crowds, women in the workforce

After all, a bird in the hand is worth two in the bush. But in the second case, we’re presented with a guaranteed loss. Now, we’re willing to do whatever it takes to avoid that loss, even if it means risking an even bigger one. We’re going to lose thousands of jobs anyway, so we throw caution to the wind and make the big gamble, hoping that we’ll lose nothing. This line of research was conducted by psychologists Amos Tversky and Daniel Kahneman; it helped give rise to the field of behavioral economics and win Kahneman a Nobel Prize. It revealed that we can dramatically shift risk preferences just by changing a few words to emphasize losses rather than gains. This knowledge has major implications for understanding how to motivate people to take risks. If you want people to modify their behavior, is it better to highlight the benefits of changing or the costs of not changing?

“By the time we were ready”: Personal interview with Brian Goshen, September 22, 2014. championed environmental issues: Lynne M. Andersson and Thomas S. Bateman, “Individual Environmental Initiative: Championing Natural Environmental Issues in U.S. Business Organizations,” Academy of Management Journal 43 (2000): 548–70. sense of urgency: John Kotter, Leading Change (Boston: Harvard Business School Press, 1996). dramatically shift risk preferences: Amos Tversky and Daniel Kahneman, “The Framing of Decisions and the Psychology of Choice,” Science 211 (1981): 453–58; Max Bazerman, Judgment in Managerial Decision Making (New York: John Wiley, 1994). perceive the new behavior as safe or risky: Alexander J. Rothman, Roger D. Bartels, Jhon Wlaschin, and Peter Salovey, “The Strategic Use of Gain- and Loss-Framed Messages to Promote Healthy Behavior: How Theory Can Inform Practice,” Journal of Communication 56 (2006): 202–20.

Linking Domain Expertise to Intuitive Decision-Making Effectiveness,” Organizational Behavior and Human Decision Processes 119 (2012): 187–94. intuitions are only trustworthy: Daniel Kahneman and Gary Klein, “Conditions for Intuitive Expertise: A Failure to Disagree,” American Psychologist 64 (2009): 515–26. The more successful people have been: Pino G. Audia, Edwin A. Locke, and Ken G. Smith, “The Paradox of Success: An Archival and a Laboratory Study of Strategic Persistence Following Radical Environmental Change,” Academy of Management Journal 43 (2000): 837–53. five dozen angel investors: Cheryl Mitteness, Richard Sudek, and Melissa S. Cardon, “Angel Investor Characteristics That Determine Whether Perceived Passion Leads to Higher Evaluations of Funding Potential,” Journal of Business Venturing 27 (2012): 592606. intuition operates rapidly: Daniel Kahneman, Thinking, Fast and Slow (New York: Macmillan, 2011).


pages: 387 words: 110,820

Cheap: The High Cost of Discount Culture by Ellen Ruppel Shell

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barriers to entry, Berlin Wall, big-box store, cognitive dissonance, computer age, creative destruction, Daniel Kahneman / Amos Tversky, delayed gratification, deskilling, Donald Trump, Edward Glaeser, fear of failure, Ford paid five dollars a day, Frederick Winslow Taylor, George Akerlof, global supply chain, global village, greed is good, Howard Zinn, income inequality, interchangeable parts, inventory management, invisible hand, James Watt: steam engine, Joseph Schumpeter, Just-in-time delivery, knowledge economy, loss aversion, market design, means of production, mental accounting, Pearl River Delta, Ponzi scheme, price anchoring, price discrimination, race to the bottom, Richard Thaler, Ronald Reagan, side project, Steve Jobs, The Market for Lemons, The Wealth of Nations by Adam Smith, Thomas L Friedman, trade liberalization, traveling salesman, ultimatum game, Victor Gruen, washing machines reduced drudgery, working poor, yield management, zero-sum game

It doesn’t explain why people decline to pay more than $200 for a ticket to a football game and yet refuse to sell that same ticket for $300. (If they won’t pay more than $200 for the ticket, then $300 should in theory be worth more to them than the ticket.) In fact, utility maximization doesn’t explain many ways in which real people relate to money. In their seminal “Prospect Theory: An Analysis of Decision Under Risk,” published in the journal Econometrica in 1979, Israel-born psychologists Daniel Kahneman and Amos Tversky challenged the homo economicus orthodoxy. They argued that human decision making is less a matter of weighing evidence and calculating probabilities than it is of reconciling new information with old familiar patterns branded into the brain from as early as birth. These patterns of mind, or what psychologists call “heuristics,” allow us to make judgments quickly. Much like Freud’s primary system, they require very little if any conscious thought, and that is as it should be.

Those who were asked to memorize a long list were much more likely to choose chocolate cake, which the authors theorize indicates that their higher order brain is swamped in thought, allowing their lower order, more impulsive brain to assert itself. 60 “response to block the cognitive assessment”: Jodie Ferguson, “Beliefs of Fair Price Setting Rules: Pervasiveness in the Marketplace and Effects on Perceptions of Price Fairness,” dissertation delivered in abstract form at Fordham Pricing Conference, September 28, 2007, Fordham University, New York. 61 “the laws of society, is not altogether without it”: Adam Smith, The Theory of Moral Sentiments (1790, 6th edition), Part 1, Sec. 1, Ch 1:9. 62 “An Analysis of Decision Under Risk”: Daniel Kahneman and Amos Tversky, “Prospect Theory: An Analysis of Decision Under Risk,” Econometrica 47, no. 2 (1979): 363-91. 63 are projected far into the future: See, for example, D. Soman et al., “The Psychology of Intertemporal Discounting: Why Are Distant Events Valued Differently from Proximal Ones?” Marketing Letters 16, nos. 3/4 (2005): 347-60. 63 the distance estimated by the students: Plenary lecture at the annual meeting of the American Association for the Advancement of Science, February 15, 2008, in Boston. 64 “for a new field of research”: As announced in the press release from the Royal Swedish Academy of Science, October 9, 2002, available at http://nobelprize. org/nobel__prizes/economics/laureates/2002/press.html. 65 when making financial transactions: Thaler compressed and compiled many of these cases into a book.

Discount retailers rely heavily on psychological manipulation to set customers up for the buy, but as Burman demonstrated, this tactic can backfire if customers get wise to it. “High-cognition customers will feel cheated, and this negative feeling will be transferred onto the product,” she said. “The value perception of the product itself may be reduced.” Again, most of us are highly sensitive to what we perceive as the fairness of transactions. Daniel Kahneman once surveyed randomly selected adults, asking them whether they thought it was okay for a hardware store to raise the price of snow shovels during a snowstorm, and the response was a resounding no. Years later another team of social scientists asked the same question of a large group of executives and got pretty much the same response. Yet whether it is truly unfair to raise the price of a snow shovel during a storm is debatable.


pages: 309 words: 95,495

Foolproof: Why Safety Can Be Dangerous and How Danger Makes Us Safe by Greg Ip

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Affordable Care Act / Obamacare, Air France Flight 447, air freight, airport security, Asian financial crisis, asset-backed security, bank run, banking crisis, break the buck, Bretton Woods, capital controls, central bank independence, cloud computing, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency peg, Daniel Kahneman / Amos Tversky, diversified portfolio, double helix, endowment effect, Exxon Valdez, financial deregulation, financial innovation, Financial Instability Hypothesis, floating exchange rates, full employment, global supply chain, hindsight bias, Hyman Minsky, Joseph Schumpeter, Kenneth Rogoff, London Whale, Long Term Capital Management, market bubble, money market fund, moral hazard, Myron Scholes, Network effects, new economy, offshore financial centre, paradox of thrift, pets.com, Ponzi scheme, quantitative easing, Ralph Nader, Richard Thaler, risk tolerance, Ronald Reagan, savings glut, technology bubble, The Great Moderation, too big to fail, transaction costs, union organizing, Unsafe at Any Speed, value at risk, William Langewiesche, zero-sum game

Since the probability of flipping heads is 50 percent, the expected value of this bet is 50 percent × $1,000 = $500. Another approach is to imagine you flipped a coin 100 times. You’d probably come up heads 50 times and win $50,000, which works out to $500 per coin flip. 9 Amos Tversky and Daniel Kahneman, two Israeli psychologists: The findings of Tversky and Kahneman are based on their papers “Advances in Prospect Theory: Cumulative Representation of Uncertainty,” Journal of Risk and Uncertainty 5 (1992): 297–323, and ”Prospect Theory: An Analysis of Decision under Risk,” Econometrica 47, no. 2 (1979): 263–291, and Daniel Kahneman’s book Thinking, Fast and Slow (New York: Farrar, Straus and Giroux, 2011). I have modified one of their examples to express the value of the bet in dollars; their original paper didn’t specify a currency. 10 In other words, the typical: The expected value is the reward, times its probability.

In fact, even if I raise the value of the prize for flipping heads to $1,200, you will still probably pick the first option. That simply demonstrates that real people are not “risk neutral”: they value certainty so much that they will give up economic value to achieve it. This observation was first made by the Swiss mathematician Daniel Bernoulli in 1738 and has been confirmed repeatedly in real life and experimental settings. Amos Tversky and Daniel Kahneman, two Israeli psychologists, concluded after a series of experiments that the expected value of a gamble would have to be worth twice as much as the sure thing before people found it equally appealing. In other words, the typical person wouldn’t pick the coin flip over $500 in an envelope until he was promised $2,000 for winning the coin flip. So people put enormous value on probabilities of 100 percent.

This tends to happen in the case of extreme events—devastating floods, earthquakes, and financial crises—when insurance must cope with two problems: emotional consumers, and emotional insurance companies. Recall that Howard Kunreuther, a risk expert at the Wharton School, says that consumers suffer from “disaster myopia”: they are simply incapable of evaluating risk when probabilities are small. Kunreuther, Nathan Novemsky, and Daniel Kahneman demonstrated this incisively in an experiment they reported on in 2001. They asked several hundred participants to consider a scenario that described a chemical plant in an urban New Jersey area that used a dangerous chemical called Syntox (in fact, a fictitious agent). An accidental release of the chemical could produce a deadly toxic plume. They then showed three separate groups of participants three different probabilities that someone living near the plant might die in any given year from a toxic discharge: 1 in 100,000, 1 in 1 million, or 1 in 10 million.


pages: 324 words: 93,175

The Upside of Irrationality: The Unexpected Benefits of Defying Logic at Work and at Home by Dan Ariely

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Alvin Roth, assortative mating, Burning Man, business process, cognitive dissonance, corporate governance, Daniel Kahneman / Amos Tversky, end world poverty, endowment effect, Exxon Valdez, first-price auction, Frederick Winslow Taylor, George Akerlof, happiness index / gross national happiness, Jean Tirole, job satisfaction, knowledge economy, knowledge worker, loss aversion, Peter Singer: altruism, placebo effect, Richard Thaler, Saturday Night Live, second-price auction, software as a service, The Wealth of Nations by Adam Smith, ultimatum game, Upton Sinclair, young professional

Chapter 1: Paying More for Less: Why Big Bonuses Don’t Always Work Based on Dan Ariely, Uri Gneezy, George Loewenstein, and Nina Mazar, “Large Stakes and Big Mistakes,” The Review of Economic Studies 76, vol. 2 (2009): 451–469. Racheli Barkan, Yosef Solomonov, Michael Bar-Eli, and Dan Ariely, “Clutch Players at the NBA,” manuscript, Duke University, 2010. Mihály Csíkszentmihályi, Flow: The Psychology of Optimal Experience (New York: Harper and Row, 1990). Daniel Kahneman and Amos Tversky, “Prospect Theory: An Analysis of Decision under Risk,” Econometrica 47, no. 2 (1979): 263–291. Robert Yerkes and John Dodson, “The Relation of Strength of Stimulus to Rapidity of Habit-Formation,” Journal of Comparative Neurology and Psychology 18 (1908): 459–482. Robert Zajonc, “Social Facilitation,” Science 149 (1965): 269–274. Robert Zajonc, Alexander Heingartner, and Edward Herman, “Social Enhancement and Impairment of Performance in the Cockroach,” Journal of Personality and Social Psychology 13, no. 2 (1969): 83–92.

Neeli Bendapudi and Robert P. Leone, “Psychological Implications of Customer Participation in Co-Production,” Journal of Marketing 67, no. 1 (2003): 14–28. Ziv Carmon and Dan Ariely, “Focusing on the Forgone: How Value Can Appear So Different to Buyers and Sellers,” Journal of Consumer Research 27, no. 3 (2000): 360–370. Daniel Kahneman, Jack Knetsch, and Richard Thaler, “Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias,” Journal of Economic Perspectives 5, no. 1 (1991): 193–206. Daniel Kahneman, Jack Knetsch, and Richard Thaler, “Experimental Tests of the Endowment Effect and the Coase Theorem,” The Journal of Political Economy 98, no. 6 (1990): 1325–1348. Jack Knetsch, “The Endowment Effect and Evidence of Nonreversible Indifference Curves,” The American Economic Review 79, no. 5 (1989): 1277–1284.

The funny thing about this theory is that if you follow it to its logical conclusion, you would not only pay CEOs ridiculously high salaries, but you would also force them to spend more time with their friends and families and send them on expensive vacations in order to complete the picture of a perfect life—because this would be the best way to motivate other people to try to become CEOs. *Each participant played in a different, random order. The order of the games did not make a difference in terms of performance. *Loss aversion is a powerful idea that was introduced by Danny Kahneman and Amos Tversky, and it has been applied to many domains. For this line of work, Danny received the 2002 Nobel Prize in Economics (sadly, Amos had already passed away in 1996). *I suspect that economists who fully believe in the rationality of businesses have never worked a day outside academia. *In defense of those who place too much confidence in their intuition, the payment-to-performance link is not easy to figure out or study.


pages: 487 words: 151,810

The Social Animal: The Hidden Sources of Love, Character, and Achievement by David Brooks

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Albert Einstein, asset allocation, assortative mating, Atul Gawande, Bernie Madoff, business process, Cass Sunstein, choice architecture, clean water, creative destruction, Daniel Kahneman / Amos Tversky, David Brooks, delayed gratification, deliberate practice, disintermediation, Donald Trump, Douglas Hofstadter, Emanuel Derman, en.wikipedia.org, fear of failure, financial deregulation, financial independence, Flynn Effect, George Akerlof, Henri Poincaré, hiring and firing, impulse control, invisible hand, Joseph Schumpeter, labor-force participation, loss aversion, medical residency, meta analysis, meta-analysis, Monroe Doctrine, Paul Samuelson, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, school vouchers, six sigma, Steve Jobs, Steven Pinker, the scientific method, The Spirit Level, The Wealth of Nations by Adam Smith, Thorstein Veblen, transaction costs, Walter Mischel, young professional

As M. Mitchell Waldrop put it, “Theoretical economists use their mathematical prowess the way great stags of the forest use their antlers: to do battle with one another and to establish dominance. A stag who doesn’t use his antlers is nothing.” Behavioral economists argue that the caricature is not accurate enough to produce reliable predictions about real events. Two psychologists, Daniel Kahneman and Amos Tversky, were the pioneers. Then their insights were picked up by economists proper: including Richard Thaler, Sendhil Mullainathan, Robert Schiller, George Akerlof, and Colin Camerer. These scholars investigate cognition that happens below the level of awareness. Rationality is bounded by emotion. People have a great deal of trouble exercising self-control. They perceive the world in biased ways.

In the nonaroused state, 23 percent said they could imagine having sex with a twelve-year-old girl. In the aroused state, 46 percent said they could imagine it. In the nonaroused state, 20 percent said they would try to have sex with their date after she said no. In the aroused state, 45 percent said they would keep trying. Finally, there is loss aversion. Losing money brings more pain than winning money brings pleasure. Daniel Kahneman and Amos Tversky asked people if they would accept certain bets. They found that people needed the chance of winning $40 if they were going to undergo a bet that might cost them $20. Because of loss aversion investors are quicker to sell stocks that have made them money than they are to sell stocks that have been declining. They’re making self-destructive decisions because they don’t want to admit their losses.

Ornstein, Multimind: A New Way of Looking at Human Behavior (New York: Houghton Mifflin, 1996), 86. 21 high Social Security numbers Dan Ariely, “The Fallacy of Supply and Demand,” Huffington Post, March 20, 2008, http://www.huffingtonpost.com/dan-ariely/the-fallacy-of-supply-and_b_92590.html. 22 People who are given Hallinan, 50. 23 “Their predictions became” Jonah Lehrer, How We Decide (New York: Houghton Mifflin Co., 2009), 146. 24 They just stick with Thaler and Sunstein, 34. 25 The picture of the smiling Hallinan, 101. 26 In the aroused state Ariely, 96 and 106. 27 Daniel Kahneman and Amos Tversky Jonah Lehrer, “Loss Aversion,” The Frontal Cortex, February 10, 2010, http://scienceblogs.com/cortex/2010/02/loss_aversion.php. CHAPTER 12: FREEDOM AND COMMITMENT 1 In Guess culture Oliver Burkerman, “This Column Will Change Your Life,” The Guardian, May 8, 2010, http://www.guardian.co.uk/lifeandstyle/2010/may/08/change-life-asker-guesser. 2 Thirty-eight percent of young Americans “Pew Report on Community Satisfaction,” Pew Research Center (January 29, 2009): 10, http://pewsocialtrends.org/assets/pdf/Community-Satisfaction.pdf. 3 In Western Europe William A.


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SuperFreakonomics by Steven D. Levitt, Stephen J. Dubner

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agricultural Revolution, airport security, Andrei Shleifer, Atul Gawande, barriers to entry, Bernie Madoff, call centre, clean water, cognitive bias, collateralized debt obligation, creative destruction, credit crunch, Daniel Kahneman / Amos Tversky, deliberate practice, Did the Death of Australian Inheritance Taxes Affect Deaths, disintermediation, endowment effect, experimental economics, food miles, indoor plumbing, Intergovernmental Panel on Climate Change (IPCC), John Nash: game theory, Joseph Schumpeter, Joshua Gans and Andrew Leigh, loss aversion, Louis Pasteur, market design, microcredit, Milgram experiment, oil shale / tar sands, patent troll, presumed consent, price discrimination, principal–agent problem, profit motive, randomized controlled trial, Richard Feynman, Richard Feynman, Richard Thaler, selection bias, South China Sea, Stephen Hawking, The Wealth of Nations by Adam Smith, too big to fail, trickle-down economics, ultimatum game, urban planning, William Langewiesche, women in the workforce, young professional

. / 169 A Stern warning: see Nicholas Herbert Stern, The Economics of Climate Change: The Stern Review (Cambridge University Press, 2007). / 169 There is much to be read about the influence of uncertainty, especially as it compares with its cousin risk. The Israeli psychologists Amos Tversky and Daniel Kahneman, whose work is generally credited with giving ultimate birth to behavioral economics, conducted pioneering research on how people make decisions under pressure and found that uncertainty leads to “severe and systematic errors” in judgment. (See “Judgment Under Uncertainty: Heuristics and Biases,” from Judgment Under Uncertainty: Heuristics and Biases, ed. Daniel Kahneman, Paul Slovic, and Amos Tversky [Cambridge University Press, 1982].) We wrote about the difference between risk and uncertainty in a New York Times Magazine column (“The Jane Fonda Effect,” September 16, 2007) about the fear over nuclear power: “[The economist Frank Knight] made a distinction between two key factors in decision making: risk and uncertainty.

His stay at Arizona was brief, for he was soon recruited by the University of Maryland. While teaching there, he also served on the President’s Council of Economic Advisors; List was the lone economist on a forty-two-person U.S. delegation to India to help negotiate the Kyoto Protocol. He was by now firmly at the center of experimental economics, a field that had never been hotter. In 2002, the Nobel Prize for economics was shared by Vernon Smith and Daniel Kahneman, a psychologist whose research on decision-making laid the groundwork for behavioral economics. These men and others of their generation had built a canon of research that fundamentally challenged the status quo of classical economics, and List was following firmly in their footsteps, running variants of Dictator and other behavioralist lab games. But since his days at Stevens Point, he had also been conducting quirky field experiments—studies where the participants didn’t know an experiment was going on—and found that the lab findings didn’t always hold up in the real world.

ULTIMATUM AND DICTATOR: The first paper on Ultimatum as it is commonly known is Werner Guth, Rolf Schmittberger, and Bernd Schwarze, “An Experimental Analysis of Ultimatum Bargaining,” Journal of Economic Behavior and Organization 3, no. 4 (1982). For a good background on the evolution of such games, see Steven D. Levitt and John A. List, “What Do Laboratory Experiments Measuring Social Preferences Tell Us About the Real World,” Journal of Economic Perspectives 21, no. 2 (2007). See also: Daniel Kahneman, Jack L. Knetsch, and Richard Thaler, “Fairness as a Constraint on Profit Seeking: Entitlements in the Market,” American Economic Review 76, no. 4 (September 1986); Robert Forsythe, Joel L. Horowitz, N. E. Savin, and Martin Sef-ton, “Fairness in Simple Bargaining Experiments,” Games and Economic Behavior 6, no. 3 (May 1994); Colin F. Camerer, Behavioral Game Theory (Princeton University Press, 2003); and John A.


pages: 387 words: 120,155

Inside the Nudge Unit: How Small Changes Can Make a Big Difference by David Halpern

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Affordable Care Act / Obamacare, availability heuristic, carbon footprint, Cass Sunstein, centre right, choice architecture, cognitive dissonance, collaborative consumption, correlation does not imply causation, Daniel Kahneman / Amos Tversky, endowment effect, happiness index / gross national happiness, hindsight bias, illegal immigration, job satisfaction, Kickstarter, libertarian paternalism, light touch regulation, market design, meta analysis, meta-analysis, Milgram experiment, nudge unit, peer-to-peer lending, pension reform, presumed consent, QR code, quantitative easing, randomized controlled trial, Richard Feynman, Richard Thaler, Right to Buy, Ronald Reagan, Rory Sutherland, Simon Kuznets, skunkworks, the built environment, theory of mind, traffic fines, World Values Survey

Prior to this, David was Chief Analyst in the Prime Minister’s Strategy Unit (2001–2007), and has held academic positions at the Universities of Cambridge, Oxford and Harvard. To the elected FOREWORD ONE OF THE most powerful and pernicious of the many cognitive biases that have been uncovered by behavioural scientists is ‘hindsight bias’, first investigated by Baruch Fischhoff when he was a graduate student studying at the Hebrew University with Daniel Kahneman and Amos Tversky. Simply put, hindsight bias is the phenomenon that after the fact, we think we knew it all along. Would America elect an African-American as President before a woman? Sure, we all thought that could happen. Did we think in 2000 that fifteen years later most of us would be carrying powerful computers in our pockets that could keep us up-to-date with email, answer nearly any factual question just by speaking to it, and get us anywhere without getting lost?

The rise of empirical social psychology marked a decisive shift in approach to the study of human behaviour, from the armchair musings of philosophers into an empirical project. In so doing, it has had profound ramifications for how we think of everything from war and wickedness, to kindness and love. Third, cognitive psychology has looked into our internal thought processes. To most contemporary psychologists, the ground-breaking work of Amos Tversky and Daniel Kahneman from the 1970s onwards stands out, highlighting the mental shortcuts that people use in everyday decision-making. For example, people generally don’t estimate the safety of air versus car travel by dividing the number of crashes over the last year by the number of planes versus cars travelling in the world over that time. Rather, most people use a mental shortcut along the lines of how easily they can recall examples of planes versus cars crashing – what Tversky and Kahneman called an ‘availability’ heuristic.

It considers whether behavioural insights have anything to add to the deepest and most daunting challenges that face us today, including how we get along with our fellow humans – challenges and frontiers that ‘nudgers’ are starting to explore. Suffice it to say that when the time came for the two-year sunset review of BIT, far from shutting the team down the Prime Minister decided to expand it. The Nobel Laureate Daniel Kahneman, whose research has led the field, commended the team’s work. The press, civil service and political parties turned – for the most part – from sceptics to supporters. Love it, or hate it, nudging is here to stay. The history and remarkable results of the 10 Downing Street Behavioural Insights Team have led governments across the world to adopt similar approaches, many advised by the Behavioural Insights Team itself.


pages: 263 words: 75,455

Quantitative Value: A Practitioner's Guide to Automating Intelligent Investment and Eliminating Behavioral Errors by Wesley R. Gray, Tobias E. Carlisle

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activist fund / activist shareholder / activist investor, Albert Einstein, Andrei Shleifer, asset allocation, Atul Gawande, backtesting, beat the dealer, Black Swan, capital asset pricing model, Checklist Manifesto, cognitive bias, compound rate of return, corporate governance, correlation coefficient, credit crunch, Daniel Kahneman / Amos Tversky, discounted cash flows, Edward Thorp, Eugene Fama: efficient market hypothesis, forensic accounting, hindsight bias, intangible asset, Louis Bachelier, p-value, passive investing, performance metric, quantitative hedge fund, random walk, Richard Thaler, risk-adjusted returns, Robert Shiller, Robert Shiller, shareholder value, Sharpe ratio, short selling, statistical model, survivorship bias, systematic trading, The Myth of the Rational Market, time value of money, transaction costs

For example, if we are given a test and after taking it asked to determine the number of questions that we got right, we tend to overrate how well we performed. This is not a matter of simply incorrectly guessing our performance on the test because the errors all tend to be in one direction—we reliably overestimate how well we perform. Further, the more difficult the questions, and the less familiar we are with the content, the more we tend overestimate how well we performed. The two pioneers of the field of behavioral finance, Daniel Kahneman and Amos Tversky, suggest that our overconfidence may stem from two other biases, self-attribution bias and hindsight bias.34 Self-attribution bias refers to our propensity to ascribe our successes to our skill, while blaming our failures on bad luck, rather than a lack of skill. For example, the stocks we buy that go up show our great stock picking skills, while those we buy that go down do so because of some outside factor, like Congress changing the law or the Federal Reserve increasing interest rates.

Wall Street Journal, Fund Track (December 31, 2009), http://online.wsj.com/article/SB10001424052748704876804574628561609012716.html. 33. Jesse J. Prinz, Gut Reactions: A Perceptual Theory of Emotion (Philosophy of Mind) (Oxford: Oxford University Press, USA, 2004). 34. Nicholas Barberis and Richard Thaler, “A Survey of Behavioral Finance.” NBER Working Paper No. 9222, September 2002, www.nber.org/papers/w9222. 35. Amos Tversky and Daniel Kahneman, “Judgment under Uncertainty: Heuristics and Biases.” Science, New Series 185(4157) (September 27, 1974): 1124–1131; www.jstor.org/pss/1738360. 36. Dan Ariely, Predictably Irrational: The Hidden Forces that Shape Our Decisions (New York: HarperCollins, 2008). 37. Philip E. Tetlock. Expert Political Judgment: How Good Is It? How Can We Know? (Princeton University Press, 2005). 38.


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Progress: Ten Reasons to Look Forward to the Future by Johan Norberg

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agricultural Revolution, anti-communist, availability heuristic, Bartolomé de las Casas, Berlin Wall, British Empire, business climate, clean water, continuation of politics by other means, Daniel Kahneman / Amos Tversky, demographic transition, desegregation, Donald Trump, Flynn Effect, germ theory of disease, Gini coefficient, Gunnar Myrdal, Haber-Bosch Process, Hans Island, Hans Rosling, Ignaz Semmelweis: hand washing, income inequality, income per capita, indoor plumbing, Isaac Newton, Jane Jacobs, John Snow's cholera map, Kibera, Louis Pasteur, Mahatma Gandhi, meta analysis, meta-analysis, Mikhail Gorbachev, more computing power than Apollo, moveable type in China, Naomi Klein, open economy, place-making, Rosa Parks, sexual politics, special economic zone, Steven Pinker, telerobotics, The Wealth of Nations by Adam Smith, transatlantic slave trade, very high income, working poor, Xiaogang Anhui farmers, zero-sum game

If we didn’t want to read about, listen to and watch bad news, journalists would not report it. Indeed, when they don’t cover it, we often make up a worst-case scenario ourselves. When news reporters do not have access to a spectacular event, we often fill in the gaps with rumours and horror stories. When something bad happens anywhere, two billion smartphones will nowadays make sure that we find out, even if no reporters are on the scene. The psychologists Daniel Kahneman and Amos Tversky have shown that people do not base their estimates of how frequent something is on data, but on how easy it is to recall examples from memory.16 This ‘availability heuristic’ means that the more memorable an incident is, the more probable we think it is, so we imagine that horrible and shocking things, which stay in our thoughts, are more frequent than they are. We are probably built to be worried.

Damon, Michael L. Washington, ‘Estimating the future number of cases in the Ebola epidemic – Liberia and Sierra Leone, 2014–2015’, Morbidity and Mortality Weekly Report Supplements, 63, 3 (2014), 1–14. 13 ‘Predictions with a Purpose’, The Economist, 7 February 2015. 14 Strömstads Tidning, 30 June 2007. 15 Anders Bolling, Apokalypsens gosiga mörker. Stockholm: Bonniers, 2009, p. 51. 16 Amos Tversky and Daniel Kahneman, ‘Availability: a heuristic for judging frequency and probability’, Cognitive Psychology, 5, 2 (1973), 207–232. 17 Steven Pinker, ‘If everything is getting better, why are people so pessimistic?’, Cato Policy Report, January/February 2015. 18 Roy F. Baumeister, Ellen Bratslavsky, Catrin Finkenauer and Kathleen D. Vohs, ‘Bad is stronger than good’, Review of General Psychology, 5, 4 (2001), 323–70, p. 323f. 19 Arthur Herman, The Idea of Decline in Western History.

Everydata: The Misinformation Hidden in the Little Data You Consume Every Day by John H. Johnson

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Affordable Care Act / Obamacare, Black Swan, business intelligence, Carmen Reinhart, cognitive bias, correlation does not imply causation, Daniel Kahneman / Amos Tversky, Donald Trump, en.wikipedia.org, Kenneth Rogoff, labor-force participation, lake wobegon effect, Long Term Capital Management, Mercator projection, Mercator projection distort size, especially Greenland and Africa, meta analysis, meta-analysis, Nate Silver, obamacare, p-value, PageRank, pattern recognition, publication bias, QR code, randomized controlled trial, risk-adjusted returns, Ronald Reagan, selection bias, statistical model, The Signal and the Noise by Nate Silver, Thomas Bayes, Tim Cook: Apple, wikimedia commons, Yogi Berra

Andrew Simon, “Game 1 Rout Not Necessarily Precursor to Title,” MLB.com website, October 23, 2013, http://m.mlb.com/news/article/63287950. 23. Burton G. Malkiel, “Returns from Investing in Equity Mutual Funds, ­1971–​ ­1991,” Journal of Finance 50 (1995), ­549–​­572. 24. Not to mention the distinction between causation and correlation, which we talked about in chapter 4. 25. Esteemed economist Daniel Kahneman shared the Nobel Prize in 2002 for his work related to psychological factors that affect our decisions. Much of Kahneman’s work was done in collaboration with Amos Tversky, who passed away in 1996 and was therefore ineligible for the Nobel Prize. 26. In case you’re wondering, the first example is the Johns Hopkins Hospital (“The Johns Hopkins Hospital Ranked Among the Top Hospitals in the Nation in 2015,” Johns Hopkins Medicine website, accessed September 1, 2015, http:// www.hopkinsmedicine.org/usnews/); the second is Mayo Clinic (Mayo Clinic website homepage, accessed September 1, 2015, http://www.mayoclinic.org/); and the third is New ­York-​­Presbyterian (“Awards and Recognition,” New ­York-​­Presbyterian website, accessed September 1, 2015, http://nyp.org/about/­ americas-​­top-​­doctors.html). 27.

But it’s also influenced by other, past ­factors—​­everything from your fatigue to your state of mind after making (or missing) your past shot. That said, there is conflicting research in terms of whether or not athletes can have a so‑called “hot hand,” with one paper finding that “[t]he belief in the hot hand and the ‘detection’ of streaks in random sequences is attributed to a general misconception 221158 i-xiv 1-210 r4ga.indd  186 2/8/16  5:58:50 PM Notes 187 of chance” (Thomas Gilovich, Robert Vallone, and Amos Tversky, “The Hot Hand in Basketball: On the Misperception of Random Sequences,” Cognitive Psychology 17 (1985): ­295–​­314, http://citeseerx.ist.psu.edu/viewdoc/ summary?doi=10.1.1.115.6700), while a study from Harvard found that “players who are outperforming will continue to do so, conditional on the difficulty of their present shot” (Andrew Bocskocsky, John Ezekowitz, and Carolyn Stein, “The Hot Hand: A New Approach to an Old ‘Fallacy,’ ” presented at the MIT Sloan Sports Analytics Conference, February 28–March 1, 2014, http://www.sloansportsconference.com/wp‑content/uploads/2014/02/­2014 _SSAC_The-​­Hot-​­Hand‑A‑­New-​­Approach.pdf). 26.

Melissa Dahl, “Most of Us Think We’re Hotter Than Average, Survey Says,” NBC News website, September 8, 2010, http://www.nbcnews.com/ id/39044399/ns/­h ealth-​­skin_and_beauty/t/most‑us‑­t hink-​­were-​­hotter​ -​­average-​­survey-​­says/#.VcO_OflViko. 42. Ola Svenson, “Are We All Less Risky and More Skillful Than Our Fellow Drivers?,” Acta Psychologica 47, no. 2 (February 1981): ­143–​­148. 43. “Podcast,” A Prairie Home Companion website, accessed September 1, 2015, http://prairiehome.org/listen/podcast/. 44. If you want to learn more about these biases, pick up a copy of Daniel Kahneman’s Thinking, Fast and Slow (New York: Farrar, Straus and Giroux, 2013). 45. Adrian Furnham, Joanna Moutafi, and Thomas ­Chamorro-​­Premuzic, “Personality and Intelligence: Gender, the Big Five, ­Self-​­Estimated and Psychometric Intelligence,” International Journal of Selection and Assessment 13 (March 4, 2005): ­11–​­24, doi: 10.1111/j.­0965-​­075X.2005.00296.x. 46. Okay, so this isn’t a perfect comparison.


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Essentialism: The Disciplined Pursuit of Less by Greg McKeown

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Albert Einstein, Clayton Christensen, Daniel Kahneman / Amos Tversky, deliberate practice, double helix, en.wikipedia.org, endowment effect, Isaac Newton, iterative process, Jeff Bezos, Lao Tzu, loss aversion, Mahatma Gandhi, microcredit, minimum viable product, North Sea oil, Peter Thiel, Ralph Waldo Emerson, Richard Thaler, Rosa Parks, side project, Silicon Valley, Silicon Valley startup, sovereign wealth fund, Steve Jobs, Vilfredo Pareto

Hansen, Great by Choice: Uncertainty, Chaos, and Luck—Why Some Thrive Despite Them All (New York: Harper Business, 2011). 6. Daniel Kahneman and Amos Tversky, “Intuitive Prediction: Biases and Corrective Procedures,” TIMS Studies in Management Science 12 (1979): 313–27. 7. Roger Buehler, Dale Griffin, and Michael Ross, “Exploring the ‘Planning Fallacy’: Why People Underestimate Their Task Completion Times,” Journal of Personality and Social Psychology 67, no. 3 (1994): 366–81, doi:10.1037/0022-3514.67.3.366. 8. Roger Buehler, Dale Griffin, and Michael Ross, “Inside the Planning Fallacy: The Causes and Consequences of Optimistic Time Predictions,” in Heuristics and Biases: The Psychology of Intuitive Judgment, ed. Thomas Gilovich, Dale Griffin, and Daniel Kahneman (Cambridge: Cambridge University Press, 2002), 250–70. 9. Stephanie P. Pezzo, Mark V.

Avoiding Commitment Traps BEWARE OF THE ENDOWMENT EFFECT A sense of ownership is a powerful thing. As the saying goes, nobody in the history of the world has washed their rental car! This is because of something called “the endowment effect,” our tendency to undervalue things that aren’t ours and to overvalue things because we already own them. In one study demonstrating the power of the endowment effect, the Nobel Prize–winning researcher Daniel Kahneman and colleagues randomly gave coffee mugs to only half the subjects in an experiment.5 The first group was asked how much they would be willing to sell their mug for, while the second group was asked what they would be willing to pay for it. It turned out the students who “owned” the mugs refused to sell for less than $5.25, while those without the cups were willing to pay only $2.25 to $2.75.

But she still continues to believe she can make it to the store in five minutes—or finish the conference call in half an hour or the major report in a week, or whatever else she is trying to squeeze in—and every once in a while she does. But the costs are high to her and the people around her. She would make a far greater contribution on all these rushed endeavors if she were simply to create a buffer. Have you ever underestimated how long a task will take? If you have, you are far from alone. The term for this very common phenomenon is the “planning fallacy.”6 This term, coined by Daniel Kahneman in 1979, refers to people’s tendency to underestimate how long a task will take, even when they have actually done the task before. In one study thirty-seven students were asked how long they thought it would take them to complete their senior thesis. When the students were asked to estimate how long it would take “if everything went as well as it possibly could,” their averaged estimate was 27.4 days.

Stocks for the Long Run, 4th Edition: The Definitive Guide to Financial Market Returns & Long Term Investment Strategies by Jeremy J. Siegel

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asset allocation, backtesting, Black-Scholes formula, Bretton Woods, buy low sell high, California gold rush, capital asset pricing model, cognitive dissonance, compound rate of return, correlation coefficient, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, dividend-yielding stocks, equity premium, Eugene Fama: efficient market hypothesis, fixed income, German hyperinflation, implied volatility, index arbitrage, index fund, Isaac Newton, joint-stock company, Long Term Capital Management, loss aversion, market bubble, mental accounting, Myron Scholes, new economy, oil shock, passive investing, Paul Samuelson, popular capitalism, prediction markets, price anchoring, price stability, purchasing power parity, random walk, Richard Thaler, risk tolerance, risk/return, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, short selling, South Sea Bubble, survivorship bias, technology bubble, The Great Moderation, The Wisdom of Crowds, transaction costs, tulip mania, Vanguard fund

Many of the ideas my profession explores are based on psychological concepts that have rarely before been applied to the stock market and portfolio management. Let me give you some background. Until recently, finance was dominated by theories that assumed investors maximized their expected utility, or well-being, and always acted rationally. This was an extension of the rational theory of consumer choice under certainty applied to uncertain outcomes. In the 1970s two psychologists, Amos Tversky and Daniel Kahneman, noted that many individuals did not behave as this theory predicted. They developed a new model—called prospect theory—of how individuals actually behave and make decisions when faced with uncertainty.3 Their CHAPTER 19 Behavioral Finance and the Psychology of Investing 323 model established them as the pioneers of behavioral finance, and their research has been making much headway in the finance profession.

Psychologists have long known how hard it is to remain separate from a crowd. This was confirmed by a social psychologist named Solomon Asch. He conducted a famous experiment where subjects were presented with four lines and asked to pick the two that were the same length. The right answer was obvious, but when confederates of Dr. Asch presented conflicting views, the subjects often gave the incorrect answer.6 3 Daniel Kahneman and Amos Tversky, “Prospect Theory: An Analysis of Decision under Risk,” Econometrica, vol. 47, no. 2 (March 1979). 4 Robert Shiller, “Stock Prices and Social Dynamics,” Brookings Papers on Economic Activity, Washington, D.C.: Brookings Institution, 1984. 5 Robert Shiller, “Do Stock Prices Move Too Much to Be Justified by Subsequent Movements in Dividends?” American Economic Review, vol. 71, no. 3 (1981), pp. 421–436.

He showed me that 80 percent of his trades made money, but he was down overall since he had lost so much money on his losing trades that they drowned out his winners. After I counseled him, he became a successful trader. Now he says that only one-third of his trades make money, but overall he’s way ahead. When things don’t work out as he planned, he gets rid of losing trades quickly while holding on to his winners. There is an old adage on Wall Street that sums up successful trading: “Cut your losers short and let your winners ride.” 22 Amos Tversky and Daniel Kahneman, “Judgment under Uncertainty: Heuristics and Biases,” Science, vol. 185 (1974), pp. 1124–1131. 23 Terrance Odean, “Are Investors Reluctant to Realize Their Losses,” Journal of Finance, vol. 53, no. 5 (October 1998), p. 1786. CHAPTER 19 Behavioral Finance and the Psychology of Investing 331 Rules for Avoiding Behavioral Traps Dave: I don’t feel secure enough to trade again soon. I just want to learn the right longer-term strategy.


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Numbers Rule Your World: The Hidden Influence of Probability and Statistics on Everything You Do by Kaiser Fung

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American Society of Civil Engineers: Report Card, Andrew Wiles, Bernie Madoff, Black Swan, call centre, correlation does not imply causation, cross-subsidies, Daniel Kahneman / Amos Tversky, edge city, Emanuel Derman, facts on the ground, fixed income, Gary Taubes, John Snow's cholera map, moral hazard, p-value, pattern recognition, profit motive, Report Card for America’s Infrastructure, statistical model, the scientific method, traveling salesman

Clearly, weak execution has run afoul of good intention. It is time we started turning over those pebbles! As the professors showed us, a few well-chosen numbers paint a far richer picture than hundreds of thousands of disorganized data. Conclusion Statistical thinking is hard,” the Nobel prize winner Daniel Kahneman told a gathering of mathematicians in New York City in 2009. A revered figure in the world of behavioral economics, Professor Kahneman spoke about his renewed interest in this topic, which he first broached in the 1970s with his frequent collaborator Amos Tversky. The subject matter is not inherently difficult, but our brains are wired in such a way that it requires a conscious effort to switch away from the default mode of reasoning, which is not statistical. Psychologists found that when research subjects were properly trained, and if they recognized the statistical nature of the task at hand, they were much likelier to make the correct judgment.

In advocating perception management, they subordinated the well-established research program in queuing theory, a branch of applied mathematics that has produced a set of sophisticated tools for minimizing actual average wait times in queues. As with traditional economics, queuing theory makes an assumption about rational human behavior that does not match reality. For example, in putting up signs showing inflated estimates of waiting time, the Disney engineers counted on irrationality, and customer surveys consistently confirmed their judgment. For further exploration of the irrational mind, see the seminal work of Daniel Kahneman, starting with his 2003 overview article “Maps of Bounded Rationality: Psychology for Behavioral Economics” in American Economic Review, and Predictably Irrational by Dan Ariely. Political considerations often intrude on the work of applied scientists. For instance, Minnesota state senator Dick Day seized upon the highway congestion issue to score easy points with his constituents, some of whom blamed the ramp-metering policy for prolonging their commute times.

Two books in the finance area also fit the bill: in The Black Swan, Nassim Taleb harangues theoreticians of financial mathematics (and other related fields) on their failure in statistical thinking, while in My Life as a Quant, Emanuel Derman offers many valuable lessons for financial engineers, the most important of which is that modelers in the social sciences—unlike physicists—should not seek the truth. Daniel Kahneman summarized his Nobel-prize-winning research on the psychology of judgment, including the distinction between intuition and reasoning, in “Maps of Bounded Rationality: Psychology for Behavioral Economics,” published in American Economic Review. This body of work has tremendous influence on the development of behavioral economics. The psychologist Richard Nisbett and his cohorts investigated the conditions under which people switch to statistical thinking; see, for example, “The Use of Statistical Heuristics in Everyday Inductive Reasoning,” published in Psychological Review.


pages: 190 words: 53,409

Success and Luck: Good Fortune and the Myth of Meritocracy by Robert H. Frank

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2013 Report for America's Infrastructure - American Society of Civil Engineers - 19 March 2013, Amazon Mechanical Turk, American Society of Civil Engineers: Report Card, attribution theory, availability heuristic, Branko Milanovic, Capital in the Twenty-First Century by Thomas Piketty, carried interest, Daniel Kahneman / Amos Tversky, David Brooks, deliberate practice, en.wikipedia.org, endowment effect, experimental subject, framing effect, full employment, hindsight bias, If something cannot go on forever, it will stop - Herbert Stein's Law, income inequality, invisible hand, labor-force participation, labour mobility, lake wobegon effect, loss aversion, minimum wage unemployment, Network effects, Paul Samuelson, Report Card for America’s Infrastructure, Richard Thaler, Rod Stewart played at Stephen Schwarzman birthday party, Ronald Reagan, Rory Sutherland, selection bias, side project, sovereign wealth fund, Steve Jobs, The Wealth of Nations by Adam Smith, Tim Cook: Apple, ultimatum game, Vincenzo Peruggia: Mona Lisa, winner-take-all economy

Those models have enhanced our understanding of human behavior and social institutions, to be sure, but they also fail to capture much of the craziness we see around us. That’s why behavioral economics—a cross-disciplinary effort that draws insights from economics, psychology, biology, and other fields—has been the most vibrant and rapidly growing specialty in economics for the past three decades. Inspired by the pioneering work of the psychologists Daniel Kahneman and the late Amos Tversky, this field has cataloged a large inventory of behavioral anomalies in which people clearly violate the predictions and prescriptions of standard economic models.2 It is common, for example, for someone to be willing to drive across town to save $10 on a $20 clock radio, but unwilling to do so to save $10 on a $1,000 television set. Yet the benefit of making the drive is $10 in each case.

Carl Sagan, Broca’s Brain: Reflections on the Romance of Science, New York: Random House, 1979, 61. 5. Chris McKittrick, “Bryan Cranston: ‘Without Luck You Will Not Have a Successful Career,’ ” Daily Actor, October 31, 2012, http://www.dailyactor.com/tv/bryan-cranston-acting-luck/. CHAPTER 5: WHY FALSE BELIEFS ABOUT LUCK AND TALENT PERSIST 1. Michael Mauboussin, The Success Equation, Cambridge, MA: Harvard Business Review Press, 2012. 2. Much of this research is elegantly summarized in Daniel Kahneman, Thinking Fast and Slow, New York: Farrar, Strauss, and Giroux, 2011. For an extremely readable account of how this work became important to economists, see Richard H. Thaler, Misbehaving, New York: W. W. Norton, 2015. 3. P. Cross, “Not Can but Will College Teachers Be Improved?,” New Directions for Higher Education 17 (1977): 1–15. 4. Ezra W. Zuckerman and John T. Jost, “What Makes You Think You’re So Popular?

Chunliang Feng, Yi Luo, Ruolei Gu, Lucas S Broster, Xueyi Shen, Tengxiang Tian, Yue-Jia Luo, Frank Krueger, “The Flexible Fairness: Equality, Earned Entitlement, and Self-Interest,” PLOS ONE 8.9 (September 2013), http://www.plosone.org/article/info%3Adoi%2F10.1371%2Fjournal.pone.0073106. 7. Mechanical Turk, https://www.mturk.com/mturk/welcome. 8. John Locke, Second Treatise on Civil Government, 1689, chap. 5, section 27, http://www.constitution.org/jl/2ndtr05.htm. 9. Daniel Kahneman, Jack L. Knetsch, and Richard H. Thaler, “Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias,” Journal of Economic Perspectives 5.1 (1991): 193–206. 10. Liam Murphy and Thomas Nagel, The Myth of Ownership, New York: Oxford University Press, 2001. 11. David DeSteno, Monica Y. Bartlett, Jolie Baumann, Lisa A. Williams, and Leah Dickens, “Gratitude as Moral Sentiment: Emotion-Guided Cooperation in Economic Exchange,” Emotion 10.2 (2010): 289–93. 12.


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The Signal and the Noise: Why So Many Predictions Fail-But Some Don't by Nate Silver

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airport security, availability heuristic, Bayesian statistics, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, big-box store, Black Swan, Broken windows theory, Carmen Reinhart, Claude Shannon: information theory, Climategate, Climatic Research Unit, cognitive dissonance, collapse of Lehman Brothers, collateralized debt obligation, complexity theory, computer age, correlation does not imply causation, Credit Default Swap, credit default swaps / collateralized debt obligations, cuban missile crisis, Daniel Kahneman / Amos Tversky, diversification, Donald Trump, Edmond Halley, Edward Lorenz: Chaos theory, en.wikipedia.org, equity premium, Eugene Fama: efficient market hypothesis, everywhere but in the productivity statistics, fear of failure, Fellow of the Royal Society, Freestyle chess, fudge factor, George Akerlof, haute cuisine, Henri Poincaré, high batting average, housing crisis, income per capita, index fund, Intergovernmental Panel on Climate Change (IPCC), Internet Archive, invention of the printing press, invisible hand, Isaac Newton, James Watt: steam engine, John Nash: game theory, John von Neumann, Kenneth Rogoff, knowledge economy, locking in a profit, Loma Prieta earthquake, market bubble, Mikhail Gorbachev, Moneyball by Michael Lewis explains big data, Monroe Doctrine, mortgage debt, Nate Silver, negative equity, new economy, Norbert Wiener, PageRank, pattern recognition, pets.com, Pierre-Simon Laplace, prediction markets, Productivity paradox, random walk, Richard Thaler, Robert Shiller, Robert Shiller, Rodney Brooks, Ronald Reagan, Saturday Night Live, savings glut, security theater, short selling, Skype, statistical model, Steven Pinker, The Great Moderation, The Market for Lemons, the scientific method, The Signal and the Noise by Nate Silver, The Wisdom of Crowds, Thomas Bayes, Thomas Kuhn: the structure of scientific revolutions, too big to fail, transaction costs, transfer pricing, University of East Anglia, Watson beat the top human players on Jeopardy!, wikimedia commons

If you forecast that a particular incumbent congressman will win his race 90 percent of the time, you’re also forecasting that he should lose it 10 percent of the time.28 The signature of a good forecast is that each of these probabilities turns out to be about right over the long run. Tetlock’s hedgehogs were especially bad at understanding these probabilities. When you say that an event has a 90 percent chance of happening, that has a very specific and objective meaning. But our brains translate it into something more subjective. Evidence from the psychologists Daniel Kahneman and Amos Tversky suggests that these subjective estimates don’t always match up with the reality. We have trouble distinguishing a 90 percent chance that the plane will land safely from a 99 percent chance or a 99.9999 percent chance, even though these imply vastly different things about whether we ought to book our ticket. With practice, our estimates can get better. What distinguished Tetlock’s hedgehogs is that they were too stubborn to learn from their mistakes.

Shannon, “Programming a Computer for Playing Chess,” Philosophical Magazine, Series 7, 41, 314, March 1950. http://archive.computerhistory.org/projects/ chess/related_materials/software/2-0%20and%202-1.Programming_a_computer_for_playing_chess.shannon/2-0%20and%202-1.Programming_a_computer_for_playing_chess.shannon.062303002.pdf. 9. William G. Chase and Herbert A. Simon, “The Mind’s Eye in Chess” in Visual Information Processing (New York: Academic Press, 1973). 10. Douglas Harper, Online Etymology Dictionary. http://www.etymonline.com/index.php?term=eureka. 11. Amos Tversky and Daniel Kahneman, “Judgement Under Uncertainty: Heuristics and Biases,” Science, 185 (September 27, 1974), pp. 1124–1131. http://www.econ.yale.edu/~nordhaus/homepage/documents/tversky_kahn_science.pdf. 12. Lauren Himiak, “Bear Safety Tips,” National & States Parks, About.com. http://usparks.about.com/od/backcountry/a/Bear-Safety.htm. 13. billwall, “Who Is the Strongest Chess Player?” Chess.com, October 27, 2008. http://www.chess.com/article/view/who-is-the-strongest-chess-player. 14.

Global Terrorism Database, National Consortium for the Study of Terrorism and Responses to Terrorism, U.S. Department of Homeland Security, University of Maryland. http://www.start.umd.edu/gtd/search/Results.aspx?page=2&casualties_type=b&casualties_max=&start_yearonly=1979&end_yearonly=2000&dtp2=all&sAttack=1&count=100&expanded=no&charttype=line&chart=overtime&ob=GTDID&od=desc#results-table. 39. Amos Tversky and Daniel Kahneman, “Availability: A Heuristic for Judging Frequency and Probability,” Cognitive Psychology, 5, 2 (Setepmber 1973), pp. 207–232. http://www.sciencedirect.com/science/article/pii/0010028573900339. 40. “Nineteen hijackers using commercial airliners as guided missiles to incinerate three thousand men, women, and children was perhaps the most horrific single unknown unknown America has experienced.”


pages: 670 words: 194,502

The Intelligent Investor (Collins Business Essentials) by Benjamin Graham, Jason Zweig

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3Com Palm IPO, accounting loophole / creative accounting, air freight, Andrei Shleifer, asset allocation, buy low sell high, capital asset pricing model, corporate governance, corporate raider, Daniel Kahneman / Amos Tversky, diversified portfolio, Eugene Fama: efficient market hypothesis, George Santayana, hiring and firing, index fund, intangible asset, Isaac Newton, Long Term Capital Management, market bubble, merger arbitrage, money market fund, new economy, passive investing, price stability, Ralph Waldo Emerson, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, sharing economy, short selling, Silicon Valley, South Sea Bubble, Steve Jobs, survivorship bias, the market place, the rule of 72, transaction costs, tulip mania, VA Linux, Vanguard fund, Y2K, Yogi Berra

For the commission’s report, see www.ssa.gov/history/reports/boskinrpt.html. Many investment experts now feel that deflation, or falling prices, is an even greater threat than inflation; the best way to hedge against that risk is by including bonds as a permanent component of your portfolio. (See the commentary on Chapter 4.) 3 For more insights into this behavioral pitfall, see Eldar Shafir, Peter Diamond, and Amos Tversky, “Money Illusion,” in Daniel Kahneman and Amos Tversky, eds., Choices, Values, and Frames (Cambridge University Press,2000), pp. 335–355. 4 That year, President Jimmy Carter gave his famous “malaise” speech, in which he warned of “a crisis in confidence” that “strikes at the very heart and soul and spirit of our national will” and “threatens to destroy the social and the political fabric of America.” 5 See Stanley Fischer, Ratna Sahay, and Carlos A.

But when stocks drop, that financial loss fires up your amygdala—the part of the brain that processes fear and anxiety and generates the famous “fight or flight” response that is common to all cornered animals. Just as you can’t keep your heart rate from rising if a fire alarm goes off, just as you can’t avoid flinching if a rattlesnake slithers onto your hiking path, you can’t help feeling fearful when stock prices are plunging.9 In fact, the brilliant psychologists Daniel Kahneman and Amos Tversky have shown that the pain of financial loss is more than twice as intense as the pleasure of an equivalent gain. Making $1,000 on a stock feels great—but a $1,000 loss wields an emotional wallop more than twice as powerful. Losing money is so painful that many people, terrified at the prospect of any further loss, sell out near the bottom or refuse to buy more. That helps explain why we fixate on the raw magnitude of a market decline and forget to put the loss in proportion.

But the impatient and hyperactive traders made their brokers rich, not themselves. (The bars at the far right show a market index fund for comparison.) Source: Profs. Brad Barber, University of California at Davis, and Terrance Odean, University of California at Berkeley Unfortunately, for every IPO like Microsoft that turns out to be a big winner, there are thousands of losers. The psychologists Daniel Kahnerman and Amos Tversky have shown when humans estimate the likelihood or frequency of an event, we make that judgment based not on how often the event has actually occurred, but on how vivid the past examples are. We all want to buy “the next Microsoft”—precisely because we know we missed buying the first Microsoft. But we conveniently overlook the fact that most other IPOs were terrible investments. You could have earned that $533 decillion gain only if you never missed a single one of the IPO market’s rare winners—a practical impossibility.


pages: 280 words: 75,820

Rapt: Attention and the Focused Life by Winifred Gallagher

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Albert Einstein, Atul Gawande, Build a better mousetrap, Daniel Kahneman / Amos Tversky, David Brooks, delayed gratification, epigenetics, Frank Gehry, fundamental attribution error, Isaac Newton, knowledge worker, loss aversion, Mahatma Gandhi, McMansion, music of the spheres, Ralph Waldo Emerson, Richard Feynman, Richard Feynman, Rodney Brooks, Ronald Reagan, Silicon Valley, Walter Mischel, zero-sum game

Next, he listens to a visitor’s attempt to put a temperament in a nutshell: “Do you want to spend more time today by yourself or with other people?” He considers this, then says, “That’s a good one. Although the answer would depend very much on your immediate context—on how much time you’re spending with other people now. You’d have to refine the question.” In their work on decision-making, Kahneman and his late partner Amos Tversky made the art of the refined query into a science. “Our research method was to write one question at a time, formulated to make a specific point,” he says. “Then we published our questions, answers, and predictions. That is what we did.” Of the Nobel, he says, “I got the prize because some economists became convinced that you could do economics in a slightly different way—by being more realistic about psychology.”

Considering the number of fine colleges to choose from, students have to narrow their selection somehow or go mad. On the other hand, by zeroing in on certain criteria—a school’s status, say, or geographical location—and ignoring others, they can end up focused on one dimension of an important experience that might not prove to be as vital as they thought. Early in his long and varied career, the Princeton psychologist Daniel Kahneman wrote a book about attention, and the subject figures prominently in his more recent work on the decision-making process. In 2002, this research brought him the Nobel Prize in economics, yet Kahneman remains every inch a psychologist. His demeanor is that of a certain kind of therapist: not the warm, fuzzy sort but the penetrating, hard-hat type who doesn’t miss a thing. Unlike some venerable figures, he doesn’t treat an interview as a monologue, but attends closely to his interlocutor’s remarks.

All my practice was concentrated on seeing what mind really is.” Realizing that he has ventured into deep water, he laughs merrily and says, “Mind is not like any other thing, so it’s hard to explain. Just as air can’t explain fire, or space explain earth.” In the rinpoche’s tradition, paying attention is the way to experience true clarity about what is—knowledge that can’t be accessed through thinking, but only through being. (In the psychologist Daniel Kahneman’s terms, this awareness comes from the experiencing rather than the remembering self.) Within Buddhism, someone who sustains this effortless rapt focus on the right here, right now on a continual basis is said to be “enlightened” or “realized.” In the rinpoche’s Kargyu world, the ranks of these special individuals include elite yogi-monks called togdens. One of them, called Amtrin, spent many years meditating alone in desolate mountain caves, attained realization, and became a revered figure in his community.


pages: 250 words: 88,762

The Logic of Life: The Rational Economics of an Irrational World by Tim Harford

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activist fund / activist shareholder / activist investor, affirmative action, Albert Einstein, Andrei Shleifer, barriers to entry, Berlin Wall, colonial rule, Daniel Kahneman / Amos Tversky, double entry bookkeeping, Edward Glaeser, en.wikipedia.org, endowment effect, European colonialism, experimental economics, experimental subject, George Akerlof, income per capita, invention of the telephone, Jane Jacobs, John von Neumann, law of one price, Martin Wolf, mutually assured destruction, New Economic Geography, new economy, Plutocrats, plutocrats, Richard Florida, Richard Thaler, Ronald Reagan, Silicon Valley, spinning jenny, Steve Jobs, The Death and Life of Great American Cities, the market place, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Thomas Malthus, women in the workforce, zero-sum game

The Earth isn’t a perfect sphere, as anyone who has climbed Mount Everest will tell you. But it’s nearly a sphere, and for many purposes the simplification that the Earth is spherical will do nicely. I’VE CLAIMED THAT we’re smart, but I’ve admitted that we make mistakes. The laboratory work of psychologists and “behavioral” economists has provided plenty of proof. One of the most famous examples was a discovery by Daniel Kahneman and Amos Tversky: Their experiments showed that people make different choices depending on how the choices are framed. (Although he is a psychologist, Kahneman won the Nobel Prize in economics in 2002; Tversky had died a few years earlier, or he would have shared it.) To one group of subjects, Kahneman and Tversky offered this choice: Imagine that the U.S. is preparing for the outbreak of an unusual Asian disease, which is expected to kill 600 people.

Smoking rates have fallen dramatically: According to the WHO Tobacco Atlas, www.who.int/tobacco/statistics/tobacco_atlas/en/, smoking among adult men in the United States fell from 52 to 26 percent between 1965 and 1999, and for women from 34 percent to 22 percent. In the United Kingdom, the fall was from 61 to 28 percent among men and 42 to 26 percent among women, between 1960 and 1999. To one group of subjects: Amos Tversky and Daniel Kahneman, “The Framing of Decisions and the Psychology of Choice,” Science 211 (1981): 453–58. “I was a sports card dealer”: Telephone interview with John List, January 2007. That’s why Professor List: John A. List, “Does Market Experience Eliminate Anomalies?” Quarterly Journal of Economics, February 2003. On another occasion: Uri Gneezy and John List, “Putting Behavioral Economics to Work: Testing for Gift Exchange in Labor Markets Using Field Experiments,” Econometrica 74, no. 5(September 2006): 1365–84, rady.ucsd.edu/faculty/directory/gneezy/docs/behavioral-economics.pdf.


pages: 345 words: 87,745

The Power of Passive Investing: More Wealth With Less Work by Richard A. Ferri

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asset allocation, backtesting, Bernie Madoff, capital asset pricing model, cognitive dissonance, correlation coefficient, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, endowment effect, estate planning, Eugene Fama: efficient market hypothesis, fixed income, implied volatility, index fund, intangible asset, Long Term Capital Management, money market fund, passive investing, Paul Samuelson, Ponzi scheme, prediction markets, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Sharpe ratio, survivorship bias, too big to fail, transaction costs, Vanguard fund, yield curve, zero-sum game

We know that can’t happen. People tend to be unrealistic about their investment skills. Behavioral finance helps explain why overconfidence exists. Behavioral Finance Behavioral finance is a branch of financial analysis that uses social, cognitive, and emotional factors to understand the economic beliefs and decisions of investors. Its beginnings stem from a revolutionary 1979 paper by Daniel Kahneman and Amos Tversky on investor behavior. Their paper proposed a new theory called prospect theory (prospect in this sense means “lottery”). Prospect theory describes how people make choices based on how they analyze potential losses and payouts.3 Prospect theory is very involved and beyond the scope of this book. However, a superbly written and easy to read synopsis of this theory and many other behavioral finance theories can be found in Your Money & Your Brain by Jason Zweig (Simon & Schuster, 2007).

Chapter 9: Changing Investor Behavior 1. LeRoy Gross, The Art Selling Intangibles: How to Make Your Millions Investing Other People’s Money (New York: Simon & Schuster, 1988). The firm I worked for was Kidder, Peabody, Inc. The firm was wholly acquired by General Electric in the late 1989 and sold in part to UBS in 1994. 2. John R. Nofsinger, The Psychology of Investing, 3rd ed. (New Jersey: Pearson, 2008), 11. 3. Daniel Kahneman and Amos Tversky, “Prospect Theory: An Analysis of Decision under Risk,” Econometrica 47 (1979): 263–291. 4. Jason Zweig, Your Money & Your Brain (New York: Simon & Schuster, 2007), 1. 5. Anonymous, “Confessions of a Former Mutual Funds Reporter,” Fortune, April 26, 1999. 6. James J. Cramer, “Cramer: Mutual Fund Advertising” April 2, 2008, www.abcnews.go.com. 7. Thierry Post, Martijn J. Van den Assem, Guido Baltussen, and Richard H.

The End of Accounting and the Path Forward for Investors and Managers (Wiley Finance) by Feng Gu

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active measures, Affordable Care Act / Obamacare, barriers to entry, business process, Claude Shannon: information theory, Clayton Christensen, commoditize, conceptual framework, corporate governance, creative destruction, Daniel Kahneman / Amos Tversky, discounted cash flows, diversified portfolio, double entry bookkeeping, Exxon Valdez, financial innovation, fixed income, hydraulic fracturing, index fund, information asymmetry, intangible asset, inventory management, Joseph Schumpeter, Kenneth Arrow, knowledge economy, moral hazard, new economy, obamacare, quantitative easing, quantitative trading / quantitative finance, QWERTY keyboard, race to the bottom, risk/return, Robert Shiller, Robert Shiller, shareholder value, Steve Jobs, The Great Moderation, value at risk

57 Average ratio of "special" and "extraordinary" income statement items to net earnings, 1950–2013 Percentage of Earnings 20% 16% 12% 8% 4% 0% 1950–1959 1960–1969 1970–1979 1980–1989 1990–1999 2000–2013 FIGURE 5.2 Increasing Impact on Earnings of Transitory Items The steeply increasing curve—from less than 2 percent to 17 percent of earnings—demonstrates vividly the continuous increase in the impact of transitory items on reported earnings, diminishing their usefulness as predictors of future operations.14 One-time items, are, of course, not the only detractors of earnings usefulness, as we will show in Part II, but they do considerable damage. The implications of this much-diminished usefulness of the bottom line for investors, lenders, and others relying on this seemingly important indicator (“earnings move markets”) are obvious.15 INVESTORS ALERT: AN ACCOUNTING LOSS ISN’T WHAT IT USED TO BE “Losses loom larger than gains” famously said Amos Tversky and the Nobel (economics) laureate Daniel Kahneman, meaning that people strongly prefer avoiding losses to acquiring gains.16 So, reporting a loss is a big deal for a company and its constituents, and it better be a credible signal of a company in distress, not a false alarm. Which brings us to another surprise for you: Many of the losses reported by companies are due to accounting procedures that don’t really reflect a permanent deterioration of business fundamentals.

However, the continual expansion of the balance sheet approach [by the FASB] is gradually destroying the forward-looking usefulness of earnings, mainly through the effect of various asset revaluations, which manifest as noise in the process of generating normal operating earnings.” In “On the Balance Sheet-Based Model of Financial Reporting,” Occasional Paper Series, Center for Excellence in Accounting and Security Analysis, Columbia Business School, 2007, p. 2. Daniel Kahneman and Amos Tversky, “Prospect Theory: An Analysis of Decisions Under Risk,” Econometrica, 47 (2) (1979): 263−292. This, of course, is a reflection of the widely known phenomenon—“mean reversion,” namely extreme observations in one period, will tend to get closer to the average in subsequent period. The speed of such reversion to the mean indicates the impact of chance, or transitory items on the observation (earnings in our case).


pages: 471 words: 97,152

Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism by George A. Akerlof, Robert J. Shiller

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affirmative action, Andrei Shleifer, asset-backed security, bank run, banking crisis, collateralized debt obligation, conceptual framework, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, Deng Xiaoping, Donald Trump, Edward Glaeser, en.wikipedia.org, experimental subject, financial innovation, full employment, George Akerlof, George Santayana, housing crisis, Hyman Minsky, income per capita, inflation targeting, invisible hand, Isaac Newton, Jane Jacobs, Jean Tirole, job satisfaction, Joseph Schumpeter, Long Term Capital Management, loss aversion, market bubble, market clearing, mental accounting, Mikhail Gorbachev, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, Myron Scholes, new economy, New Urbanism, Paul Samuelson, Plutocrats, plutocrats, price stability, profit maximization, purchasing power parity, random walk, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Reagan, South Sea Bubble, The Chicago School, The Death and Life of Great American Cities, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, tulip mania, working-age population, Y2K, Yom Kippur War

Journal of Political Economy 101(3):410–42. Jung, Jeeman, and Robert J. Shiller. 2005. “Samuelson’s Dictum and the Stock Market.” Economic Inquiry 43(2):221–28. Kahn, Richard F. 1931. “The Relation of Home Investment to Unemployment.” Economic Journal 41(162):173–98. Kahn, Shulamit. 1997. “Evidence of Nominal Wage Stickiness from Microdata.” American Economic Review 87(5):993–1008. Kahneman, Daniel, and Amos Tversky. 1979. “Prospect Theory: An Analysis of Decision under Risk.” Econometrica 47(2):263–92. ———. 2000. Choices, Values and Frames. Cambridge, Mass.: Cambridge University Press. Kahneman, Daniel, Jack Knetsch, and Richard H. Thaler. 1986a. “Fairness as a Constraint on Profit-Seeking: Entitlements in the Market.” American Economic Review 76(4):728–41. ———. 1986b. “Fairness and the Assumptions of Economics.”

., Knowledge and Memory: The Real Story. Hillsdale, N.J.: Erlbaum, pp. 1–85. Schultze, Charles L. 1959. “Recent Inflation in the United States.” Study Paper 1, Joint Economic Committee, 86th Cong., 1st sess., September. Schumpeter, Joseph A. 1939. Business Cycles: A Theoretical, Historical, and Statistical Analysis of the Capitalist Process. New York: McGraw-Hill. Shafir, Eldar, Peter Diamond, and Amos Tversky. 1997. “Money Illusion.” Quarterly Journal of Economics 112(2):341–74. Shapiro, Carl, and Joseph E. Stiglitz. 1984. “Equilibrium Unemployment as a Worker Discipline Device.” American Economic Review 74(3):433–44. Shea, John. 1995a. “Union Contracts and the Life-Cycle/Permanent-Income Hypothesis.” American Economic Review 85(1):186–200. ———. 1995b. “Myopia, Liquidity Constraints, and Aggregate Consumption: A Simple Test.”

It would violate the etiquette of textbooks to mention that some other factor, outside the formal discipline of economics, is the fundamental cause of certain major economic phenomena. It would be like burping loudly at a fancy dinner. It is just not done. Questionnaires But studies of fairness do indicate the strong possibility that such concerns will override the effects of rational economic motivation. One of our favorite studies comes from a team consisting of a psychologist, Daniel Kahneman, and two economists, Jack Knetsch and Richard Thaler.4 The study asked respondents about their reactions to a number of vignettes. Was the action taken acceptable or unfair? The first question, dealing with the price of snow shovels after a snowstorm, illustrates the method and the answers. According to the vignette, there has been a snowstorm, and the local hardware store has increased the price of snow shovels.


pages: 580 words: 168,476

The Price of Inequality: How Today's Divided Society Endangers Our Future by Joseph E. Stiglitz

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affirmative action, Affordable Care Act / Obamacare, airline deregulation, Andrei Shleifer, banking crisis, barriers to entry, Basel III, battle of ideas, Berlin Wall, capital controls, Carmen Reinhart, Cass Sunstein, central bank independence, collapse of Lehman Brothers, collective bargaining, colonial rule, corporate governance, Credit Default Swap, Daniel Kahneman / Amos Tversky, Dava Sobel, declining real wages, deskilling, Exxon Valdez, Fall of the Berlin Wall, financial deregulation, financial innovation, Flash crash, framing effect, full employment, George Akerlof, Gini coefficient, income inequality, income per capita, indoor plumbing, inflation targeting, information asymmetry, invisible hand, jobless men, John Harrison: Longitude, John Markoff, John Maynard Keynes: Economic Possibilities for our Grandchildren, Kenneth Arrow, Kenneth Rogoff, labour market flexibility, London Interbank Offered Rate, lone genius, low skilled workers, Marc Andreessen, Mark Zuckerberg, market bubble, market fundamentalism, mass incarceration, medical bankruptcy, microcredit, moral hazard, mortgage tax deduction, negative equity, obamacare, offshore financial centre, paper trading, Pareto efficiency, patent troll, Paul Samuelson, payday loans, price stability, profit maximization, profit motive, purchasing power parity, race to the bottom, rent-seeking, reserve currency, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, shareholder value, short selling, Silicon Valley, Simon Kuznets, spectrum auction, Steve Jobs, technology bubble, The Chicago School, The Fortune at the Bottom of the Pyramid, The Myth of the Rational Market, The Spirit Level, The Wealth of Nations by Adam Smith, too big to fail, trade liberalization, transaction costs, trickle-down economics, ultimatum game, uranium enrichment, very high income, We are the 99%, wealth creators, women in the workforce, zero-sum game

See George Lakoff, Don’t Think of an Elephant! Know Your Values and Frame the Debate (White River Junction, VT: Chelsea Green, 2004). 11. This is called the anchoring effect. See discussions of anchoring and framing effects on judgments and preferences in Daniel Kahneman, Paul Slovic, and Amos Tversky, eds., Judgment under Uncertainty: Heuristics and Biases (Cambridge: Cambridge University Press, 1982); and Daniel Kahneman and Amos Tversky, eds., Choices, Values and Frames (New York: Cambridge University Press, 2000). For a popular and recent discussion, see Daniel Kahneman, Thinking, Fast and Slow (New York: Farrar, Straus and Giroux, 2011); and Richard Thaler and Cass Sunstein, Nudge: Improving Decisions about Health, Wealth, and Happiness (New Haven and London: Yale University Press, 2008). 12. See the discussion of framing effects in the case of the introduction of lifecycle funds in U.S. 401(k) plans in Ning Tang, Olivia S.

For a discussion of these outcomes (and the sums people will accept or veto in ultimatum games), see Colin Camerer and Richard Thaler, “Anomalies: Ultimatums, Dictators and Manners,” Journal of Economic Perspectives 9, no. 2 (1995): 209–19. 16. For a sample of the large literature, see, e.g., Daniel Kahneman, Jack L. Knetsch, and Richard H. Thaler, “Fairness and the Assumptions of Economics,” Journal of Business 59, no. 4 (1986): S285–S300; Gary E. Bolton and Axel Ockenfels, “ERC: A Theory of Equity, Reciprocity, and Competition,” American Economic Review 90, no. 1 (March 2000): 166–93; Armin Falk, Ernst Fehr, and Urs Fischbacher, “On the Nature of Fair Behavior,” Economic Inquiry 41, no. 1 (January 2003): 20–26; Daniel Kahneman, Jack L. Knetsch, and Richard H. Thaler, “Fairness as a Constraint on Profit Seeking: Entitlements in the Market,” American Economic Review 76, no. 4 (1986): 728–41; Amartya Sen, “Moral Codes and Economic Success,” in Market Capitalism and Moral Values, ed.

This turns out to raise theoretical issues that are closely akin to the measurement of risk, and my early work, four decades ago, was done jointly with Michael Rothschild. Subsequently, I began work with a former student, Ravi Kanbur, on the measurement of socioeconomic mobility. The influence of behavioral economics on my thinking should be evident in this work. I was first introduced to these ideas some forty years ago by the late Amos Tversky, a pioneer in this field, and subsequently Richard Thaler and Danny Kahneman have greatly influenced my thinking. (When I founded the Journal of Economic Perspectives in the mid-1980s, I asked Richard to do a regular column on the subject.) I benefited enormously from the discussions with Edward Stiglitz of some of the legal issues treated in chapter 7, and with Robert Perkinson on the issues related to America’s high incarceration rate.

Investment: A History by Norton Reamer, Jesse Downing

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activist fund / activist shareholder / activist investor, Albert Einstein, algorithmic trading, asset allocation, backtesting, banking crisis, Berlin Wall, Bernie Madoff, break the buck, Brownian motion, buttonwood tree, California gold rush, capital asset pricing model, Carmen Reinhart, carried interest, colonial rule, credit crunch, Credit Default Swap, Daniel Kahneman / Amos Tversky, debt deflation, discounted cash flows, diversified portfolio, equity premium, estate planning, Eugene Fama: efficient market hypothesis, Fall of the Berlin Wall, family office, Fellow of the Royal Society, financial innovation, fixed income, Gordon Gekko, Henri Poincaré, high net worth, index fund, information asymmetry, interest rate swap, invention of the telegraph, James Hargreaves, James Watt: steam engine, joint-stock company, Kenneth Rogoff, labor-force participation, land tenure, London Interbank Offered Rate, Long Term Capital Management, loss aversion, Louis Bachelier, margin call, means of production, Menlo Park, merger arbitrage, money market fund, moral hazard, mortgage debt, Myron Scholes, negative equity, Network effects, new economy, Nick Leeson, Own Your Own Home, Paul Samuelson, pension reform, Ponzi scheme, price mechanism, principal–agent problem, profit maximization, quantitative easing, RAND corporation, random walk, Renaissance Technologies, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, Sand Hill Road, Sharpe ratio, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, spinning jenny, statistical arbitrage, survivorship bias, technology bubble, The Wealth of Nations by Adam Smith, time value of money, too big to fail, transaction costs, underbanked, Vanguard fund, working poor, yield curve

Behavioral finance essentially attempts to explain empirical anomalies and deviations from the classical risk models, including the efficient market hypothesis. Instead of considering market participants as hyperrational agents obeying arguably overly elegant utility functions, they are thought of as possessing biases, prejudices, and tendencies that have real and measurable effects on markets and financial transactions. Daniel Kahneman and Amos Tversky wrote a seminal paper in the field outlining what they call prospect theory, a description of individuals’ optimization outside of the classical expected utility framework. Their pioneering paper noted many 252 Investment: A History of the known behaviors that represent aberrations from expected utility theory, including lottery problems (in which individuals tend to elect a lump-sum payment up front even if that is smaller than the expected value of receiving a larger amount or zero when a coin flip is involved) and probabilistic insurance (in which individuals have a more disproportionate dislike for a form of insurance that would cover losses based on a coin flip more than the math suggests they should).

Benjamin Graham and David L. Dodd, Security Analysis (New York: McGraw-Hill, 1934). 43. Benjamin Graham, The Intelligent Investor (New York: Harper, 1949). 44. Benjamin Graham, “A Conversation with Benjamin Graham,” Financial Analysts Journal 32, no. 5 (September–October 1976): 22. 45. Warren Buffett, “The Superinvestors of Graham-and-Doddsville,” Hermes (Columbia Business School), Fall 1984, 4–15. 46. Daniel Kahneman and Amos Tversky, “Prospect Theory: An Analysis of Decision under Risk,” Econometrica 47, no. 2 (March 1979): 265–278. 47. Rajnish Mehra and Edward C. Prescott, “The Equity Premium: A Problem,” Journal of Monetary Economics 15, no. 2 (March 1985): 145–161. 48. Stephen J. Brown, William N. Goetzmann, and Stephen A. Ross, “Survival,” Journal of Finance 50, no. 3 (July 1995): 853–873. 49. Shlomo Benartzi and Richard H.

Economic History Association. February 10, 2008. http://eh.net/encyclopedia/usury. J. P. Morgan Chase & Co. Annual Report 2013. April 9, 2014. http://investor .shareholder.com/jpmorganchase/annual.cfm. Kabele, Thomas. “James Dodson, First Lecture on Insurances, 1757: Discussion.” Kabele and Associates (New Canaan, CT), May 2, 2008. http:// www.kabele.us/papers/dodsonms2.pdf. Kahneman, Daniel, and Amos Tversky. “Prospect Theory: An Analysis of Decision under Risk.” Econometrica 47, no. 2 (March 1979): 263–292. Kaul, Chandrika. “From Empire to Independence: The British Raj in India, 1858–1947.” BBC. Last modified March 3, 2011. http://www.bbc.co.uk /history/british/modern/independence1947_01.shtml. Kedmey, Dan. “2 Years and 900 Pages Later, the Volcker Rule Gets the Green Light.” TIME.com, December 11, 2013. http://business.time .com/2013/12/11/2-years-and-900-pages-later-the-volcker-rule-gets-the -green-light.


pages: 384 words: 118,572

The Confidence Game: The Psychology of the Con and Why We Fall for It Every Time by Maria Konnikova

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attribution theory, Bernie Madoff, British Empire, Cass Sunstein, cognitive dissonance, Daniel Kahneman / Amos Tversky, endowment effect, epigenetics, hindsight bias, lake wobegon effect, libertarian paternalism, Milgram experiment, placebo effect, Ponzi scheme, publish or perish, Richard Thaler, risk tolerance, side project, Skype, Steven Pinker, the scientific method, tulip mania, Walter Mischel

The players and coaches, too, seemed to believe it—even going so far as to select certain draft picks because they were perceived to be playing hot at the time. To Gilovich, the whole thing seemed highly unlikely. He was a cognitive psychologist, studying rationality and its departures, and there was simply no reason to assume that people’s talent and skills could show such tremendous, lasting deviations. He’d also been working with Amos Tversky, who, along with Daniel Kahneman, had identified the “belief in the law of small numbers” some ten years prior: that we believe that chance rates seen over the long term should also be reflected in the short term, and if they are not, something else must be going on. For instance, since a coin is supposed to land on heads half the time, we expect it to do so if we toss it, say, ten times. We don’t take into consideration the fact that averages are derived over a broader timescale.

Anticipated emotion—that is, the emotion we can anticipate feeling if we take a certain course of action—strongly favors the status quo. Anticipated regret makes us want to keep doing what we’re doing; anticipated stress makes us want to cope proactively, by not doing anything that might provoke said stress; and anticipated guilt makes us likewise want to prevent it from ever happening. In one of their famous thought experiments, Daniel Kahneman and Amos Tversky described two individuals who’d been playing the stock market. Both had just lost $1,200 on a certain stock. The difference between them was in how they’d lost it. The first had lost it after initially buying one stock and then, after a bit of thought, switching to another. The second had made the mistake of sticking with a losing stock rather than, after some reflection, switching to a winner.

While we laypeople are good at the broad strokes basics, we tend to fare worse when it comes to reading nuance. While we’re good at the overt bodily cues, we are not so great at the cues of the mind. We infer entire belief systems from one rogue statement, craft personalities and backstories with no bearing on reality from one surface clue. We simplify when we should caveat and gloss where we should elaborate. Often, we use snap judgments—what Daniel Kahneman calls heuristics—when we meet someone new, and end up with a superficial, highly stereotyped version of what they are like. Take Saalfield’s impression of Mitchell: charming, comforting, pretty. And indeed, Mitchell is always elegant, impeccably dressed, well coiffed and manicured, with an enticing, open smile. She relies in part on those surface cues to inspire the type of trust she will need to lure her fortune-seekers.


pages: 577 words: 149,554

The Problem of Political Authority: An Examination of the Right to Coerce and the Duty to Obey by Michael Huemer

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Cass Sunstein, Chelsea Manning, cognitive dissonance, cuban missile crisis, Daniel Kahneman / Amos Tversky, en.wikipedia.org, Eratosthenes, experimental subject, framing effect, Gini coefficient, illegal immigration, impulse control, Isaac Newton, Julian Assange, laissez-faire capitalism, Machinery of Freedom by David Friedman, Milgram experiment, moral hazard, Phillip Zimbardo, profit maximization, profit motive, Ralph Nader, RAND corporation, rent-seeking, Ronald Coase, The Wealth of Nations by Adam Smith, unbiased observer, uranium enrichment, WikiLeaks

‘Intransitivity of Prefentryerences’, Psychological Review 76: 31–48. Tversky, Amos, and Daniel Kahneman. 1981. ‘The Framing of Decisions and the Psychology of Choice’, Science 211: 453–8. ——. 1982. ‘Evidential Impact of Base Rates’. Pp. 153–60 in Judgment under Uncertainty: Heuristics and Biases, ed. Daniel Kahneman, Paul Slovic, and Amos Tversky. Cambridge: Cambridge University Press. ——. 1986. ‘Rational Choice and the Framing of Decisions’, Journal of Business 59: S251–S278. ——. 2002. ‘Extensional versus Intuitive Reasoning: The Conjunction Fallacy in Probability Judgment’. Pp. 19–48 in Heuristics and Biases: The Psychology of Intuitive Judgment, ed. Thomas Gilovich, Dale Griffin, and Daniel Kahneman. Cambridge: Cambridge University Press. Twenty-Fifth Aviation Battalion. n.d. Vietnam War Statistics and Facts, http://25thaviation.org/facts/id430.htm.

Notes on the State of Virginia. Paris. Jencks, Christopher. 1992. Rethinking Social Policy: Race, Poverty and the Underclass. Cambridge, MA: Harvard University Press. Julich, S. 2005. ‘“Stockholm Syndrome” and Child Sexual Abuse’, Journal of Child Sexual Abuse 14: 107–29. Juvenal, Decimus Junius. 1967. The Sixteen Satires, tr. Peter Green. Baltimore: Penguin. Kahneman, Daniel, Paul Slovic, and Amos Tversky, eds. 1982. Judgment under Uncertainty: Heuristics and Biases. Cambridge: Cambridge University Press. Kant, Immanuel. 1957. Perpetual Peace, ed. and tr. Lewis White Beck. Indianapolis: Bobbs-Merrill. Originally published 1795. Karsh, Efraim. 2002. The Iran-Iraq War 1980–1988. Oxford: Osprey. Kelman, Herbert, and V. Lee Hamilton. 1989. Crimes of Obedience: Toward a Social Psychology of Authority and Responsibility.

Pp. 61–78 in Democratic Peace in Theory and Practice, ed. Steven W. Hook. Kent, OH: Kent State University Press. Gat, Azar. 2006. War in Human Civilization. Oxford: Oxford University Press. Gaus, Gerald. 2003. Contemporary Theories of Liberalism: Public Reason as a Post-Enlightenment Project. London: Sage. Gauthier, David. 1986. Morals by Agreement. Oxford: Clarendon Press. Gilovich, Thomas, Dale Griffin, and Daniel Kahneman. 2002. Heuristics and Biases: The Psychology of Intuitive Judgment. Cambridge: Cambridge University Press. Gleditsch, Nils P. 1992. ‘Democracy and Peace’, Journal of Peace Research 29: 369–76. Goldstein, Amy. 2007. ‘More Security Firms Getting Police Powers: Some See Benefits To Public Safety, But Others Are Wary’, San Francisco Chronicle, Sunday, January 7, A3, www.sfgate.com/cgi-bin/article.cgi?


pages: 237 words: 50,758

Obliquity: Why Our Goals Are Best Achieved Indirectly by John Kay

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Andrew Wiles, Asian financial crisis, Berlin Wall, bonus culture, British Empire, business process, Cass Sunstein, computer age, corporate raider, credit crunch, Daniel Kahneman / Amos Tversky, discounted cash flows, discovery of penicillin, diversification, Donald Trump, Fall of the Berlin Wall, financial innovation, Gordon Gekko, greed is good, invention of the telephone, invisible hand, Jane Jacobs, Long Term Capital Management, Louis Pasteur, market fundamentalism, Myron Scholes, Nash equilibrium, pattern recognition, Paul Samuelson, purchasing power parity, RAND corporation, regulatory arbitrage, shareholder value, Simon Singh, Steve Jobs, The Death and Life of Great American Cities, The Predators' Ball, The Wealth of Nations by Adam Smith, ultimatum game, urban planning, value at risk

Chapter 5: Objectives, Goals and Actions—How the Means Help Us Discover the End 1 Plutarch, Plutarch’s Lives (London, William Heinemann, 1948), p. 483. 2 Daniel Nettle, Happiness: The Science Behind Your Smile (Oxford: Oxford University Press, 2005), p. 18. 3 See, for example, C. D. Ryff, “Happiness Is Everything, or Is It?” Journal of Personality and Social Psychology 57, no. 6 (1989); Daniel Kahneman, “Objective Happiness,” in Daniel Kahneman, Ed Diener, and Norbert Schwarz, Well-being: The Foundations of Hedonic Psychology (New York, Russell Sage Foundation, 2001). 4 Jack Welch, “Jack Welch Elaborates: Shareholder Value,” BusinessWeek, March 16, 2009. 5 Ed Smith, What Sport Tells Us About Life (London: Penguin, 2008), p. 28. 6 Bob Rotella with Bob Cullen, Golf Is Not a Game of Perfect (London: Pocket Books, 2004).

Matt Ridley’s Origins of Virtue introduced me to the idea that many of our social and economic institutions can best be explained with the aid of evolutionary psychology; in a very different style, Ken Binmore and Herbert Gintis explore similar themes. And the attack on Franklin’s rule as the epitome of rational thought comes today from many quarters, especially the projects on decision making led by Gerd Gigerenzer. Behavioral economics tends, as I have described, to persist in the notion that the failure of standard concepts of rationality is a problem in our own behavior rather than in our models, but the work of Dan Kahneman and Amos Tversky must nevertheless be credited with a transformation in the way I—and many others—think about economic behavior. Ansoff, H. Igor. Corporate Strategy. Harmondsworth, UK: Penguin, 1985. Ariely, Dan. Predictably Irrational. London: HarperCollins, 2008. Aristotle. Nicomachean Ethics. Cambridge: Cambridge University Press, 2000. Aristotle. The Politics. London: Penguin, 1992. Arrow, Kenneth J., and F.


pages: 226 words: 59,080

Economics Rules: The Rights and Wrongs of the Dismal Science by Dani Rodrik

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airline deregulation, Albert Einstein, bank run, barriers to entry, Bretton Woods, butterfly effect, capital controls, Carmen Reinhart, central bank independence, collective bargaining, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, distributed generation, Donald Davies, Edward Glaeser, endogenous growth, Eugene Fama: efficient market hypothesis, Everything should be made as simple as possible, Fellow of the Royal Society, financial deregulation, financial innovation, floating exchange rates, fudge factor, full employment, George Akerlof, Gini coefficient, Growth in a Time of Debt, income inequality, inflation targeting, informal economy, information asymmetry, invisible hand, Jean Tirole, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, labor-force participation, liquidity trap, loss aversion, low skilled workers, market design, market fundamentalism, minimum wage unemployment, oil shock, open economy, Pareto efficiency, Paul Samuelson, price stability, prisoner's dilemma, profit maximization, quantitative easing, randomized controlled trial, rent control, rent-seeking, Richard Thaler, risk/return, Robert Shiller, Robert Shiller, school vouchers, South Sea Bubble, spectrum auction, The Market for Lemons, the scientific method, The Wealth of Nations by Adam Smith, Thomas Kuhn: the structure of scientific revolutions, Thomas Malthus, trade liberalization, trade route, ultimatum game, University of East Anglia, unorthodox policies, Vilfredo Pareto, Washington Consensus, white flight

Simon Wren-Lewis, “When Economics Students Rebel,” Mainly Macro (blog), April 24, 2014, http://mainlymacro.blogspot.co.uk-2014-04-when=economocs=students=rebel.html. 11. Herbert A. Simon, “A Behavioral Model of Rational Choice,” Quarterly Journal of Economics 69 (February 1955): 99–118; Richard R. Nelson and Sidney G. Winter, An Evolutionary Theory of Economic Change (Cambridge, MA: Belknap Press of Harvard University Press, 1982). 12. Daniel Kahneman, Paul Slovic, and Amos Tversky, Judgement under Uncertainty: Heuristics and Biases (Cambridge: Cambridge University Press, 1982). 13. Werner F. M. De Bondt and Richard Thaler, “Does the Stock Market Overreact?” Journal of Finance 40, no. 3 (1985): 793–805. 14. David Laibson, “Golden Eggs and Hyperbolic Discounting,” Quarterly Journal of Economics 112, no. 2 (1997): 443–77; Brigitte C. Madrian and Dennis F.

Using these techniques, economists derive specific predictions for how consumers choose which products to buy, how households save, how firms invest, how workers search for jobs, and so on—as well as for how these actions depend on the particulars of the setting. The postulate always had its critics from within economics, such as Herbert Simon, who argued for a limited form of rationality (called “bounded rationality”), and Richard Nelson, who proposed that firms move by trial and error rather than by optimization—not to mention Adam Smith himself, who may have been the first behavioral economist.11 But it was the work of psychologist Daniel Kahneman and his coauthors that had the greatest impact on mainstream economics.12 This contribution was recognized by a Nobel memorial prize in economics given to Kahneman in 2002, the first time that the prize was awarded to a noneconomist.# Kahneman and his colleagues’ experiments cataloged a long list of behavioral regularities that violated rationality, as the concept is used in economics. People value an object more when giving it up than they do when acquiring it (loss aversion), overgeneralize from small amounts of data (overconfidence), discount evidence that contradicts their beliefs (confirmation bias), yield to short-term temptations that they realize are bad for them (weak self-control), value fairness and reciprocity (bounded selfishness), and so on.


pages: 322 words: 77,341

I.O.U.: Why Everyone Owes Everyone and No One Can Pay by John Lanchester

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asset-backed security, bank run, banking crisis, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Black-Scholes formula, Celtic Tiger, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, diversified portfolio, double entry bookkeeping, Exxon Valdez, Fall of the Berlin Wall, financial deregulation, financial innovation, fixed income, George Akerlof, greed is good, hindsight bias, housing crisis, Hyman Minsky, intangible asset, interest rate swap, invisible hand, Jane Jacobs, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Meriwether, laissez-faire capitalism, light touch regulation, liquidity trap, Long Term Capital Management, loss aversion, Martin Wolf, money market fund, mortgage debt, mortgage tax deduction, mutually assured destruction, Myron Scholes, negative equity, new economy, Nick Leeson, Norman Mailer, Northern Rock, Own Your Own Home, Ponzi scheme, quantitative easing, reserve currency, Right to Buy, risk-adjusted returns, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, South Sea Bubble, statistical model, The Great Moderation, the payments system, too big to fail, tulip mania, value at risk

The economics profession, however, is split between economic rationalists in the Milton Friedman tradition and economic liberals in the tradition of John Maynard Keynes, and the subject of strict rationality is the occasion of a permanent pitched battle. The fact that noneconomists see the general assumption of rationality as self-evidently ridiculous has no effect on economists. What has had an effect, however, is the work of two Israeli psychologist-economists, Daniel Kahneman and Amos Tversky, who have produced a body of work studying “the susceptibility to erroneous intuitions of intelligent, sophisticated, and perceptive individuals,” in the words of the fascinating autobiography written by Kahneman on the occasion of winning the Nobel Prize in 2002. I have a confession to make about Kahneman and Tversky. I’d never heard of them until Kahneman won the Nobel,* and when I first read about their work, it seemed to me to consist of things which were surprising only to economists.

It may be, as Judge Richard Posner has observed, that journalists have a built-in affinity for narratives of disaster and collapse: the press, as he puts it, “thrives on drama and therefore conflict and alarms, discord and discontinuities.”14 (It’s also true, of course, that there were industrial quantities of property market puffery and hype, a considerable amount of which took place on television.) I can’t claim to have been onto this story early, but once I started working on it in the late summer of 2007, it was immediately clear to me that the global banking system was facing a structural crisis. If it was clear to me, why wasn’t it as obvious to the people in charge of the economy and to the people whose job it is to advise them? It’s the kind of question Daniel Kahneman has profitably studied. There is some really interesting work being done in the field of psychology and engineering (where it deeply matters) about “expert overconfidence”: the likelihood of experts in a field to place too high a confidence in their own judgments. It may be that the reason why some journalists were more alert to the imminent crunch than their betters were was because of expert overconfidence combined with an overreliance on the idea that because a crisis of this sort hadn’t happened, it therefore couldn’t happen.

In Baltimore, I’d especially like to thank Steve Hunter and Jean Marbella for their hospitality and advice. I’d also like to thank Ann LoLordo, Fern Shen, Lisa Evans, Mary Waldrow, Tony Damazio, and Philip Robinson. I would also like to thank Fram Dinshaw, Rhomaios Ram, Nicolas Doisy, and Richard Smith. I would like to thank The Atlantic for permission to quote Simon Johnson’s article “The Quiet Coup,” and the Nobel Foundation for permission to quote Daniel Kahneman’s Biography. SOURCES This is a list both of sources and of suggestions for further reading. These are all books from which I have learnt a great deal. Ahamed, Liaquat. Lords of Finance: The Bankers Who Broke the World. Penguin Press, New York, 2009. Akerlof, George, and Robert Shiller. Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism.


pages: 309 words: 78,361

Plenitude: The New Economics of True Wealth by Juliet B. Schor

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Asian financial crisis, big-box store, business climate, carbon footprint, cleantech, Community Supported Agriculture, creative destruction, credit crunch, Daniel Kahneman / Amos Tversky, decarbonisation, dematerialisation, demographic transition, deskilling, Edward Glaeser, en.wikipedia.org, Gini coefficient, global village, income inequality, income per capita, Intergovernmental Panel on Climate Change (IPCC), Isaac Newton, Joseph Schumpeter, Kenneth Arrow, knowledge economy, life extension, McMansion, new economy, peak oil, pink-collar, post-industrial society, prediction markets, purchasing power parity, ride hailing / ride sharing, Robert Shiller, Robert Shiller, sharing economy, Simon Kuznets, single-payer health, smart grid, The Chicago School, Thomas L Friedman, Thomas Malthus, too big to fail, transaction costs, Zipcar

Well being: The foundation of hedonic psychology. New York: Russell Sage. Kahneman, Daniel, and Alan B. Krueger. 2006. Developments in the measurement of subjective well-being. Journal of Economic Perspectives 20 (1): 3-24. Kahneman, Daniel, Alan B. Krueger, David A. Schkade, Norbert Schwarz, and Arthur A. Stone. 2006. Would you be happier if you were richer? A focusing illusion. Science 312 (30): 1776-80. Kahneman, Daniel, and Amos Tversky. 2000. Choices, values and frames. New York: Cambridge University Press. Kasser, Tim, and Kirk W. Brown. 2003. On time, happiness, and ecological footprints. In Take back your time: Fighting overwork and time poverty in America, edited by John De Graaf. San Francisco: Berrett-Koehler, 107-12. Kasser, Tim, and Kennon M. Sheldon. 2009. Time affluence as a path towards personal happiness and ethical business practices: Empirical evidence from four studies.

In a series of studies, the psychologists Tim Kasser and Kennon Sheldon found that being time-affluent is positively associated with well-being, even controlling for income. In some of their studies, time trumped material goods in importance. Kasser and Kirk Brown found that working hours are negatively correlated with life satisfaction. The study on neighbors’ incomes cited above had a similar finding. The Nobel laureate Daniel Kahneman and his Princeton colleague Alan Krueger, using a sample of working women in Texas, report that the three activities most likely to elicit a bad mood are the evening commute, work, and the morning commute. A study among European Union countries found that the higher the working hours, the lower the happiness level, again controlling for other variables. Data from a large-scale German survey also found a negative relationship between working hours and happiness.

Luttmer found that the impact of neighbors’ income rising is equivalent to a similarly sized fall in one’s own income. 178 anticipate that additional income will yield more happiness . . . projection bias: On overvaluing income, or projection bias, see Loewenstein, O’Donoghue, and Rabin (2003); on the related concept of the focusing illusion, see Kahneman et al. (2006). 178 In a series of studies, the psychologists Tim Kasser and Kennon Sheldon: Kasser and Sheldon (2009). 178 Kasser and Kirk Brown found that working hours: Kasser and Brown (2003). 178 Nobel laureate Daniel Kahneman and his Princeton colleague: Kahneman and Krueger (2006), table 2. 178 A study among European Union countries: Alesina, Glaeser, and Sacerdote (2005), table 15. 178 Data from a large-scale German survey: Pouwels, Siegers, and Vlasblom (2008). 178 income is positional, but leisure time is not: Vacations and shorter hours not being positional is from Solnick and Hemenway (1998). See also Frank (1985). 179 No surprises here: Activities that yield well-being are from Kahneman and Krueger (2006), table 2. 179 numerous benefits to humans from contact with the outdoors: See the review of findings by Kellert (2005).


pages: 239 words: 70,206

Data-Ism: The Revolution Transforming Decision Making, Consumer Behavior, and Almost Everything Else by Steve Lohr

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23andMe, Affordable Care Act / Obamacare, Albert Einstein, big data - Walmart - Pop Tarts, bioinformatics, business intelligence, call centre, cloud computing, computer age, conceptual framework, Credit Default Swap, crowdsourcing, Daniel Kahneman / Amos Tversky, Danny Hillis, data is the new oil, David Brooks, East Village, Edward Snowden, Emanuel Derman, Erik Brynjolfsson, everywhere but in the productivity statistics, Frederick Winslow Taylor, Google Glasses, impulse control, income inequality, indoor plumbing, industrial robot, informal economy, Internet of things, invention of writing, John Markoff, John von Neumann, lifelogging, Mark Zuckerberg, market bubble, meta analysis, meta-analysis, money market fund, natural language processing, obamacare, pattern recognition, payday loans, personalized medicine, precision agriculture, pre–internet, Productivity paradox, RAND corporation, rising living standards, Robert Gordon, Second Machine Age, self-driving car, Silicon Valley, Silicon Valley startup, six sigma, skunkworks, speech recognition, statistical model, Steve Jobs, Steven Levy, The Design of Experiments, the scientific method, Thomas Kuhn: the structure of scientific revolutions, unbanked and underbanked, underbanked, Von Neumann architecture, Watson beat the top human players on Jeopardy!

A closer look at the strengths and weaknesses of human cognition provides clues to the role that data science can play in helping humans. In short, what is the sensible division of labor in decision making between man and machine? In the fall of 2013, IBM held a symposium at its Watson research lab that probed that issue, in the context of computer software that keeps getting smarter and smarter. The first speaker was Daniel Kahneman, the Princeton psychologist and Nobel Prize winner in economics. His 2011 best seller, Thinking, Fast and Slow, describes his research, with Amos Tversky, a mathematical psychologist, into the basis of common human errors. Humans, Kahneman explains, are often error-prone when we make decisions by applying rules of thumb and biases. The culprit is “fast” thinking, the quick assessment of a situation to take action. It is thinking anchored in experience, and seems easy—reading a novel, recognizing emotions in others, or the back-and-forth of social conversation.

“But we were kind of sad when Watson no longer answered Wonder Woman,” recalls Jennifer Chu-Carroll, a scientist on the Watson team, as if a bit of whimsy had departed from their creation. Wonder Woman was soon shunted aside, as Watson’s knowledge base became larger, more detailed, and more refined. The computerized knowledge systems being developed at IBM, Google, other companies, and universities are starting to put together “a rich and accurate model of the world,” as Daniel Kahneman summed up the virtue of human-style fast thinking. That sort of cognitive model is the engine of intuition, inference, and cause-and-effect reasoning—getting to the “why” of things, to understanding. It is a horizon of connection that is well beyond correlation. But there is a lively debate among data enthusiasts as to whether the pursuit of causes is even necessary. In their timely and authoritative book Big Data, Viktor Mayer-Schönberger and Kenneth Cukier forcefully state the case for correlation supremacy.

The technology is impressive, and increasingly so. But what struck me while reporting these stories, and what came up repeatedly in conversations with artificial intelligence experts, is what awesome things the human brain and what we call general human intelligence really are. The general intelligence involves the effortless capacity to tap life experience, and make intuitive connections and quick decisions—what Daniel Kahneman calls “thinking fast.” Then there is the human brain as a processor, cramming incredible computing power into a tiny space and using only 20 watts of energy. By contrast, the Watson computer that won its Jeopardy! contest with human champions burned 85,000 watts. Still, the virtuous cycle of more and more varied data and smarter and smarter algorithms, written by human programmers, is delivering a big-data-fueled renaissance in artificial intelligence.


pages: 294 words: 82,438

Simple Rules: How to Thrive in a Complex World by Donald Sull, Kathleen M. Eisenhardt

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Affordable Care Act / Obamacare, Airbnb, asset allocation, Atul Gawande, barriers to entry, Basel III, Berlin Wall, carbon footprint, Checklist Manifesto, complexity theory, Craig Reynolds: boids flock, Credit Default Swap, Daniel Kahneman / Amos Tversky, diversification, drone strike, en.wikipedia.org, European colonialism, Exxon Valdez, facts on the ground, Fall of the Berlin Wall, haute cuisine, invention of the printing press, Isaac Newton, Kickstarter, late fees, Lean Startup, Louis Pasteur, Lyft, Moneyball by Michael Lewis explains big data, Nate Silver, Network effects, obamacare, Paul Graham, performance metric, price anchoring, RAND corporation, risk/return, Saturday Night Live, sharing economy, Silicon Valley, Startup school, statistical model, Steve Jobs, TaskRabbit, The Signal and the Noise by Nate Silver, transportation-network company, two-sided market, Wall-E, web application, Y Combinator, Zipcar

. [>] The team had only won: Beyda, “Turley Named NSCA Coach of the Year”; and Bishop, “Stanford’s Distinct Training Regimen Redefines Strength.” [>] Chris Bingham, a professor: Christopher B. Bingham and Kathleen M. Eisenhardt, “Rational Heuristics: The ‘Simple Rules’ that Strategists Learn from Process Experience,” Strategic Management Journal 32, no. 13 (2011): 1437–64. [>] They lack the information: Daniel Kahneman, Thinking Fast and Thinking Slow (New York: Farrar, Straus and Giroux, 2011). See also Amos Tversky and Daniel Kahneman, “Judgment Under Uncertainty: Heuristics and Biases,” Science 185, no. 4157 (1974): 1124–31. [>] This pattern of improving: Paul J. Feltovich, Michael J. Prietula, and K. Anders Ericsson, “Studies of Expertise from Psychological Perspectives,” in Cambridge Handbook of Expertise and Expert Performance, edited by K. A. Ericsson et al.

The remainder were from Finland, a Scandinavian country boasting a rich ecosystem of technology-based ventures. Despite this cultural and geographic diversity, Chris and Kathy observed an identical pattern for improving simple rules across the countries. First off, Chris and Kathy found that people usually begin with poor rules or even no conscious rules at all. They lack the information and time to develop quality rules at the outset, so they engage in what Nobel Prize–winning psychologist Daniel Kahn­e­man termed fast thinking—rather than expending conscious cognitive effort, they adopt innate universal heuristics that are cognitively easy, like representativeness (“Pick what is usual”) and availability (“Pick what first comes to mind”). For example, every Finnish team began operating in Sweden as their first foreign country, although there was no particular reason for this choice beyond familiarity.


pages: 240 words: 73,209

The Education of a Value Investor: My Transformative Quest for Wealth, Wisdom, and Enlightenment by Guy Spier

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Albert Einstein, Atul Gawande, Benoit Mandelbrot, big-box store, Black Swan, Checklist Manifesto, Clayton Christensen, Daniel Kahneman / Amos Tversky, Exxon Valdez, Gordon Gekko, housing crisis, information asymmetry, Isaac Newton, Kenneth Arrow, Long Term Capital Management, Mahatma Gandhi, mandelbrot fractal, NetJets, pattern recognition, pre–internet, random walk, Ronald Reagan, South Sea Bubble, Steve Jobs, winner-take-all economy, young professional, zero-sum game

It’s worth thinking a little more about the effect of all this gratuitous noise on my poor brain. Checking the stock price too frequently uses up my limited willpower since it requires me to expend unnecessary mental energy simply resisting these calls to action. Given that my mental energy is a scarce resource, I want to direct it in more constructive ways. We also know from behavioral finance research by Daniel Kahneman and Amos Tversky that investors feel the pain of loss twice as acutely as the pleasure of gain. So I need to protect my brain from the emotional storm that occurs when I see that my stocks—or the market—are down. If there’s average volatility, the market is typically up in most years over a 20-year period. But if I check it frequently, there’s a much higher probability that it will be down at that particular moment.

The mind itself is a confounded thing, woefully ill-suited to the task of investing. This is not a science book or a weighty tome about the structure of the brain, but it’s worth taking a few moments to ponder why it’s so hard to think and invest in a rational manner. People often misguidedly regard the brain as one structure: a neocortex that rationally takes in information, computes it, and spits out the answer. Daniel Kahneman, a trailblazing psychologist who won a Nobel Prize for economics in 2002, describes this aspect of the brain’s processes with the phrase “thinking slow.” For my part, I used to have a deluded image of myself as the equivalent of a fighter pilot, intensely focusing on the instrument panel in the cockpit of my jet, making optimal decisions and operating in full control of all the aircraft’s levers.

Force: The Hidden Determinants of Human Behavior by David Hawkins Simple Heuristics That Make Us Smart by Gerd Gigerenzer and Peter Todd The Archaeology of Mind: Neuroevolutionary Origins of Human Emotions by Jaak Panksepp and Lucy Biven The Art of Thinking Clearly by Rolf Dobelli The Developing Mind: How Relationships and the Brain Interact to Shape Who We Are by Daniel Siegel The Feeling of What Happens: Body and Emotion in the Making of Consciousness by Antonio Damasio The 48 Laws of Power by Robert Greene The Neuroscience of Psychotherapy: Healing the Social Brain by Louis Cozolino There Are No Accidents: Synchronicity and the Stories of Our Lives by Robert Hopcke Thinking, Fast and Slow by Daniel Kahneman Waking the Tiger: Healing Trauma by Peter Levine with Ann Frederick Willpower: Rediscovering the Greatest Human Strength by Roy Baumeister and John Tierney Science At Home in the Universe: The Search for the Laws of Self-Organization and Complexity by Stuart Kauffman Connected: The Surprising Power of Our Social Networks and How They Shape Our Lives by Nicholas Christakis and James Fowler Deep Simplicity: Bringing Order to Chaos and Complexity by John Gribbin Emergence: The Connected Lives of Ants, Brains, Cities, and Software by Steven Johnson How Nature Works: The Science of Self-Organized Criticality by Per Bak Journey to the Ants: A Story of Scientific Exploration by Bert Hölldobler and Edward O.


pages: 401 words: 112,784

Hard Times: The Divisive Toll of the Economic Slump by Tom Clark, Anthony Heath

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Affordable Care Act / Obamacare, British Empire, Carmen Reinhart, credit crunch, Daniel Kahneman / Amos Tversky, debt deflation, deindustrialization, Etonian, eurozone crisis, falling living standards, full employment, Gini coefficient, hiring and firing, income inequality, interest rate swap, invisible hand, John Maynard Keynes: Economic Possibilities for our Grandchildren, Kenneth Rogoff, labour market flexibility, low skilled workers, mortgage debt, new economy, Northern Rock, obamacare, oil shock, Plutocrats, plutocrats, price stability, quantitative easing, Right to Buy, Ronald Reagan, science of happiness, statistical model, The Wealth of Nations by Adam Smith, unconventional monetary instruments, War on Poverty, We are the 99%, women in the workforce, working poor

But the psychology, and hence the politics, could be very different. If people blame ‘rising prices’ rather than falling wages for their difficulties, they may blame shops (for high prices) or the government (for failing to control inflation), rather than bosses (for having cut pay). 28. Daniel Kahneman and Amos Tversky dominate the relevant literature. One important early paper in which they developed the idea of ‘anchoring’ (i.e. making decisions with reference to gains and losses from a particular starting point, rather than on the basis of final outcomes) was Amos Tversky and Daniel Kahneman, ‘Judgment under uncertainty: Heuristics and biases source’, Science, NS 185:4157 (1974), pp. 1124–31, at: www.socsci.uci.edu/∼bskyrms/bio/readings/tversky_k_heuristics_biases.pdf This developed into the ‘prospect theory’ of decision making in: D.

The Body Economic: Why austerity kills, Penguin/Allen Lane, London, 2013. Thomas, K. and D. Gunnell. ‘Suicide in England and Wales 1861–2007: A time-trends analysis’, International Journal of Epidemiology, 39:6 (2010), pp. 1464–75, available at: http://ije.oxfordjournals.org/content/39/6/1464.full Tocqueville, Alexis de. Democracy in America, Fontana/HarperCollins, London, 1994 [1840]. Tversky, Amos and Daniel Kahneman. ‘Judgment under uncertainty: Heuristics and biases source’, Science, NS 185:4157 (1974), pp. 1124–31, available at: www.socsci.uci.edu/∼bskyrms/bio/readings/tversky_k_heuristics_biases.pdf Walkerdine, Valerie and Luis Jimenez. Gender, Work and Community after De-Industrialisation: A psychosocial approach to affect, Palgrave Macmillan, London, 2012. Whittaker, Matthew. On Borrowed Time? Dealing with household debt in an era of stagnant incomes, Resolution Foundation, London, 2012.


pages: 464 words: 139,088

The End of Alchemy: Money, Banking and the Future of the Global Economy by Mervyn King

Andrei Shleifer, Asian financial crisis, asset-backed security, balance sheet recession, bank run, banking crisis, banks create money, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, bitcoin, Black Swan, Bretton Woods, British Empire, capital controls, Carmen Reinhart, Cass Sunstein, central bank independence, centre right, collapse of Lehman Brothers, creative destruction, Credit Default Swap, crowdsourcing, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, distributed generation, Doha Development Round, Edmond Halley, Fall of the Berlin Wall, falling living standards, fiat currency, financial innovation, financial intermediation, floating exchange rates, forward guidance, Fractional reserve banking, Francis Fukuyama: the end of history, full employment, German hyperinflation, Hyman Minsky, inflation targeting, invisible hand, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Meriwether, joint-stock company, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, labour market flexibility, large denomination, liquidity trap, Long Term Capital Management, manufacturing employment, market clearing, Martin Wolf, Mexican peso crisis / tequila crisis, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, Myron Scholes, Nick Leeson, North Sea oil, Northern Rock, oil shale / tar sands, oil shock, open economy, paradox of thrift, Paul Samuelson, Ponzi scheme, price mechanism, price stability, purchasing power parity, quantitative easing, rent-seeking, reserve currency, Richard Thaler, rising living standards, Robert Shiller, Robert Shiller, Satoshi Nakamoto, savings glut, secular stagnation, seigniorage, stem cell, Steve Jobs, The Great Moderation, the payments system, Thomas Malthus, too big to fail, transaction costs, Tyler Cowen: Great Stagnation, yield curve, Yom Kippur War, zero-sum game

The main challenge to the economists’ assumption of optimising behaviour comes from ‘behavioural economics’, a relatively new field often associated with Daniel Kahneman, Richard Thaler and Amos Tversky.20 It studies the emotional and psychological dimensions of economic choices.21 Behavioural economics has identified an impressive array of cognitive biases in the way people behave in practice. For example, people are observed both to display overconfidence in their ability to judge probabilities and to underestimate the likelihood of rare events. But behavioural economics assumes that deviations from traditional optimising behaviour result from the fact that humans are hardwired to behave in a way that is ‘irrational’. Daniel Kahneman suggested that decisions are made by two different systems in the mind: one fast and intuitive, the other slower, deliberate, and closer to optimising behaviour.22 In this way he was able to explain aspects of behaviour that appear anomalous in the traditional approach.

Jackson, Julian (2001), France: The Dark Years 1940–44, Oxford University Press. Jarvie, J.R. (1934), The Old Lady Unveiled: A Criticism and Explanation of the Bank of England, Wishart & Company, London. Johnson, Paul (1997), A History of the American People, Weidenfeld and Nicolson, London. Kahneman, Daniel (2011), Thinking, Fast and Slow, Farrar, Straus and Giroux, New York. Kahneman, Daniel and Amos Tversky (1979), ‘Prospect Theory: An Analysis of Decision under Risk’, Econometrica, Vol. 47, pp. 263–91. Kalemli-Ozcan, Sebnem, Bent E. Sorensen and Sevcan Yesiltas (2012), ‘Leverage Across Firms, Banks and Countries’, Federal Reserve Bank of Dallas Conference on Financial Frictions and Monetary Policy in an Open Economy, mimeo. Kareken, John (1986), ‘Federal Bank Regulatory Policy: A Description and Some Observations’, Journal of Business, 59, pp. 3–48.

. —— (2015), ‘In Defense of Derivatives: From Beer to the Financial Crisis’, Policy Analysis, Number 781, Cato Institute. Turner, Adair (2014), ‘Central Banking and Monetary Policy after the Crisis’, City Lecture at the Official Monetary and Financial Institutions Forum (OMFIF), London, 9 December 2014. —— (2015), Between Debt and the Devil, Princeton University Press, Princeton, New Jersey. Tversky, Amos and Daniel Kahneman (1974), ‘Judgment under Uncertainty: Heuristics and Biases’, Science, Vol. 185, No. 4157, pp. 1124–31. Waley, Arthur (1938), The Analects of Confucius, Allen and Unwin, London. Weale, Martin (2015), ‘Prospects for Supply Growth in Western Europe’, Speech at the Rijksuniversiteit, Groningen, 12 October, Bank of England website. Wheatley, Martin (2012), The Wheatley Review of LIBOR – Final Report, HM Treasury, London.


pages: 368 words: 96,825

Bold: How to Go Big, Create Wealth and Impact the World by Peter H. Diamandis, Steven Kotler

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3D printing, additive manufacturing, Airbnb, Amazon Mechanical Turk, Amazon Web Services, augmented reality, autonomous vehicles, cloud computing, creative destruction, crowdsourcing, Daniel Kahneman / Amos Tversky, dematerialisation, deskilling, Elon Musk, en.wikipedia.org, Exxon Valdez, fear of failure, Firefox, Galaxy Zoo, Google Glasses, Google Hangouts, Google X / Alphabet X, gravity well, ImageNet competition, industrial robot, Internet of things, Jeff Bezos, John Harrison: Longitude, John Markoff, Jono Bacon, Just-in-time delivery, Kickstarter, Kodak vs Instagram, Law of Accelerating Returns, Lean Startup, life extension, loss aversion, Louis Pasteur, Mahatma Gandhi, Marc Andreessen, Mark Zuckerberg, Mars Rover, meta analysis, meta-analysis, microbiome, minimum viable product, move fast and break things, Narrative Science, Netflix Prize, Network effects, Oculus Rift, optical character recognition, packet switching, PageRank, pattern recognition, performance metric, Peter H. Diamandis: Planetary Resources, Peter Thiel, pre–internet, Ray Kurzweil, recommendation engine, Richard Feynman, Richard Feynman, ride hailing / ride sharing, risk tolerance, rolodex, self-driving car, sentiment analysis, shareholder value, Silicon Valley, Silicon Valley startup, skunkworks, Skype, smart grid, stem cell, Stephen Hawking, Steve Jobs, Steven Levy, Stewart Brand, technoutopianism, telepresence, telepresence robot, Turing test, urban renewal, web application, X Prize, Y Combinator, zero-sum game

“[People] will do things because others are doing them,” Musk explains, “because there is a trend, because they see everyone moving in one direction and decide that’s the best direction to go. Sometimes this is correct, but sometimes this will take you right off a cliff. Thinking in first principles protects you from these errors.” When it comes to scale, these aren’t the only errors one must guard against. Daniel Kahneman and Amos Tversky won the Nobel Prize for their work on human irrationality. One great example of this is what happens when two of the most common cognitive biases—loss aversion and narrow framing—begin to overlap. Loss aversion is the idea that humans are more sensitive to losses—even small losses—than gains, while narrow framing is our tendency to treat every risk we encounter as an isolated incident.

v=O4MtQGRIIuA. 8 Dominic Basulto, “The new #Fail: Fail fast, fail early and fail often,” Washington Post, May 30, 2012, http://www.washingtonpost.com/blogs/innovations/post/the-new-fail-fail-fast-fail-early-and-fail-often/2012/05/30/gJQAKA891U_blog.html. 9 John Anderson, “Change on a Dime: Agile Design,” UX Magazine, July 19, 2011, http://uxmag.com/articles/change-on-a-dime-agile-design. 10 AI with Ismail, 2013. 11 For an amazing breakdown of these ideas, see Dan Pink, “RSA Animate—Drive: The surprising truth about what motivates us,” RSA, April 1, 2010, https://www.youtube.com/watch?v=u6XAPnuFjJc. 12 Daniel Kahneman, “The riddle of experience vs. memory,” TED, March 1, 2010, http://www.ted.com/talks/daniel_kahneman_the_riddle_of_experience_vs_memory. 13 Daniel H. Pink, Drive: The Surprising Truth About What Motivates Us (New York: Riverhead Books, 2010). 14 Christopher Mims, “When 110% won’t do: Google engineers insist 20% time is not dead—it’s just turned into 120% time” qz.com, August 16, 2013. 15 James Marshall Reilly, “The Zappos Story: How Failure can Fuel Business Success,” Monster.com, http://hiring.monster.com/hr/hr-best-practices/workforce-management/hr-management-skills/business-success.aspx. 16 All Astro Teller quotes come from a series of AIs conducted between 2013 and 2014. 17 Susan Wojcicki, “The Eight Pillars of Innovation,” thinkwithgoogle.com, July 2011, http://www.thinkwithgoogle.com/articles/8-pillars-of-innovation.html. 18 For a much deeper look at flow and its impact on performance see Steven Kotler, The Rise of Superman: Decoding the Science of Ultimate Human Performance (New York: New Harvest, 2014). 19 AI with John Hagel conducted 2014. 20 Steven Kotler and Jamie Wheal, “Five Surprising Ways Richard Branson Harnessed Flow to Build A Multi-Billion Dollar Empire,” Forbes, March 25, 2014, http://www.forbes.com/sites/stevenkotler/2014/03/25/five-surprising-ways-richard-branson-harnessed-flow-to-build-a-multi-billion-dollar-empire/. 21 Steven Kotler, “The Rise of Superman: 17 Flow Triggers,” Slideshare.net, March 2014, http://www.slideshare.net/StevenKotler/17-flow-triggers. 22 AI with Ned Hallowell conducted 2013. 23 Kevin Rathunde, “Montessori Education and Optimal Experience: A Framework for New Research,” The NAMTA Journal (Winter 2001): 11–43. 24 Mihaly Csikszentmihalyi, Flow: The Psychology of Optimal Experience (New York: Harper & Row, 1990), 48–70. 25 For a great breakdown of group flow and the social triggers see Keith Sawyer, Group Genius: The Creative Power of Collaboration (New York: Basic Books), 2008. 26 AI with Ismail, 2013.

But once tasks become slightly more complex—such as shaping those nailed boards into a house—once they require even the slightest bit of conceptual ability, money actually has the exact opposite effect: It lowers motivation, hinders creativity, and decreases performance.11 What’s more, this isn’t the only issue with money as a motivator. Money, it now appears, is only an effective motivator until our basic biological needs are met, with a little left over for discretionary spending. This is why, in America, as the Nobel laureate Daniel Kahneman recently discovered, when you plot happiness and life satisfaction alongside income, they overlap until $70,000—i.e., the point at which money stops being a major issue—then wildly diverge.12 Once we pay people enough so that meeting basic needs is no longer a constant cause for concern, extrinsic rewards lose their effectiveness, while intrinsic rewards—meaning internal, emotional satisfactions—become far more critical.


pages: 306 words: 85,836

When to Rob a Bank: ...And 131 More Warped Suggestions and Well-Intended Rants by Steven D. Levitt, Stephen J. Dubner

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Affordable Care Act / Obamacare, Airbus A320, airport security, augmented reality, barriers to entry, Bernie Madoff, Black Swan, Broken windows theory, Captain Sullenberger Hudson, creative destruction, Daniel Kahneman / Amos Tversky, deliberate practice, feminist movement, food miles, George Akerlof, information asymmetry, invisible hand, loss aversion, mental accounting, Netflix Prize, obamacare, oil shale / tar sands, Pareto efficiency, peak oil, pre–internet, price anchoring, price discrimination, principal–agent problem, profit maximization, Richard Thaler, security theater, Ted Kaczynski, the built environment, The Chicago School, the High Line, Thorstein Veblen, transaction costs, US Airways Flight 1549

True to his word, Levitt hasn’t touched a bowling ball since. Loss Aversion in the NFL (SJD) Football coaches are known for being extraordinarily conservative when it comes to calling risky plays, since a single bad decision (or even a good decision that doesn’t work out) can get you fired. In the jargon of behavioral economics, coaches are “loss-averse”; this concept, pioneered by Amos Tversky and Daniel Kahneman, holds that we experience more pain with a loss of x than we experience pleasure with a gain of x. Who experiences loss aversion? Well, just about everyone: day traders, capuchin monkeys, and especially football coaches. Which is why the last play of yesterday’s Chiefs-Raiders game was so interesting. With five seconds left, Chiefs coach Dick Vermeil had a tough decision to make. His team was trailing by three points with the ball inside the Raiders’ one-yard line.

Now it seems only logical that someone will step up to try to sue McDonald’s for putting all those extra pounds on the passengers in the first place. Daniel Kahneman Answers Your Questions (SDL) One of the first times I met Danny Kahneman was over dinner, just after SuperFreakonomics was published. “I enjoyed your new book,” Danny said. “It will change the future of the world.” I beamed with pride. Danny, however, was not done speaking. “It will change the future of the world—and not for the better.” While I’m sure many people would agree, he was the only person who ever said it to my face! If you don’t know the name, Daniel Kahneman is the non-economist who has had the greatest influence on economics of any non-economist who ever lived. A psychologist, he’s the only non-economist to win the Nobel Prize in Economics for his pioneering work in behavioral economics.

But mostly, having the blog gave us good reason to stay curious and open about the world. Unlike that first post, the vast majority of the blog entries were written by just one of us, not the pair, as in our book writing. We sometimes asked friends (and even enemies) to write for the blog; we’ve held “quorums” (asking a bunch of smart people to answer a tough question) and Q&As (with people like Daniel Kahneman and a high-end call girl named Allie). For several years, The New York Times hosted the blog, which gave it a veneer of legitimacy that wasn’t quite warranted. But the Times eventually came to its senses and sent us off to do the thing we do, once more on our lonesome. All these years, we routinely asked ourselves why we kept blogging. There was no obvious answer. It didn’t pay; there wasn’t any evidence the blog helped sell more copies of our books.


pages: 377 words: 97,144

Singularity Rising: Surviving and Thriving in a Smarter, Richer, and More Dangerous World by James D. Miller

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23andMe, affirmative action, Albert Einstein, artificial general intelligence, Asperger Syndrome, barriers to entry, brain emulation, cloud computing, cognitive bias, correlation does not imply causation, crowdsourcing, Daniel Kahneman / Amos Tversky, David Brooks, David Ricardo: comparative advantage, Deng Xiaoping, en.wikipedia.org, feminist movement, Flynn Effect, friendly AI, hive mind, impulse control, indoor plumbing, invention of agriculture, Isaac Newton, John von Neumann, knowledge worker, Long Term Capital Management, low skilled workers, Netflix Prize, neurotypical, pattern recognition, Peter Thiel, phenotype, placebo effect, prisoner's dilemma, profit maximization, Ray Kurzweil, recommendation engine, reversible computing, Richard Feynman, Richard Feynman, Rodney Brooks, Silicon Valley, Singularitarianism, Skype, statistical model, Stephen Hawking, Steve Jobs, supervolcano, technological singularity, The Coming Technological Singularity, the scientific method, Thomas Malthus, transaction costs, Turing test, Vernor Vinge, Von Neumann architecture

CMAJ 180 (12): 1216—20. http://www.cmaj.ca/cgi/rapidpdf/cmaj.081125v1.pdf. Turner, Danielle C., Trevor W. Robbins, Luke Clark, Adam R. Aron, Jonathan Dowson, and Barbara J. Sahakian. 2003. “Cognitive Enhancing Effects of Modafinil in Healthy Volunteers.” Psychopharmacology 165 (3): 260—69. doi:10.1007/s00213-002-1250-8. Tversky, Amos, and Daniel Kahneman. 1982. “Judgments Of and By Representativeness.” In Judgment under Uncertainty: Heuristics and Biases, edited by Daniel Kahneman, Paul Slovic, and Amos Tversky. New York: Cambridge University Press. Tversky, Amos, and Daniel Kahneman. 1983. “Extensional Versus Intuitive Reasoning: The Conjunction Fallacy in Probability Judgment. Psychological Review 90 (4): 293—315. Ulam, Stanislaw. 1958. “John von Neumann: 1903—1957.” Bulletin of the American Mathematical Society 64, part 2: 1—49. Vance, Ashlee. June 12, 2010.

Consequently, the Singularity community’s possible failure to defeat these biases represents another possible reason why you should doubt the conclusions of this book. The community recognizes the danger of cognitive biases, and through the blog Less Wrong, many members of it study how to overcome them. It’s certainly possible, however, that the community hasn’t overcome enough of its innate biases to make our predictions trustworthy. For futurists, one of the most dangerous cognitive biases was uncovered by Daniel Kahneman, winner of a Nobel Prize in economics. Kahneman conducted an experiment in which he told his test subjects to imagine that: Linda is 31 years old, single, outspoken, and very bright. She majored in philosophy. As a student, she was deeply concerned with issues of discrimination and social justice and also participated in antinuclear demonstrations.342 The subjects were then asked to rank a set of statements by the likelihood of their being true.


pages: 317 words: 97,824

Mastermind: How to Think Like Sherlock Holmes by Maria Konnikova

Albert Einstein, Alfred Russel Wallace, availability heuristic, Daniel Kahneman / Amos Tversky, dark matter, delayed gratification, fear of failure, feminist movement, functional fixedness, Lao Tzu, pre–internet, Richard Feynman, Richard Feynman, Steve Jobs, Steven Pinker, the scientific method, Thomas Kuhn: the structure of scientific revolutions, Walter Mischel

After you’ve made your ranking, take a look at two pairs of statements in particular: Bill plays jazz for a hobby and Bill is an accountant who plays jazz for a hobby, and Linda is a bank teller and Linda is a bank teller and is active in the feminist movement. Which of the two statements have you ranked as more likely in each pair? I am willing to bet that it was the second one in both cases. If it was, you’d be with the majority, and you would be making a big mistake. This exercise was taken verbatim from a 1983 paper by Amos Tversky and Daniel Kahneman, to illustrate our present point: when it comes to separating crucial details from incidental ones, we often don’t fare particularly well. When the researchers’ subjects were presented with these lists, they repeatedly made the same judgment that I’ve just predicted you would make: that it was more likely that Bill was an accountant who plays jazz for a hobby than it was that he plays jazz for a hobby, and that it was more likely that Linda was a feminist bank teller than that she was a bank teller at all.

Your brain can be one quick study if it wants to be. The trick is to duplicate that same process, to let your brain study and learn and make effortless what was once effortful, in something that lacks the discrete nature of a cognitive task like the sentence verification, in something that is so basic that we do it constantly, without giving it much thought or attention: the task of looking and thinking. Daniel Kahneman argues repeatedly that System 1—our Watson system—is hard to train. It likes what it likes, it trusts what it trusts, and that’s that. His solution? Make System 2—Holmes—do the work by taking System 1 forcibly out of the equation. For instance, use a checklist of characteristics when hiring a candidate for a job instead of relying on your impression, an impression that, as you’ll recall, is formed within the first five minutes or less of meeting someone.

Chapter Three: Stocking the Brain Attic The seminal work on the brain’s default network, resting state, and intrinsic natural activity and attentional disposition was conducted by Marcus Raichle. For a discussion of attention, inattentional blindness, and how our senses can lead us astray, I recommend Christopher Chabris and Daniel Simon’s The Invisible Gorilla. For an in-depth look at the brain’s inbuilt cognitive biases, Daniel Kahneman’s Thinking, Fast and Slow. The correctional model of observation is taken from the work of Daniel Gilbert. Chapter Four: Exploring the Brain Attic For an overview of the nature of creativity, imagination, and insight, I recommend the work of Mihaly Csikszentmihalyi, including his books Creativity: Flow and the Psychology of Discovery and Invention and Flow: The Psychology of Optimal Experience.


pages: 295 words: 66,824

A Mathematician Plays the Stock Market by John Allen Paulos

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Benoit Mandelbrot, Black-Scholes formula, Brownian motion, business climate, butterfly effect, capital asset pricing model, correlation coefficient, correlation does not imply causation, Daniel Kahneman / Amos Tversky, diversified portfolio, Donald Trump, double entry bookkeeping, Elliott wave, endowment effect, Erdős number, Eugene Fama: efficient market hypothesis, four colour theorem, George Gilder, global village, greed is good, index fund, intangible asset, invisible hand, Isaac Newton, John Nash: game theory, Long Term Capital Management, loss aversion, Louis Bachelier, mandelbrot fractal, margin call, mental accounting, Myron Scholes, Nash equilibrium, Network effects, passive investing, Paul Erdős, Paul Samuelson, Ponzi scheme, price anchoring, Ralph Nelson Elliott, random walk, Richard Thaler, Robert Shiller, Robert Shiller, short selling, six sigma, Stephen Hawking, survivorship bias, transaction costs, ultimatum game, Vanguard fund, Yogi Berra

A number of psychologists in recent years have pointed out the countless ways in which we’re all subject to other sorts of counterproductive behavior that spring from cognitive blind spots that are analogues, perhaps, of optical illusions. These psychological illusions and foibles often make us act irrationally in a variety of disparate endeavors, not the least of which is investing. Amos Tversky and Daniel Kahneman are the founders of this relatively new field of study, many of whose early results are reported upon in the classic book Judgment Under Uncertainty , edited by them and Paul Slovic. (Kahneman was awarded the 2002 Nobel Prize in economics, and Tversky almost certainly would have shared it had he not died.) Others who have contributed to the field include Thomas Gilovich, Robin Dawes, J.

Ross, Sheldon, Mathematical Finance, Cambridge, Cambridge University Press, 1999. Siegel, Jeremy J., Stocks for the Long Run, New York, McGraw-Hill, 1998. Shiller, Robert J., Irrational Exuberance, Princeton, Princeton University Press, 2000. Taleb, Nassim Nicholas, Fooled by Randomness, New York, Texere, 2001. Thaler, Richard, The Winner’s Curse, Princeton, Princeton University Press, 1992. Tversky, Amos, Daniel Kahneman, and Paul Slovic, Judgment Under Uncertainty: Heuristics and Biases, Cambridge, Cambridge University Press, 1982. Index accounting practices assumptions vs. practices auditors and comparing corporate and personal accounting conflict of interest and deciphering company financial health Enron reforms transparency vagueness and subjectivity of value investing and WorldCom (WCOM) accounting scandals. see also fraud Benford’s Law and deciphering company financial health Efficient Market Hypothesis and psychology of cover ups volatility and WCOM fraud Al Qaeda Albert, Réka anchoring effect financial numbers and number experiments online chatroom example arithmetic mean. see also mean value IPO purchases/sales outstripping geometric mean rate of return Arthur Andersen Arthur, W.


pages: 503 words: 131,064

Liars and Outliers: How Security Holds Society Together by Bruce Schneier

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airport security, barriers to entry, Berlin Wall, Bernie Madoff, Bernie Sanders, Brian Krebs, Broken windows theory, carried interest, Cass Sunstein, Chelsea Manning, commoditize, corporate governance, crack epidemic, credit crunch, crowdsourcing, cuban missile crisis, Daniel Kahneman / Amos Tversky, David Graeber, desegregation, don't be evil, Double Irish / Dutch Sandwich, Douglas Hofstadter, experimental economics, Fall of the Berlin Wall, financial deregulation, George Akerlof, hydraulic fracturing, impulse control, income inequality, invention of agriculture, invention of gunpowder, iterative process, Jean Tirole, John Nash: game theory, joint-stock company, Julian Assange, mass incarceration, meta analysis, meta-analysis, microcredit, moral hazard, mutually assured destruction, Nate Silver, Network effects, Nick Leeson, offshore financial centre, patent troll, phenotype, pre–internet, principal–agent problem, prisoner's dilemma, profit maximization, profit motive, race to the bottom, Ralph Waldo Emerson, RAND corporation, rent-seeking, RFID, Richard Thaler, risk tolerance, Ronald Coase, security theater, shareholder value, slashdot, statistical model, Steven Pinker, Stuxnet, technological singularity, The Market for Lemons, The Nature of the Firm, The Spirit Level, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, theory of mind, too big to fail, traffic fines, transaction costs, ultimatum game, UNCLOS, union organizing, Vernor Vinge, WikiLeaks, World Values Survey, Y2K, zero-sum game

Krauss (1960), “The Effect of Threat upon Interpersonal Bargaining,” Journal of Abnormal & Normal Social Psychology, 61:181–9. better model Rolf Kümmerli, Caroline Colliard, Nicolas Fiechter, Blaise Petitpierre, Flavien Russier, and Laurent Keller (2007), “Human Cooperation in Social Dilemmas: Comparing the Snowdrift Game with the Prisoner's Dilemma,” Proceedings of the Royal Society B: Biological Sciences, 274:2965–70. Prospect Theory Daniel Kahneman and Amos Tversky (1979), “Prospect Theory: An Analysis of Decision under Risk,” Econometrica, 47:263–92. systems of regulation Susan Jane Buck Cox (1985), “No Tragedy on the Commons,” Environmental Ethics, 7:49–62. superrationality Douglas Hofstadter (1985), Metamagical Themas, Bantam Dell Publishing Group. collectively rational Anatol Rapoport, ed. (1974), Game Theory as a Theory of Conflict Resolution, Reidel Publishing Co.

Bounded Rationality Bryan D. Jones (1999), “Bounded Rationality,” Annual Review of Political Science, 2:297–321. Daniel Kahneman (2003), “Maps of Bounded Rationality: Psychology for Behavioral Economics,” The American Economic Review, 93:1449–75. Gerd Gigerenzer (2007), Gut Feelings: The Intelligence of the Unconscious, Viking Adult. Dan Ariely (2008), Predictably Irrational: The Hidden Forces that Shape our Decisions, Harper Perennial. Ori Brafman and Rom Brafman (2008), Sway: The Irresistible Pull of Irrational Behavior, Crown Business. Shankar Vedantam (2010), The Hidden Brain: How Our Unconscious Minds Elect Presidents, Control Markets, Wage Wars, and Save our Lives, Spiegel & Grau. Daniel Kahneman (2011), Thinking Fast and Slow, Farrar, Straus and Giroux. Duncan J. Watts (2011), Everything is Obvious: *Once You Know the Answer, Crown Business.

Goldstein and Gerd Gigerenzer (2002), “Models of Ecological Rationality: The Recognition Heuristic,” Psychological Review, 109:75–90. There's social proof Herbert C. Kelman (1958), “Compliance, Identification, and Internalization: Three Processes of Attitude Change,” Journal of Conflict Resolution, 2:51–60. attribute substitution Daniel Kahneman and Shane Frederick (2002), “Representativeness Revisited: Attribute Substitution in Intuitive Judgment,” in Thomas Gilovich, Dale Griffin, and Daniel Kahneman, eds., Heuristics and Biases: The Psychology of Intuitive Judgment, Cambridge University Press, 49–81. a lemons market George Akerlof (1970), “The Market for Lemons: Quality Uncertainty and the Market Mechanism,” Quarterly Journal of Economics, 83:488–500. George E. Hoffer and Michael D. Pratt (1987), “Used Vehicles, Lemons Markets, and Used Car Rules: Some Empirical Evidence,” Journal of Consumer Policy, 10:409–14.


pages: 294 words: 81,292

Our Final Invention: Artificial Intelligence and the End of the Human Era by James Barrat

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3D printing, AI winter, Amazon Web Services, artificial general intelligence, Asilomar, Automated Insights, Bayesian statistics, Bernie Madoff, Bill Joy: nanobots, brain emulation, cellular automata, Chuck Templeton: OpenTable, cloud computing, cognitive bias, commoditize, computer vision, cuban missile crisis, Daniel Kahneman / Amos Tversky, Danny Hillis, data acquisition, don't be evil, drone strike, Extropian, finite state, Flash crash, friendly AI, friendly fire, Google Glasses, Google X / Alphabet X, Isaac Newton, Jaron Lanier, John Markoff, John von Neumann, Kevin Kelly, Law of Accelerating Returns, life extension, Loebner Prize, lone genius, mutually assured destruction, natural language processing, Nicholas Carr, optical character recognition, PageRank, pattern recognition, Peter Thiel, prisoner's dilemma, Ray Kurzweil, Rodney Brooks, Search for Extraterrestrial Intelligence, self-driving car, semantic web, Silicon Valley, Singularitarianism, Skype, smart grid, speech recognition, statistical model, stealth mode startup, stem cell, Stephen Hawking, Steve Jobs, Steve Wozniak, strong AI, Stuxnet, superintelligent machines, technological singularity, The Coming Technological Singularity, Thomas Bayes, traveling salesman, Turing machine, Turing test, Vernor Vinge, Watson beat the top human players on Jeopardy!, zero day

Because vampires have provided so much fun, it’d take time for the guffawing to stop, and the wooden stakes to come out. Maybe we’re in that period right now with AI, and only an accident or a near-death experience will jar us awake. Another reason AI and human extinction do not often receive serious consideration may be due to one of our psychological blind spots—a cognitive bias. Cognitive biases are open manholes on the avenues of our thinking. Israeli American psychologists Amos Tversky and Daniel Kahneman began developing the science of cognitive biases in 1972. Their basic idea is that we humans make decisions in irrational ways. That observation alone won’t earn you a Nobel Prize (Kahneman received one in 2002); the stunner is that we are irrational in scientifically verifiable patterns. In order to make the quick decisions useful during our evolution, we repeatedly take the same mental shortcuts, called heuristics.

They think there’s a better than 10 percent chance: Goertzel, Ben, Seth Baum, and Ted Goertzel, “How Long Till Human-Level AI.” H+ Magazine, February 5, 2010, http://hplusmagazine.com/2010/02/05/how-long-till-human-level-ai/ (accessed March 4, 2010). Furthermore, experts claim: Sandburg Anders, and Nick Bostrom, “Machine Intelligence Survey,” 2011, http://www.fhi.ox.ac.uk/__data/assets/pdf_file/0015/21516/MI_survey.pdf (accessed December 4, 2011). the science of cognitive biases: Kahneman, Daniel, Paul Slovic, and Amos Tversky, Judgment under Uncertainty: Heuristics and Biases (Cambridge: Cambridge University Press, 1982), 11. fire ranks well down the list: Centers for Disease Control and Prevention, “Accidents or Unintentional Injuries,” March 28, 2011, http://www.cdc.gov/nchs/fastats/acc-inj.htm (accessed April 4, 2011). But by choosing fire: Kahneman, et al., Judgment under Uncertainty, 11. Engineering at an atomic scale: Bostrom, Nick, “Ethical Issues in Advanced Artificial Intelligence,” 2003, http://www.nickbostrom.com/ethics/ai.html (accessed April 4, 2011).


pages: 467 words: 154,960

Trend Following: How Great Traders Make Millions in Up or Down Markets by Michael W. Covel

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Albert Einstein, asset allocation, Atul Gawande, backtesting, beat the dealer, Bernie Madoff, Black Swan, buy low sell high, capital asset pricing model, Clayton Christensen, commodity trading advisor, computerized trading, correlation coefficient, Daniel Kahneman / Amos Tversky, delayed gratification, deliberate practice, diversification, diversified portfolio, Edward Thorp, Elliott wave, Emanuel Derman, Eugene Fama: efficient market hypothesis, Everything should be made as simple as possible, fiat currency, fixed income, game design, hindsight bias, housing crisis, index fund, Isaac Newton, John Meriwether, John Nash: game theory, linear programming, Long Term Capital Management, mandelbrot fractal, margin call, market bubble, market fundamentalism, market microstructure, mental accounting, money market fund, Myron Scholes, Nash equilibrium, new economy, Nick Leeson, Ponzi scheme, prediction markets, random walk, Renaissance Technologies, Richard Feynman, Richard Feynman, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, shareholder value, Sharpe ratio, short selling, South Sea Bubble, Stephen Hawking, survivorship bias, systematic trading, the scientific method, Thomas L Friedman, too big to fail, transaction costs, upwardly mobile, value at risk, Vanguard fund, volatility arbitrage, William of Occam, zero-sum game

Opponents hit .364 off Pedro this year after his 105th pitch—even Tony Clark could hit Pedro in the late innings.”26 The late, great Stephen Jay Gould, a numbers man (and lifelong baseball fan), offered some insight into the decision-making process that might have left Martinez in the game: “Everybody knows about hot hands. The only problem is that no such phenomenon exists. The Stanford psychologist Amos Tversky studied every basket made by the Philadelphia 76ers for more than a season. He found, first of all, that probabilities of making a second basket did not rise following a successful shot. Moreover, the number of ‘runs,’ or baskets in succession, was no greater than what a standard random, or coin-tossing, model would predict. Of course Larry Bird, the great forward of the Boston Celtics, will have more sequences of five than Joe Airball—but not because he has greater will or gets in that magic rhythm more often.

Futures Prices in Supply Analysis. American Journal of Agricultural Economics, 58 (1976): 81–84. Gary, Loren. The Right Kind of Failure. Harvard Management Update. Gigerenzer, Gerd and Peter M. Todd. Simple Heuristics That Make Us Smart. Oxford: Oxford University Press, 1999. 425 426 Trend Following (Updated Edition): Learn to Make Millions in Up or Down Markets Gilovich, Thomas, Robert Valone, and Amos Tversky. The Hot Hand in Basketball: On the Misperception of Random Sequences. Cognitive Psychology, 17 (1985): 295–314. Ginyard, Johan. Position-Sizing Effects on Trader Performance: An Experimental Analysis. Uppsala University, Department of Psychology, 2001. Goldbaum, David. Technical Analysis, Price Trends, and Bubbles. Gould, Stephen Jay. Full House. New York: Three Rivers Press, 1996. Gould, Stephen Jay.

Prospect Theory Investment bubbles have always been a part of market history. For example, seventeenth century speculators in the Netherlands drove up the prices of tulip bulbs to absurd levels. The inevitable crash followed. Since then, from the Great Depression to the dotcom implosion to October and November 2008, people can’t seem to steer clear from manias. They repeatedly make the same mistakes. Daniel Kahneman, a Princeton professor who was the first psychologist to win the Nobel Prize in Economics, attributed market manias to investors’ “illusion of control,” calling the illusion “prospect theory.” He studied the intellectual underpinnings of investing—how traders estimate odds and calculate risks—to prove 195 Chapter 6 • Human Behavior how often we act from the mistaken belief that we know more than we do.


pages: 471 words: 124,585

The Ascent of Money: A Financial History of the World by Niall Ferguson

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Admiral Zheng, Andrei Shleifer, Asian financial crisis, asset allocation, asset-backed security, Atahualpa, bank run, banking crisis, banks create money, Black Swan, Black-Scholes formula, Bonfire of the Vanities, Bretton Woods, BRICs, British Empire, capital asset pricing model, capital controls, Carmen Reinhart, Cass Sunstein, central bank independence, collateralized debt obligation, colonial exploitation, commoditize, Corn Laws, corporate governance, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, Daniel Kahneman / Amos Tversky, deglobalization, diversification, diversified portfolio, double entry bookkeeping, Edmond Halley, Edward Glaeser, Edward Lloyd's coffeehouse, financial innovation, financial intermediation, fixed income, floating exchange rates, Fractional reserve banking, Francisco Pizarro, full employment, German hyperinflation, Hernando de Soto, high net worth, hindsight bias, Home mortgage interest deduction, Hyman Minsky, income inequality, information asymmetry, interest rate swap, Intergovernmental Panel on Climate Change (IPCC), Isaac Newton, iterative process, John Meriwether, joint-stock company, joint-stock limited liability company, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, knowledge economy, labour mobility, Landlord’s Game, liberal capitalism, London Interbank Offered Rate, Long Term Capital Management, market bubble, market fundamentalism, means of production, Mikhail Gorbachev, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, mortgage debt, mortgage tax deduction, Myron Scholes, Naomi Klein, negative equity, Nick Leeson, Northern Rock, Parag Khanna, pension reform, price anchoring, price stability, principal–agent problem, probability theory / Blaise Pascal / Pierre de Fermat, profit motive, quantitative hedge fund, RAND corporation, random walk, rent control, rent-seeking, reserve currency, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Reagan, savings glut, seigniorage, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, spice trade, structural adjustment programs, technology bubble, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Thomas Bayes, Thomas Malthus, Thorstein Veblen, too big to fail, transaction costs, value at risk, Washington Consensus, Yom Kippur War

For there is no question that the heuristic biases of individuals play a critical role in generating volatility in financial markets. This brings us to the second reason for the inherent instability of the financial system: human behaviour. As we have seen, all financial institutions are at the mercy of our innate inclination to veer from euphoria to despondency; our recurrent inability to protect ourselves against ‘tail risk’; our perennial failure to learn from history. In a famous article, Daniel Kahneman and Amos Tversky demonstrated with a series of experiments the tendency that people have to miscalculate probabilities when confronted with simple financial choices. First, they gave their sample group 1,000 Israeli pounds each. Then they offered them a choice between either a) a 50 per cent chance of winning an additional 1,000 pounds or b) a 100 per cent chance of winning an additional 500 pounds.

., New York, 2005) 6 Idem, The Black Swan: The Impact of the Highly Improbable (London, 2007). 7 Georges Soros, The New Paradigm for Financial Markets: The Credit Crash of 2008 and What It Means, (New York, 2008), pp. 91 ff. 8 See Frank H. Knight, Risk, Uncertainty and Profit (Boston, 1921). 9 John Maynard Keynes, ‘The General Theory of Employment’, Economic Journal, 51, 2 (1937), p. 214. 10 Daniel Kahneman and Amos Tversky, ‘Prospect Theory: An Analysis of Decision under Risk’, Econometrica, 47, 2 (March 1979), p. 273. 11 Eliezer Yudkowsky, ‘Cognitive Biases Potentially Affecting Judgment of Global Risks’, in Nick Bostrom and Milan Cirkovic (eds.), Global Catastrophic Risks (Oxford University Press, 2008), pp. 91-119. See also Michael J. Mauboussin, More Than You Know: Finding Financial Wisdom in Unconventional Places (New York / Chichester, 2006). 12 Mark Buchanan, The Social Atom: Why the Rich Get Richer, Cheaters Get Caught, and Your Neighbor Usually Looks Like You (New York, 2007), p. 54. 13 For an introduction, see Andrei Shleifer, Inefficient Markets: An Introduction to Behavioral Finance (Oxford, 2000).


pages: 369 words: 128,349

Beyond the Random Walk: A Guide to Stock Market Anomalies and Low Risk Investing by Vijay Singal

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3Com Palm IPO, Andrei Shleifer, asset allocation, capital asset pricing model, correlation coefficient, cross-subsidies, Daniel Kahneman / Amos Tversky, diversified portfolio, endowment effect, fixed income, index arbitrage, index fund, information asymmetry, liberal capitalism, locking in a profit, Long Term Capital Management, loss aversion, margin call, market friction, market microstructure, mental accounting, merger arbitrage, Myron Scholes, new economy, prediction markets, price stability, profit motive, random walk, Richard Thaler, risk-adjusted returns, risk/return, selection bias, Sharpe ratio, short selling, survivorship bias, transaction costs, Vanguard fund

In this way, prices can move away from fundamental values for an extended period of time, which makes arbitrage positions riskier and less profitable. Behavioral finance won worldwide recognition when the 2002 Nobel prize was awarded to Daniel Kahneman for having integrated insights from psychological research into economic science, especially concerning human judgment and decision making under uncertainty, and to Vernon Smith for having established laboratory experiments as a tool in empirical economic analysis, especially in the study of alternative market mechanisms. Amos Tversky (who died in 1996) deserves as much credit as Daniel Kahneman for explaining the role of human behavior in economic decision making. Lessons from Behavioral Finance Though behavioral finance is here to stay, it is not important whether one agrees with the assumption of pervasive irrational behavior.

Journal of Finance 54(6), 2143–84. Kadlec, Gregory B., and John J. McConnell. 1994. The Effect of Market Segmentation and Illiquidity on Asset Prices: Evidence from Exchange Listings. Journal of Finance 49(2), 611–36. Kahneman, Daniel, Jack L. Knetsch, and Richard H. Thaler. 1991. Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias. Journal of Economic Perspectives 5(1), 193–206. Kahneman, Daniel, and Amos Tversky. 1979. Prospect Theory: An Analysis of Decision Under Risk. Econometrica 47(2), 263–92. Mackenzie, Craig. 1997. Where Are the Motives? A Problem with Evidence in the Work of Richard Thaler. Journal of Economic Psychology 18(1), 123–35. Merton, Robert C. 1987. Presidential Address: A Simple Model of Capital Market Equilibrium with Incomplete Information. Journal of Finance 42(3), 483–510. Miller, Merton H. 1986.


pages: 393 words: 115,263

Planet Ponzi by Mitch Feierstein

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Affordable Care Act / Obamacare, Albert Einstein, Asian financial crisis, asset-backed security, bank run, banking crisis, barriers to entry, Bernie Madoff, break the buck, centre right, collapse of Lehman Brothers, collateralized debt obligation, commoditize, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, disintermediation, diversification, Donald Trump, energy security, eurozone crisis, financial innovation, financial intermediation, fixed income, Flash crash, floating exchange rates, frictionless, frictionless market, high net worth, High speed trading, illegal immigration, income inequality, interest rate swap, invention of agriculture, light touch regulation, Long Term Capital Management, mega-rich, money market fund, moral hazard, mortgage debt, negative equity, Northern Rock, obamacare, offshore financial centre, oil shock, pensions crisis, Plutocrats, plutocrats, Ponzi scheme, price anchoring, price stability, purchasing power parity, quantitative easing, risk tolerance, Robert Shiller, Robert Shiller, Ronald Reagan, too big to fail, trickle-down economics, value at risk, yield curve

What we’re experiencing now and what we’re about to experience is the slow elimination by fire of that way of seeing the world. If that’s not what you signed up for when you started this chapter, remember I did try to warn you. I’m not short your house, but still … Sorry. 13 A brief flash of reality One of the most important papers in the history of the social sciences reported the results of a strange little experiment conducted by researchers Amos Tversky and Daniel Kahneman. It’s a paper which, ideally, every investor and every regulator should read. Everyone with an interest in the financial markets, in fact‌—‌a group which includes all those who have money and all those who would like to. The study was simple and emphatic. It took a group of subjects and asked them various questions‌—‌for example, the percentage of African countries among the United Nations member states.

You can get more recent information by searching the CoreLogic site at www.corelogic.com. 12 ‘Self harm,’ The Economist, Sept. 3, 2011. 13 FHFA report on ‘Housing and mortgage markets in 2010,’ figure 16. 14 Justin Fox, ‘A slow-motion wreck for commercial real estate,’ Time, Jan. 18, 2010. 15 John Gittelsohn, ‘Shiller says U.S. home-price declines of 10% to 25% “wouldn’t surprise me”,’ Bloomberg, June 9, 2011. Chapter 13: A brief flash of reality 1 Amos Tversky and Daniel Kahneman, ‘Judgment under uncertainty: heuristics and biases,’ Science, vol. 185, no. 4157, Sept. 1974, pp. 1124–31. 2 Tali Sharot, Alison M. Riccardi, Candace M. Raio, and Elizabeth A. Phelps, ‘Neural mechanisms mediating optimism bias,’ Nature, vol. 450, Oct. 2007, pp. 102–5. 3 Go to the UK Treasury website (www.hm-treasury.gov.uk) and search for ‘Optimism bias.’ 4 Goldman Sachs, Global Economic Outlook 2011, Dec. 2010.


pages: 483 words: 134,377

The Tyranny of Experts: Economists, Dictators, and the Forgotten Rights of the Poor by William Easterly

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air freight, Andrei Shleifer, battle of ideas, Bretton Woods, British Empire, business process, business process outsourcing, Carmen Reinhart, clean water, colonial rule, correlation does not imply causation, creative destruction, Daniel Kahneman / Amos Tversky, Deng Xiaoping, desegregation, discovery of the americas, Edward Glaeser, en.wikipedia.org, European colonialism, Francisco Pizarro, fundamental attribution error, germ theory of disease, greed is good, Gunnar Myrdal, income per capita, invisible hand, James Watt: steam engine, Jane Jacobs, John Snow's cholera map, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, M-Pesa, microcredit, Monroe Doctrine, oil shock, place-making, Ponzi scheme, risk/return, road to serfdom, Silicon Valley, Steve Jobs, The Death and Life of Great American Cities, The Wealth of Nations by Adam Smith, Thomas L Friedman, urban planning, urban renewal, Washington Consensus, World Values Survey, young professional

British aid celebrated that “Ethiopia has experienced impressive growth and development in recent years,”9 while the US Agency for International Development (USAID) also affirmed “tremendous progress.”10 Even though the USAID discussion makes clear that part of the growth was simply better weather compared to a calamitous drought seven years ago, the United States is now sure that “Ethiopia” (meaning its autocratic government) is transforming “its economy and society toward middle income status.”11 World Bank President Jim Kim joined the chorus celebrating Ethiopia’s “transformational change,” which he attributed to a “stable” government that pursues “prudent economic policies,” and takes “a long-term perspective.”12 THE MYTH OF THE “HOT HAND” After using too little data to christen a particular leader’s “growth miracle,” the second psychological mistake is to take temporary success as a long-run trend. We project that today’s (temporarily) high growth will continue to be miraculous forever. We give autocrats credit for a future that has not even happened yet and that will likely never happen. The key insight on this subject came from a paper about basketball.13 One author of this study was Kahneman’s longstanding coauthor of many key insights, psychologist Amos Tversky, who died in 1996. In basketball, a player has a “hot hand” when he or she has made a string of baskets in a row. The obvious recommendation to that player’s teammates would seem to be to pass the ball to the player with the hot hand the next time they go down the court. But Tversky compiled actual data on shots, made baskets, and missed baskets and found this recommendation was wrong—the “hot hand” player is no more likely to make the next basket than any other player.

US Agency for International Development, Ethiopia (USAID Ethiopia), Country Development Cooperation Strategy 2011–2015: Accelerating the Transformation Toward Prosperity, March 2012, page 3; http://ethiopia.usaid.gov/sites/default/files/images/CDCS-Ethiopia.pdf, accessed September 12, 2013. 11. USAID Ethiopia, Country Development Cooperation Strategy 2011–2015, page 3. 12. World Bank President Jim Kim speech at Brookings Institution, July 19, 2012; http://www.worldbank.org/en/news/2012/07/18/world-bank-group-president-jim-yong-kim-brookings-institution, accessed January 14, 2013. 13. Thomas Gilovich, Robert Vallone, and Amos Tversky, “The Hot Hand in Basketball: On the Misperception of Random Sequences,” Cognitive Psychology 17 (1985): 295–314. Available at www.psych.cornell.edu/sites/default/files/Gilo.Vallone.Tversky.pdf, accessed August 31, 2013. 14. In 2010 Ghana was the world’s second largest producer of cocoa beans (after Côte d’Ivoire). Source: International Cocoa Organization Quarterly Bulletin of Cocoa Statistics Vol.

DANGEROUS PROBABILITIES Unfortunately, before we can get to testing the weaker variant that some autocrats are benevolent, we have to deal with some psychological biases in favor of the stronger variant that most or all autocrats are benevolent and produce high growth. Psychologists have documented systematic biases in the way we think about evidence. The leading psychologist on these topics is the Nobel laureate Daniel Kahneman, whose book Thinking, Fast and Slow is essential reading. Kahneman discusses how “thinking fast”—acting on gut reactions—can be an amazing problem-solver for most real-life situations, when there is not enough time for formal deductive reasoning (“thinking slow”). However, one area where thinking fast does badly is probability and statistics—in other words, in interpreting evidence.4 Thinking fast, then, has systematic biases, and most of these biases reinforce strong beliefs in benevolent autocrats.


pages: 204 words: 54,395

Drive: The Surprising Truth About What Motivates Us by Daniel H. Pink

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affirmative action, call centre, Daniel Kahneman / Amos Tversky, Dean Kamen, deliberate practice, Firefox, Frederick Winslow Taylor, functional fixedness, game design, George Akerlof, Isaac Newton, Jean Tirole, job satisfaction, knowledge worker, performance metric, profit maximization, profit motive, Results Only Work Environment, side project, the built environment, Tony Hsieh, transaction costs, zero-sum game

Then, about a decade later, came a curious turn of events that made me question much of what I'd worked hard, and taken on enormous debt, to learn. In 2002, the Nobel Foundation awarded its prize in economics to a guy who wasn't even an economist. And they gave him the field's highest honor largely for revealing that we weren't always rational calculators of our economic self-interest and that the parties often didn't bargain to a wealth-maximizing result. Daniel Kahneman, an American psychologist who won the Nobel Prize in economics that year for work he'd done with Israeli Amos Tversky, helped force a change in how we think about what we do. And one of the implications of this new way of thinking is that it calls into question many of the assumptions of Motivation 2.0. Kahneman and others in the field of behavioral economics agreed with my professor that economics was the study of human economic behavior. They just believed that we'd placed too much emphasis on the economic and not enough on the human .


pages: 187 words: 62,861

The Penguin and the Leviathan: How Cooperation Triumphs Over Self-Interest by Yochai Benkler

business process, California gold rush, citizen journalism, Daniel Kahneman / Amos Tversky, East Village, Everything should be made as simple as possible, experimental economics, experimental subject, framing effect, informal economy, invisible hand, jimmy wales, job satisfaction, Joseph Schumpeter, Kenneth Arrow, knowledge economy, laissez-faire capitalism, loss aversion, Murray Gell-Mann, Nicholas Carr, peer-to-peer, prediction markets, Richard Stallman, Scientific racism, Silicon Valley, Steven Pinker, telemarketer, Toyota Production System, ultimatum game, Washington Consensus, zero-sum game, Zipcar

We See the World Through a Frame This brings us to the second strength of psychology: its attention to situational framing. Framing, quite simply, refers to our interpretation of a situation, relationship, context, or event. Anytime we make a decision to act, we have to first interpret the situation we’re in. Even economists have grudgingly admitted this; behavioral economics describes it as the framing effect. Amos Tversky and Daniel Kahneman, the fathers of behavioral economics, explain that people will make different decisions depending on how a situation is presented. For example, when making a bet, people will risk different amounts depending on whether the bet is described as risking a loss or aiming for a gain (behavioral economists have found that people display what is often called “loss aversion”: they will reject bets framed as potential losses, but accept that same bet when it is framed as potential gains).


pages: 274 words: 93,758

Phishing for Phools: The Economics of Manipulation and Deception by George A. Akerlof, Robert J. Shiller, Stanley B Resor Professor Of Economics Robert J Shiller

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Andrei Shleifer, asset-backed security, Bernie Madoff, Capital in the Twenty-First Century by Thomas Piketty, collapse of Lehman Brothers, corporate raider, Credit Default Swap, Daniel Kahneman / Amos Tversky, dark matter, David Brooks, en.wikipedia.org, endowment effect, equity premium, financial intermediation, financial thriller, fixed income, full employment, George Akerlof, greed is good, income per capita, invisible hand, John Maynard Keynes: Economic Possibilities for our Grandchildren, Kenneth Arrow, Kenneth Rogoff, late fees, loss aversion, Menlo Park, mental accounting, Milgram experiment, money market fund, moral hazard, new economy, Pareto efficiency, Paul Samuelson, payday loans, Ponzi scheme, profit motive, publication bias, Ralph Nader, randomized controlled trial, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Reagan, Silicon Valley, the new new thing, The Predators' Ball, the scientific method, The Wealth of Nations by Adam Smith, theory of mind, Thorstein Veblen, too big to fail, transaction costs, Unsafe at Any Speed, Upton Sinclair, Vanguard fund, Vilfredo Pareto, wage slave

See “Predic­ tions of the Year 2000 from The Ladies Home Journal of December 1900,” accessed December 1, 2014, http://yorktownhistory.org/wp-content/ 205 Akerlof.indb 205 6/19/15 10:24 AM archives/homepages/1900_predictions.htm, for confirmation that the issue was for December. 11. Oxford English Dictionary, s.v. “phish,” accessed October 29, 2014, http://www.oed.com/view/Entry/264319?redirectedFrom=phish#eid. 12. It is no coincidence that early research of Daniel Kahneman and Amos Tversky, who were pioneers in the modern field of cognitive psychology, concerned optical illusion. Kahneman has told George that the distortions in thinking that underlie the field of behavioral economics can be seen as being like “optical illusion.” (Private conversation, some twenty-five years ago.) 13. Kurt Eichenwald, A Conspiracy of Fools: A True Story (New York: Random House, 2005), and Bethany McLean and Peter Elkind, The Smartest Guys in the Room: The Amazing Rise and Fall of Enron (New York: Portfolio /  Penguin Books, 2003). 14.

But, above all, the examples we shall explore will have grave implications for social policy, including the role of government as a complement rather than a hindrance to free markets—since, just as our computers need protection against malware, so too we need protection against phishing for phools more broadly defined. xvi Akerlof.indb 16 PREFACE 6/19/15 10:24 AM Phishing for Phools Akerlof.indb 17 6/19/15 10:24 AM Akerlof.indb 18 6/19/15 10:24 AM introduction Expect to Be Manipulated: Phishing Equilibrium T he psychologists have taught us over the course of more than a century—in voices ranging in style and content from Sigmund Freud to Daniel Kahneman—that people frequently make decisions that are not in their best interest. Put bluntly, they do not do what is really good for them; they do not choose what they really want. Such bad decisions make it possible for them to be phished for phools. This truth is so basic that it is critical to the first story of the Bible, where the serpent beguiles innocent Eve to make a phoolish decision that she will instantly, and forever, regret.1 The fundamental concept of economics is quite different: it is the notion of market equilibrium.2 For our explanation, we adapt the example of the checkout lane at the supermarket.3 When we arrive at the checkout at the supermarket, it usually takes at least a moment to decide which line to choose.

And Deniz Dutz, in the very final stages, did yeomanlike work; he re-fact-checked everything. And for six weeks in May and June 2015, Madeleine Adams was the copy editor; almost everywhere, she added elegance and grace to the manuscript we had given her. The ideas in this book are a collage of what we have learned, and what we have listened to, over the course of our lives as economists. In this regard we owe special thanks to four others. Daniel Kahneman, yes that one, some twenty-five or thirty years ago, told us that the distinctive feature of psychology is that it views people as imperfect machines. The job of the psychologist, he said, was to figure ACKNOWLEDGMENTS Akerlof.indb 177 177 6/19/15 10:24 AM out how and when those machines would be dysfunctional. In contrast, the basic concept of economics is equilibrium. We think that this book brings together these observations.


pages: 337 words: 86,320

Everybody Lies: Big Data, New Data, and What the Internet Can Tell Us About Who We Really Are by Seth Stephens-Davidowitz

affirmative action, AltaVista, Amazon Mechanical Turk, Asian financial crisis, Bernie Sanders, big data - Walmart - Pop Tarts, Cass Sunstein, computer vision, correlation does not imply causation, crowdsourcing, Daniel Kahneman / Amos Tversky, desegregation, Donald Trump, Edward Glaeser, Filter Bubble, game design, happiness index / gross national happiness, income inequality, Jeff Bezos, John Snow's cholera map, Mark Zuckerberg, Nate Silver, peer-to-peer lending, Peter Thiel, price discrimination, quantitative hedge fund, Ronald Reagan, Rosa Parks, sentiment analysis, Silicon Valley, statistical model, Steve Jobs, Steven Levy, Steven Pinker, TaskRabbit, The Signal and the Noise by Nate Silver, working poor

On the other hand, if we concentrate on measures that are easily quantifiable, like people’s reaction time to words, or their skin response to pictures, we can do the statistics, but we’ve pureed the complex texture of cognition into a single number. Even the most sophisticated neuroimaging methodologies can tell us how a thought is splayed out in 3-D space, but not what the thought consists of. As if the tradeoff between tractability and richness weren’t bad enough, scientists of human nature are vexed by the Law of Small Numbers—Amos Tversky and Daniel Kahneman’s name for the fallacy of thinking that the traits of a population will be reflected in any sample, no matter how small. Even the most numerate scientists have woefully defective intuitions about how many subjects one really needs in a study before one can abstract away from the random quirks and bumps and generalize to all Americans, to say nothing of Homo sapiens. It’s all the iffier when the sample is gathered by convenience, such as by offering beer money to the sophomores in our courses.

Amazon reports how many people quote various lines in books. Ellenberg realized he could compare how frequently quotes were highlighted at the beginning of the book versus the end of the book. This would give a rough guide to readers’ propensity to make it to the end. By his measure, more than 90 percent of readers finished Donna Tartt’s novel The Goldfinch. In contrast, only about 7 percent made it through Nobel Prize economist Daniel Kahneman’s magnum opus, Thinking, Fast and Slow. Fewer than 3 percent, this rough methodology estimated, made it to the end of economist Thomas Piketty’s much discussed and praised Capital in the 21st Century. In other words, people tend not to finish treatises by economists. One of the points of this book is we have to follow the Big Data wherever it leads and act accordingly. I may hope that most readers are going to hang on my every word and try to detect patterns linking the final pages to what happened earlier.

Google Will See You Now,” New York Times, August 11, 2013, SR12. 32 biggest dataset ever assembled on human relationships: Lars Backstrom and Jon Kleinberg, “Romantic Partnerships and the Dispersion of Social Ties: A Network Analysis of Relationship Status on Facebook,” in Proceedings of the 17th ACM Conference on Computer Supported Cooperative Work & Social Computing (2014). 33 people consistently rank: Daniel Kahneman, Thinking, Fast and Slow (New York: Farrar, Straus and Giroux, 2011). 33 asthma causes about seventy times more deaths: Between 1979 and 2010, on average, 55.81 Americans died from tornados and 4216.53 Americans died from asthma. See Annual U.S. Killer Tornado Statistics, National Weather Service, http://www.spc.noaa.gov/climo/torn/fatalmap.php and Trends in Asthma Morbidity and Mortality, American Lung Association, Epidemiology and Statistics Unit. 33 Patrick Ewing: My favorite Ewing videos are “Patrick Ewing’s Top 10 Career Plays,” YouTube video, posted September 18, 2015, https://www.youtube.com/watch?


pages: 472 words: 117,093

Machine, Platform, Crowd: Harnessing Our Digital Future by Andrew McAfee, Erik Brynjolfsson

3D printing, additive manufacturing, AI winter, Airbnb, airline deregulation, airport security, Albert Einstein, Amazon Mechanical Turk, Amazon Web Services, artificial general intelligence, augmented reality, autonomous vehicles, backtesting, barriers to entry, bitcoin, blockchain, book scanning, British Empire, business process, carbon footprint, Cass Sunstein, centralized clearinghouse, Chris Urmson, cloud computing, cognitive bias, commoditize, complexity theory, computer age, creative destruction, crony capitalism, crowdsourcing, cryptocurrency, Daniel Kahneman / Amos Tversky, Dean Kamen, discovery of DNA, disintermediation, distributed ledger, double helix, Elon Musk, en.wikipedia.org, Erik Brynjolfsson, ethereum blockchain, everywhere but in the productivity statistics, family office, fiat currency, financial innovation, George Akerlof, global supply chain, Hernando de Soto, hive mind, information asymmetry, Internet of things, inventory management, iterative process, Jean Tirole, Jeff Bezos, jimmy wales, John Markoff, joint-stock company, Joseph Schumpeter, Kickstarter, law of one price, Lyft, Machine translation of "The spirit is willing, but the flesh is weak." to Russian and back, Marc Andreessen, Mark Zuckerberg, meta analysis, meta-analysis, moral hazard, multi-sided market, Myron Scholes, natural language processing, Network effects, new economy, Norbert Wiener, Oculus Rift, PageRank, pattern recognition, peer-to-peer lending, performance metric, Plutocrats, plutocrats, precision agriculture, prediction markets, pre–internet, price stability, principal–agent problem, Ray Kurzweil, Renaissance Technologies, Richard Stallman, ride hailing / ride sharing, risk tolerance, Ronald Coase, Satoshi Nakamoto, Second Machine Age, self-driving car, sharing economy, Silicon Valley, Skype, slashdot, smart contracts, Snapchat, speech recognition, statistical model, Steve Ballmer, Steve Jobs, Steven Pinker, supply-chain management, TaskRabbit, Ted Nelson, The Market for Lemons, The Nature of the Firm, Thomas L Friedman, too big to fail, transaction costs, transportation-network company, traveling salesman, two-sided market, Uber and Lyft, Uber for X, Watson beat the top human players on Jeopardy!, winner-take-all economy, yield management, zero day

But almost all of us also believe that we’re capable of delivering a great deal more than digital technologies can, even as they continue to profit from Moore’s law—the remarkably steady, remarkably fast growth over time in the amount of computing hardware available for the same dollar of spending—and become exponentially more powerful. Decades of research confirm the idea that we do, in fact, reason in two different ways. This groundbreaking work resulted in a Nobel prize for Daniel Kahneman who, alongside collaborator Amos Tversky, pioneered the field that has come to be called behavioral economics.§ The work of Kahneman and his colleagues showed that we all have two modes of thinking, which he labeled System 1 and System 2.¶ System 1 is fast, automatic, evolutionarily ancient, and requires little effort; it’s closely associated with what we call intuition. System 2 is the opposite: slow, conscious, evolutionarily recent, and a lot of work.

Every company I talked to had middle and even senior managers who operated as player-coaches, tasked with both doing things and directing others.” We see the same phenomenon. We also see that after at least two decades, the standard division between mind and machine is giving way to something quite different. Second-machine-age companies are combining modern technologies with a better understanding of Daniel Kahneman’s System 1 and System 2 (discussed in Chapter 2), and of human abilities and biases, to change how they make and evaluate decisions, how they generate and refine new ideas, and how they move forward in a highly uncertain world. While new marketplaces are emerging and thriving, we see no evidence in the economic data to indicate that companies are becoming passé, or are going to be wholly replaced by any variety of technology-enabled distributed autonomous organizations.

Fuchs (New York: National Bureau of Economic Research, 1972), 62, http://www.nber.org/chapters/c7618.pdf. ** The title of their article intentionally echoed Oliver Williamson’s widely cited book Markets and Hierarchies, which built heavily on Coase’s insights. Oliver E. Williamson, Markets and Hierarchies, Analysis and Antitrust Implications: A Study in the Economics of Internal Organization (New York: Free Press, 1975). †† Like Daniel Kahneman, Ostrom was awarded the prize despite not being an economist. ‡‡ Within certain limits of law and morality. §§ Oliver Hart and John Moore, “Property Rights and the Nature of the Firm,” Journal of Political Economy 98, no. 6 (1990): 1119–58. ¶¶ For example, Oliver Hart and Bengt Holmstrom, The Theory of Contracts, MIT Department of Economics Working Paper 418 (March 1986), https://dspace.mit.edu/bitstream/handle/1721.1/64265/theoryofcontract00hart.pdf%3Bjsessionid%3DD2F89D14123801EBB5A616B328AB8CFC?


pages: 331 words: 104,366

Deep Thinking: Where Machine Intelligence Ends and Human Creativity Begins by Garry Kasparov

3D printing, Ada Lovelace, AI winter, Albert Einstein, AltaVista, barriers to entry, Berlin Wall, business process, call centre, clean water, computer age, Daniel Kahneman / Amos Tversky, David Brooks, Donald Trump, Douglas Hofstadter, Drosophila, Elon Musk, Erik Brynjolfsson, factory automation, Freestyle chess, Gödel, Escher, Bach, job automation, Leonard Kleinrock, Mikhail Gorbachev, Nate Silver, Norbert Wiener, packet switching, pattern recognition, Ray Kurzweil, Richard Feynman, Richard Feynman, rising living standards, rolodex, Second Machine Age, self-driving car, Silicon Valley, Silicon Valley startup, Skype, speech recognition, stem cell, Stephen Hawking, Steven Pinker, technological singularity, The Coming Technological Singularity, The Signal and the Noise by Nate Silver, Turing test, Vernor Vinge, Watson beat the top human players on Jeopardy!, zero-sum game

It was only more notable to pattern-obsessed humans, who lost, so the story goes, millions of francs betting that red was more likely. You can see why computers have a certain advantage in games where streaks of lucky or unlucky cards or dice rolls can influence the decision making of humans. Machines don’t look for patterns in randomness, or least if they’re programmed to, they don’t find any the way our minds often do. The fascinating work of researchers like Daniel Kahneman, Amos Tversky, and Dan Ariely has demonstrated how terrible human beings can be at thinking logically. For all the immense power of the human mind, it is very easy to fool. I’m a firm believer in the power of human intuition and how we must cultivate it by relying on it, but I cannot deny that my faith has been shaken by reading books like Kahneman’s Thinking, Fast and Slow and Ariely’s Predictably Irrational.

Not merely by providing the right answers, but by showing us how idiosyncratic and easily influenced our thinking can be. Becoming aware of these fallacies and cognitive blind spots won’t prevent them entirely, but it’s a big step toward combating them. During my annual visit to Oxford in 2015, I gave a seminar on decision making to a group of students at the Saïd Business School. For one segment, I performed an experiment based on those described by Daniel Kahneman to test what cognitive psychologists call the “anchoring effect” in our decision making. Would it work on a group of MBA students even though they knew I was trying to trick them? I broke them into seven groups of five or six students each, and each group got a slightly different version of a handout containing six questions. The first three questions were all variations on the following yes-or-no questions: Was Gandhi more or less than 25 years old when he died?


pages: 83 words: 7,274

Buyology by Martin Lindstrom

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anti-work, Berlin Wall, Daniel Kahneman / Amos Tversky, Mikhail Gorbachev, Saturday Night Live, Steve Jobs, Steven Pinker

Athletes believe in the supernatural powers of “hot” streaks, too—those times when they just can’t seem to miss a single pitch, shot, goal, or basket. When a player shoots a string of good shots in a game, it’s generally believed he has the “hot hand.” The team then conspires to get him the ball because they believe he’s on some kind of roll. In 1985, two future Nobel Prize–winning economists, Daniel Kahneman and Amos Tversky, unsettled basketball fans across the United States when they disproved this myth, well known to both players and fans. To test whether or not these “hot streaks” actually exist, Kahneman and Tversky examined the statistics for a number of teams from 1980 to 1982. When they analyzed the Boston Celtics’ free-throw 08/08/2009 10:45 38 of 83 file:///D:/000004/Buy__ology.html ratio, they discovered that if a player made his first shot, he made the second shot 75 percent of the time.


pages: 271 words: 82,159

David and Goliath: Underdogs, Misfits, and the Art of Battling Giants by Malcolm Gladwell

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affirmative action, Berlin Wall, cuban missile crisis, Daniel Kahneman / Amos Tversky, delayed gratification, mass incarceration, medical residency, Menlo Park, meta analysis, meta-analysis, RAND corporation, school choice, Silicon Valley

It also forces you to do things that you might otherwise never have considered, like doing your own version of Kamprad’s disagreeable trip to Poland or hopping in the cab of someone you’ve never met and pretending to be someone you aren’t. Kamprad, in case you are wondering, is dyslexic. And Gary Cohn? It turns out he was a really good trader, and it turns out that learning how to deal with the possibility of failure is really good preparation for a career in the business world. Today he is the president of Goldman Sachs. 1 Actually, there’s an even shorter test. One of the most brilliant modern psychologists was a man named Amos Tversky. Tversky was so smart that his fellow psychologists devised the “Tversky Intelligence Test”: The faster you realized Tversky was smarter than you, the smarter you were. Adam Alter told me about the Tversky test. He would score very highly on it. 2 To make sure he was measuring intelligence and not something else, Frederick also correlated CRT scores with other factors. “An analysis of these responses shows that CRT scores are unrelated to preferences between apples and oranges, Pepsi and Coke, beer and wine or rap concerts and ballet,” he writes.

For more discussion of class size, see Eric Hanushek, The Evidence on Class Size (University of Rochester Press, 1998); Eric Hanushek and Alfred Lindseth, Schoolhouses, Courthouses and Statehouses: Solving the Funding-Achievement Puzzle in America’s Public Schools (Princeton University Press, 2009), 272; and Ludger Wössmann and Martin R. West, “Class-Size Effects in School Systems Around the World: Evidence from Between-Grade Variation in TIMSS,” European Economic Review (March 26, 2002). For studies of money and happiness, see Daniel Kahneman and Angus Deaton, “High Income Improves Evaluation of Life but Not Emotional Well-Being,” Proceedings of the National Academy of Sciences 107, no. 38 (August 2010): 107. Barry Schwartz and Adam Grant discuss happiness in terms of an inverted-U curve in “Too Much of a Good Thing: The Challenge and Opportunity of the Inverted U,” Perspectives on Psychological Science 6, no. 1 (January 2011): 61–76.


pages: 246 words: 81,843

David and Goliath: The Triumph of the Underdog by Malcolm Gladwell

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affirmative action, Berlin Wall, cuban missile crisis, Daniel Kahneman / Amos Tversky, delayed gratification, mass incarceration, medical residency, Menlo Park, meta analysis, meta-analysis, RAND corporation, school choice, Silicon Valley

It also forces you to do things that you might otherwise never have considered, like doing your own version of Kamprad’s disagreeable trip to Poland or hopping in the cab of someone you’ve never met and pretending to be someone you aren’t. Kamprad, in case you are wondering, is dyslexic. And Gary Cohn? It turns out he was a really good trader, and it turns out that learning how to deal with the possibility of failure is really good preparation for a career in the business world. Today he is the president of Goldman Sachs. 1 Actually, there’s an even shorter test. One of the most brilliant modern psychologists was a man named Amos Tversky. Tversky was so smart that his fellow psychologists devised the “Tversky Intelligence Test”: The faster you realized Tversky was smarter than you, the smarter you were. Adam Alter told me about the Tversky test. He would score very highly on it. 2 To make sure he was measuring intelligence and not something else, Frederick also correlated CRT scores with other factors. “An analysis of these responses shows that CRT scores are unrelated to preferences between apples and oranges, Pepsi and Coke, beer and wine or rap concerts and ballet,” he writes.

For more discussion of class size, see Eric Hanushek, The Evidence on Class Size (University of Rochester Press, 1998); Eric Hanushek and Alfred Lindseth, Schoolhouses, Courthouses and Statehouses: Solving the Funding-Achievement Puzzle in America’s Public Schools (Princeton University Press, 2009), 272; and Ludger Wössmann and Martin R. West, “Class-Size Effects in School Systems Around the World: Evidence from Between-Grade Variation in TIMSS,” European Economic Review (March 26, 2002). For studies of money and happiness, see Daniel Kahneman and Angus Deaton, “High Income Improves Evaluation of Life but Not Emotional Well-Being,” Proceedings of the National Academy of Sciences 107, no. 38 (August 2010): 107. Barry Schwartz and Adam Grant discuss happiness in terms of an inverted-U curve in “Too Much of a Good Thing: The Challenge and Opportunity of the Inverted U,” Perspectives on Psychological Science 6, no. 1 (January 2011): 61–76.


pages: 254 words: 79,052

Evil by Design: Interaction Design to Lead Us Into Temptation by Chris Nodder

4chan, affirmative action, Amazon Mechanical Turk, cognitive dissonance, crowdsourcing, Daniel Kahneman / Amos Tversky, Donald Trump, en.wikipedia.org, endowment effect, game design, haute couture, jimmy wales, Jony Ive, Kickstarter, late fees, loss aversion, Mark Zuckerberg, meta analysis, meta-analysis, Milgram experiment, Netflix Prize, Nick Leeson, Occupy movement, pets.com, price anchoring, recommendation engine, Rory Sutherland, Silicon Valley, stealth mode startup, Steve Jobs, telemarketer, Tim Cook: Apple, trickle-down economics, upwardly mobile

Scarcity and loss aversion Dollar bill experiment: Baba Shiv, George Loewenstein, Antoine Bechara, Hanna Damasio, and Antonio R. Damasio. “Investment behavior and the negative side of emotion.” Psychological Science 16.6 (2005): 435–439. It’s possible to “lose” (earn less than $20 after 20 rounds) only 13 percent of the time if you always gamble. Loss twice as “powerful” as gain: Daniel Kahneman and Amos Tversky. “Prospect Theory: An Analysis of Decision under Risk.” Econometrica: Journal of the Econometric Society 47 (1979): 263–291. The Tom Sawyer effect Tom Sawyer quotes: Mark Twain (Samuel Clemens). The Adventures of Tom Sawyer. The American Publishing Company, 1884. Instill doubt to prevent cancellations Statistics on BSE: Wikipedia en.wikipedia.org/wiki/Bovine_spongiform_encephalopathy.


pages: 288 words: 16,556

Finance and the Good Society by Robert J. Shiller

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Alvin Roth, bank run, banking crisis, barriers to entry, Bernie Madoff, capital asset pricing model, capital controls, Carmen Reinhart, Cass Sunstein, cognitive dissonance, collateralized debt obligation, collective bargaining, computer age, corporate governance, Daniel Kahneman / Amos Tversky, Deng Xiaoping, diversification, diversified portfolio, Donald Trump, Edward Glaeser, eurozone crisis, experimental economics, financial innovation, financial thriller, fixed income, full employment, fundamental attribution error, George Akerlof, income inequality, information asymmetry, invisible hand, joint-stock company, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, land reform, loss aversion, Louis Bachelier, Mahatma Gandhi, Mark Zuckerberg, market bubble, market design, means of production, microcredit, moral hazard, mortgage debt, Myron Scholes, Occupy movement, passive investing, Ponzi scheme, prediction markets, profit maximization, quantitative easing, random walk, regulatory arbitrage, Richard Thaler, Right to Buy, road to serfdom, Robert Shiller, Robert Shiller, Ronald Reagan, selection bias, self-driving car, shareholder value, Sharpe ratio, short selling, Simon Kuznets, Skype, Steven Pinker, telemarketer, The Market for Lemons, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, Vanguard fund, young professional, zero-sum game, Zipcar

The “gaming industry,” as it styles itself, defends its activities as a form of entertainment. Certainly it is that, but it is unique among entertainment forms in that it cultivates and ampli es to a considerable extent human risk-taking impulses, sometimes with disastrous consequences. The puzzle comes down to why one would be willing to place even one single bet at a casino. Research by psychologists Daniel Kahneman and Amos Tversky has shown that people exhibit a tendency toward loss aversion.1 They are pathologically avoidant of even small losses. If o ered an asymmetrical bet on a coin toss—to win $20 if it comes up heads, to lose $10 if it comes up tails—most people will turn down the bet, even though it has a positive expected return of $5. How then are gambling casinos able to induce people to place bets with a negative expected return, and to do so again and again despite having experienced repeated losses?

“Land Reform, Income Redistribution, and Agricultural Production in Korea.” Economic Development and Cultural Change 48(2):253–68. Joseph, Jane E., Xun Liu, Yang Jiang, Donald Lynam, and Thomas H. Kelly. 2008. “Neural Correlates of Emotional Reactivity in Sensation Seeking.” Psychological Science 20(2):215–23. Jung, Jeeman, and Robert J. Shiller. 2005. “A Simple Test of Samuelson’s Dictum for the Stock Market.” Economic Inquiry 43(2):263–92. Kahneman, Daniel, and Amos Tversky. 1979. “Prospect Theory: An Analysis of Decision under Risk.” Econometrica 47(2):263–92. Kamstra, Mark, and Robert J. Shiller. 2010. “Trills Instead of T-Bills: It’s Time to Replace Part of Government Debt with Shares in GDP.” The Economists’ Voice 7(3), Article 5, http://www.bepress.com/ev/vol7/iss3/art5. Kaplan, Steven N., and Antoinette Schoar. 2005. “Private Equity Performance: Returns, Persistence, and Capital Flows.”


pages: 416 words: 118,592

A Random Walk Down Wall Street: The Time-Tested Strategy for Successful Investing by Burton G. Malkiel

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3Com Palm IPO, accounting loophole / creative accounting, Albert Einstein, asset allocation, asset-backed security, backtesting, beat the dealer, Bernie Madoff, BRICs, capital asset pricing model, compound rate of return, correlation coefficient, Credit Default Swap, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, Edward Thorp, Elliott wave, Eugene Fama: efficient market hypothesis, experimental subject, feminist movement, financial innovation, fixed income, framing effect, hindsight bias, Home mortgage interest deduction, index fund, invisible hand, Isaac Newton, Long Term Capital Management, loss aversion, margin call, market bubble, money market fund, mortgage tax deduction, new economy, Own Your Own Home, passive investing, Paul Samuelson, pets.com, Ponzi scheme, price stability, profit maximization, publish or perish, purchasing power parity, RAND corporation, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, short selling, Silicon Valley, South Sea Bubble, survivorship bias, The Myth of the Rational Market, the rule of 72, The Wisdom of Crowds, transaction costs, Vanguard fund, zero-coupon bond

But they quickly wriggle out by declaring that the trades of irrational investors will be random and therefore cancel each other out without affecting prices. And even if investors are irrational in a similar way, efficient-market theory believers assert that smart rational traders will correct any mispricings that might arise from the presence of irrational traders. Psychologists will have none of this economic claptrap. Two in particular—Daniel Kahneman and Amos Tversky—blasted economists’ views about how investors behave and in the process are credited with fathering a whole new economic discipline, called behavioral finance. The two argued quite simply that people are not as rational as economic models assume. Although this argument is obvious to the general public and non-economists, it took over twenty years for it to become widely accepted in academia.

Robert Shiller, in his best-selling book Irrational Exuberance, argues that the mania in Internet and high-tech stocks during the late 1990s can be explained only in terms of mass psychology. At universities, so-called behavioral theories of the stock market, stressing crowd psychology, gained favor during the early 2000s at leading economics departments and business schools across the developed world. The psychologist Daniel Kahneman won the Nobel Prize in Economics in 2002 for his seminal contributions to the field of “behavioral finance.” Earlier, Oskar Morgenstern was a leading champion. Morgenstern argued that the search for intrinsic value in stocks is a search for the will-o’-the-wisp. In an exchange economy the value of any asset depends on an actual or prospective transaction. He believed that every investor should post the following Latin maxim above his desk: Res tantum valet quantum vendi potest.

Twenty-five percent believed that they were in the top 1 percent of the population. Even in judging athletic ability, an area where self-deception would seem more difficult, at least 60 percent of the male respondents ranked themselves in the top quartile. Even the klutziest deluded themselves about their athletic ability. Only 6 percent of male respondents believed that their athleticism was below average. Daniel Kahneman has argued that this tendency to overconfidence is particularly strong among investors. More than most other groups, investors tend to exaggerate their own skill and deny the role of chance. They overestimate their own knowledge, underestimate the risks involved, and exaggerate their ability to control events. Kahneman’s tests show how well investors’ probability judgments are calibrated by asking experimental subjects for confidence intervals.


pages: 651 words: 180,162

Antifragile: Things That Gain From Disorder by Nassim Nicholas Taleb

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Air France Flight 447, Andrei Shleifer, banking crisis, Benoit Mandelbrot, Berlin Wall, Black Swan, Chuck Templeton: OpenTable, commoditize, creative destruction, credit crunch, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, discrete time, double entry bookkeeping, Emanuel Derman, epigenetics, financial independence, Flash crash, Gary Taubes, George Santayana, Gini coefficient, Henri Poincaré, high net worth, hygiene hypothesis, Ignaz Semmelweis: hand washing, informal economy, invention of the wheel, invisible hand, Isaac Newton, James Hargreaves, Jane Jacobs, joint-stock company, joint-stock limited liability company, Joseph Schumpeter, Kenneth Arrow, knowledge economy, Lao Tzu, Long Term Capital Management, loss aversion, Louis Pasteur, mandelbrot fractal, Marc Andreessen, meta analysis, meta-analysis, microbiome, money market fund, moral hazard, mouse model, Myron Scholes, Norbert Wiener, pattern recognition, Paul Samuelson, placebo effect, Ponzi scheme, principal–agent problem, purchasing power parity, quantitative trading / quantitative finance, Ralph Nader, random walk, Ray Kurzweil, rent control, Republic of Letters, Ronald Reagan, Rory Sutherland, selection bias, Silicon Valley, six sigma, spinning jenny, statistical model, Steve Jobs, Steven Pinker, Stewart Brand, stochastic process, stochastic volatility, The Great Moderation, the new new thing, The Wealth of Nations by Adam Smith, Thomas Bayes, Thomas Malthus, too big to fail, transaction costs, urban planning, Vilfredo Pareto, Yogi Berra, Zipf's Law

I will leave the discussion of what impenetrable property may help survival to the section on Empedocles’ dog. But note here the mental bias that causes people to believe in the “power of” some technology and its ability to run the world. Another mental bias causing the overhyping of technology comes from the fact that we notice change, not statics. The classic example, discovered by the psychologists Daniel Kahneman and Amos Tversky, applies to wealth. (The pair developed the idea that our brains like minimal effort and get trapped that way, and they pioneered a tradition of cataloging and mapping human biases with respect to perception of random outcomes and decision making under uncertainty). If you announce to someone “you lost $10,000,” he will be much more upset than if you tell him “your portfolio value, which was $785,000, is now $775,000.”

Kahn, James, 2011, “Can We Determine the Optimal Size of Government?” Cato Institute No. 7, September. Kahneman, D., 2011, Thinking, Fast and Slow. New York: Farrar, Straus and Giroux. Kahneman, D., 1982, “On the Study of Statistical Intuitions.” In D. Kahneman, P. Slovic, and A. Tversky, eds., Judgment Under Uncertainty: Heuristics and Biases. Cambridge: Cambridge University Press. Kahneman, D., and Amos Tversky, 1979, “Prospect Theory: An Analysis of Decision Under Risk.” Econometrica 46(2): 171–185. Kaiser, Jocelyn, 2003, “Hormesis: Sipping from a Poisoned Chalice.” Science 302 (5644): 376–379. Kantorovich, Aharon, 1993, Scientific Discovery: Logic and Tinkering. State University of New York Press. Kaplan, H., K. Hill, J. Lancaster, and A. M. Hurtado, 2000, “A Theory of Human Life History Evolution: Diet, Intelligence, and Longevity.”

One of my students (who was majoring in, of all subjects, economics) asked me for a rule on what to read. “As little as feasible from the last twenty years, except history books that are not about the last fifty years,” I blurted out, with irritation as I hate such questions as “what’s the best book you’ve ever read,” or “what are the ten best books,”—my “ten best books ever” change at the end of every summer. Also, I have been hyping Daniel Kahneman’s recent book, because it is largely an exposition of his research of thirty-five and forty years ago, with filtering and modernization. My recommendation seemed impractical, but, after a while, the student developed a culture in original texts such as Adam Smith, Karl Marx, and Hayek, texts he believes he will cite at the age of eighty. He told me that after his detoxification, he realized that all his peers do is read timely material that becomes instantly obsolete.


pages: 698 words: 198,203

The Stuff of Thought: Language as a Window Into Human Nature by Steven Pinker

airport security, Albert Einstein, Bob Geldof, colonial rule, conceptual framework, correlation does not imply causation, Daniel Kahneman / Amos Tversky, David Brooks, Douglas Hofstadter, en.wikipedia.org, experimental subject, fudge factor, George Santayana, loss aversion, luminiferous ether, Norman Mailer, Richard Feynman, Richard Feynman, Ronald Reagan, Sapir-Whorf hypothesis, science of happiness, speech recognition, stem cell, Steven Pinker, Thomas Bayes, Thorstein Veblen, traffic fines, urban renewal, Yogi Berra

The preceding chapter teemed with examples: the choice of construction can determine whether listeners think of an event as causing water to move or causing a glass to become full, whether they think of it as merely having happened or as having been caused to happen, and so on. The ability of words to frame an event has long been used in rhetoric and persuasion (pro-choice and pro-life, redistribution versus confiscation, invading versus liberating), and its effects are easy to document. The psychologists Amos Tversky and Daniel Kahneman, for example, showed that doctors will opt for a cautious public-health program (as opposed to a risky one) when it is framed as saving the lives of 200 people out of 600 who are vulnerable, but will eschew the same program when it is framed as resulting in the deaths of 400 people out of the 600.68 Naturally it is fascinating to see how languages provide the means to frame events, and that is a major goal of this book.

One of the reasons I explained verb constructions in chapter 2 was that they show that even our most quotidian acts can be framed in different ways, such as the difference between spraying paint on the wall (cause the paint to go) and spraying the wall with paint (cause the wall to change). Within cognitive psychology the most famous example of the effects of framing (briefly mentioned in chapter 3) comes from an experiment by Amos Tversky and Daniel Kahneman, who posed the following problem to a sample of doctors:17 “A new strain of flu is expected to kill 600 people. Two programs to combat the disease have been proposed.” Some of the doctors were then presented with the following dilemma:If program A is adopted, 200 people will be saved. If program B is adopted, there is a one-third probability that 600 people will be saved and a two-thirds probability that no people will be saved.


pages: 397 words: 112,034

What's Next?: Unconventional Wisdom on the Future of the World Economy by David Hale, Lyric Hughes Hale

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affirmative action, Asian financial crisis, asset-backed security, bank run, banking crisis, Basel III, Berlin Wall, Black Swan, Bretton Woods, capital controls, Cass Sunstein, central bank independence, cognitive bias, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, corporate social responsibility, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, currency manipulation / currency intervention, currency peg, Daniel Kahneman / Amos Tversky, debt deflation, declining real wages, deindustrialization, diversification, energy security, Erik Brynjolfsson, Fall of the Berlin Wall, financial innovation, floating exchange rates, full employment, Gini coefficient, global reserve currency, global village, high net worth, Home mortgage interest deduction, housing crisis, index fund, inflation targeting, information asymmetry, Intergovernmental Panel on Climate Change (IPCC), invisible hand, Just-in-time delivery, Kenneth Rogoff, labour market flexibility, labour mobility, Long Term Capital Management, Mahatma Gandhi, Martin Wolf, Mexican peso crisis / tequila crisis, Mikhail Gorbachev, money market fund, money: store of value / unit of account / medium of exchange, mortgage tax deduction, Network effects, new economy, Nicholas Carr, oil shale / tar sands, oil shock, open economy, passive investing, payday loans, peak oil, Ponzi scheme, post-oil, price stability, private sector deleveraging, purchasing power parity, quantitative easing, race to the bottom, regulatory arbitrage, rent-seeking, reserve currency, Richard Thaler, risk/return, Robert Shiller, Robert Shiller, Ronald Reagan, sovereign wealth fund, special drawing rights, technology bubble, The Great Moderation, Thomas Kuhn: the structure of scientific revolutions, Tobin tax, too big to fail, total factor productivity, trade liberalization, Washington Consensus, Westphalian system, women in the workforce, yield curve

This has been suggested as one of the possible reasons for the powerful market rally experienced since March 2009. Evidence suggests that most institutional investors were initially highly skeptical of the rebound, but then many decided to buy into the market, not wanting to miss an upturn—thus creating a positive feedback loop. Why Neuroeconomics Disproves the Theory of Rationality Since the 1970s, with the pioneering work of Daniel Kahneman and Amos Tversky, we have understood how heuristics distort our ability to make rational decisions. Kahneman and Tversky investigated the apparent anomalies in human behavior that lead to asymmetries in the choices we make. In particular, they investigated how the framing of an identical issue can lead to either risk-averse or risk-seeking behavior. In a nutshell, this is the greatest insight of behavioral economics: all the decisions we make can be greatly influenced by small changes in the context.


pages: 335 words: 94,657

The Bogleheads' Guide to Investing by Taylor Larimore, Michael Leboeuf, Mel Lindauer

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asset allocation, buy low sell high, corporate governance, correlation coefficient, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, Donald Trump, endowment effect, estate planning, financial independence, financial innovation, high net worth, index fund, late fees, Long Term Capital Management, loss aversion, Louis Bachelier, margin call, market bubble, mental accounting, money market fund, passive investing, Paul Samuelson, random walk, risk tolerance, risk/return, Sharpe ratio, statistical model, survivorship bias, the rule of 72, transaction costs, Vanguard fund, yield curve, zero-sum game

Although the customers or investors may be able to give you a sound, logical reason why they buy or invest in a certain way, more often than not, it's not the real reason. Moreover, many times they aren't even aware of the real reason. While many economists were busily assuming away the real world, a couple of psychologists working in Israel pioneered a field that became known as behavioral economics. In the late 1960s, Amos Tversky and Daniel Kahneman were at Hebrew University in Jerusalem performing psychological experiments to determine how people go about making economic choices. It didn't take Tversky and Kahneman long to realize that people don't always make rational choices in their own best interest. From their experiments they began to organize and classify the rules of thumb people used to make quick, economic decisions and named them judgmental heuristics.

All About Asset Allocation, Second Edition by Richard Ferri

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activist fund / activist shareholder / activist investor, asset allocation, asset-backed security, barriers to entry, Bernie Madoff, capital controls, commoditize, commodity trading advisor, correlation coefficient, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, equity premium, estate planning, financial independence, fixed income, full employment, high net worth, Home mortgage interest deduction, implied volatility, index fund, intangible asset, Long Term Capital Management, Mason jar, money market fund, mortgage tax deduction, passive income, pattern recognition, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, selection bias, Sharpe ratio, survivorship bias, too big to fail, transaction costs, Vanguard fund, yield curve

BEHAVIORAL FINANCE Behavioral finance is an academic field that attempts to understand and explain how psychology influences an investor’s decisionmaking process. A fledgling field of study in the early 1960s, behavioral finance has grown to be an important area of research at How Behavior Affects Asset Allocation Decisions 273 several influential institutions. Professors recognized as experts in the field include Daniel Kahneman (Princeton), Meir Statman (Santa Clara), Richard Thaler (University of Chicago), Robert J. Shiller (Yale), and Amos Tversky. Tversky is frequently cited as the forefather of the field. He died in 1996. The following list touches on a few observations made by behavioral finance researchers. Unfortunately, the list only scratches the surface. Much more information about this fascinating field is available on the Internet and in your local library: ● ● ● ● ● ● ● ● ● People tend to be more optimistic about stocks after the market goes up and more pessimistic after it goes down.


pages: 326 words: 106,053

The Wisdom of Crowds by James Surowiecki

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AltaVista, Andrei Shleifer, asset allocation, Cass Sunstein, Daniel Kahneman / Amos Tversky, experimental economics, Frederick Winslow Taylor, George Akerlof, Howard Rheingold, I think there is a world market for maybe five computers, interchangeable parts, Jeff Bezos, John Meriwether, Joseph Schumpeter, knowledge economy, lone genius, Long Term Capital Management, market bubble, market clearing, market design, moral hazard, Myron Scholes, new economy, offshore financial centre, Picturephone, prediction markets, profit maximization, Richard Feynman, Richard Feynman, Richard Feynman: Challenger O-ring, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, shareholder value, short selling, Silicon Valley, South Sea Bubble, The Nature of the Firm, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Toyota Production System, transaction costs, ultimatum game, Yogi Berra, zero-sum game

And a mountain of evidence and intelligent analysis is marshaled in support of the proposition that investor psychology matters in Kent Daniel, David Hirshleifer, and Siew Hong Teoh, “Investor Psychology in Capital Markets: Evidence and Policy Implications,” Journal of Monetary Economics 49 (2002): 139–209. Karim Jamal and Shyam Sunder, “Bayesian Equilibrium in Double Auctions Populated by Biased Heuristic Traders,” Journal of Economic Behavior and Organization 31 (1996): 273–91. See also Richard H. Thaler, “The End of Behavioral Finance,” Financial Analysts’ Journal (November–December 1999): 12–17; and Daniel Kahneman, Paul Slovic, and Amos Tversky, Judgement Under Uncertainty: Heuristics and Biases (New York: Cambridge University Press, 1982), which is the jumping-off point for much of the work in behavioral finance. See George Akerlof’s Nobel lecture, “Behavioral Macroeconomics and Macroeconomic Behavior” (December 8, 2001), for a discussion of people’s problems saving. Fischer Black, “Noise,” Journal of Finance 41 (1986): 533.


pages: 297 words: 91,141

Market Sense and Nonsense by Jack D. Schwager

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3Com Palm IPO, asset allocation, Bernie Madoff, Brownian motion, collateralized debt obligation, commodity trading advisor, computerized trading, conceptual framework, correlation coefficient, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, fixed income, high net worth, implied volatility, index arbitrage, index fund, London Interbank Offered Rate, Long Term Capital Management, margin call, market bubble, market fundamentalism, merger arbitrage, negative equity, pattern recognition, performance metric, pets.com, Ponzi scheme, quantitative trading / quantitative finance, random walk, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, selection bias, Sharpe ratio, short selling, statistical arbitrage, statistical model, survivorship bias, transaction costs, two-sided market, value at risk, yield curve

Equity hedge funds, which carry a significant short position (albeit they are still net long on average), do outperform equity indexes in return/risk terms. Insofar as hedge funds are both long and short, however, a stock index is no longer the appropriate benchmark. 12For a detailed narrative on this episode, see Sebastian Mallaby, More Money Than God (New York: Penguin Press, 2010), which provides a superb history of the hedge fund industry and its key players. 13Daniel Kahneman and Amos Tversky, “Prospect Theory: An Analysis of Decision under Risk,” Econometrica 47, no. 2 (March 1979): 263–291. Prospect theory is a branch of decision theory that attempts to explain why individuals make decisions that deviate from rational decision making by examining how the expected outcomes of alternative choices are perceived (definition source: www.qfinance.com). 14Part of the title of Charles Mackay’s classic 1841 book, Extraordinary Popular Delusions and the Madness of Crowds (New York: Broadway Books, 1995). 15Ibid. 16There is no intended duality between emotions and reason, but rather a complex interaction between the two.


pages: 403 words: 111,119

Doughnut Economics: Seven Ways to Think Like a 21st-Century Economist by Kate Raworth

3D printing, Asian financial crisis, bank run, basic income, battle of ideas, Berlin Wall, bitcoin, blockchain, Branko Milanovic, Bretton Woods, Buckminster Fuller, call centre, Capital in the Twenty-First Century by Thomas Piketty, Cass Sunstein, choice architecture, clean water, cognitive bias, collapse of Lehman Brothers, complexity theory, creative destruction, crowdsourcing, cryptocurrency, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, dematerialisation, Douglas Engelbart, Douglas Engelbart, en.wikipedia.org, energy transition, Erik Brynjolfsson, ethereum blockchain, Eugene Fama: efficient market hypothesis, experimental economics, Exxon Valdez, Fall of the Berlin Wall, financial deregulation, Financial Instability Hypothesis, full employment, global supply chain, global village, Henri Poincaré, hiring and firing, Howard Zinn, Hyman Minsky, income inequality, Intergovernmental Panel on Climate Change (IPCC), invention of writing, invisible hand, Isaac Newton, John Maynard Keynes: Economic Possibilities for our Grandchildren, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, land reform, land value tax, Landlord’s Game, loss aversion, low skilled workers, M-Pesa, Mahatma Gandhi, market fundamentalism, Martin Wolf, means of production, megacity, mobile money, Mont Pelerin Society, Myron Scholes, neoliberal agenda, Network effects, Occupy movement, off grid, offshore financial centre, oil shale / tar sands, out of africa, Paul Samuelson, peer-to-peer, planetary scale, price mechanism, quantitative easing, randomized controlled trial, Richard Thaler, Ronald Reagan, Second Machine Age, secular stagnation, shareholder value, sharing economy, Silicon Valley, Simon Kuznets, smart cities, smart meter, South Sea Bubble, statistical model, Steve Ballmer, The Chicago School, The Great Moderation, the map is not the territory, the market place, The Spirit Level, The Wealth of Nations by Adam Smith, Thomas Malthus, Thorstein Veblen, too big to fail, Torches of Freedom, trickle-down economics, ultimatum game, universal basic income, Upton Sinclair, Vilfredo Pareto, wikimedia commons

But such price signals often fail to achieve their expected results, Ormerod points out, because they can be drowned out by far stronger network effects, thanks to social norms and expectations of what others in the network are doing.35 At the same time, it may be possible to harness such interdependence for behavioural change, as we will see. From calculating to approximating Homo sapiens clearly can’t match the infallibility of rational economic man. That much has been agreed upon since the 1950s when Herbert Simon broke rank with his fellow economists and started to study how people actually behaved, finding their rationality to be severely ‘bounded’. His findings, augmented by those of psychologists Daniel Kahneman and Amos Tversky in the 1970s, gave birth to the field now known as behavioural economics, which studies the many kinds of ‘cognitive bias’ that systematically cause humans to deviate from the ideal model of rationality. Examples abound. We (the WEIRD ones, at least) typically exhibit: availability bias – making decisions on the basis of more recent and more accessible information; loss aversion – the strong preference to avoid a loss rather than to make an equivalent gain; selective cognition – taking on board facts and arguments that fit with our existing frames; and risk bias – underestimating the likelihood of extreme events, while overestimating our ability to cope with them.


pages: 386 words: 122,595

Naked Economics: Undressing the Dismal Science (Fully Revised and Updated) by Charles Wheelan

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affirmative action, Albert Einstein, Andrei Shleifer, barriers to entry, Berlin Wall, Bernie Madoff, Bretton Woods, capital controls, Cass Sunstein, central bank independence, clean water, collapse of Lehman Brothers, congestion charging, creative destruction, Credit Default Swap, crony capitalism, currency manipulation / currency intervention, Daniel Kahneman / Amos Tversky, David Brooks, demographic transition, diversified portfolio, Doha Development Round, Exxon Valdez, financial innovation, fixed income, floating exchange rates, George Akerlof, Gini coefficient, Gordon Gekko, greed is good, happiness index / gross national happiness, Hernando de Soto, income inequality, index fund, interest rate swap, invisible hand, job automation, John Markoff, Joseph Schumpeter, Kenneth Rogoff, libertarian paternalism, low skilled workers, lump of labour, Malacca Straits, market bubble, microcredit, money market fund, money: store of value / unit of account / medium of exchange, Network effects, new economy, open economy, presumed consent, price discrimination, price stability, principal–agent problem, profit maximization, profit motive, purchasing power parity, race to the bottom, RAND corporation, random walk, rent control, Richard Thaler, rising living standards, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, school vouchers, Silicon Valley, Silicon Valley startup, South China Sea, Steve Jobs, The Market for Lemons, the rule of 72, The Wealth of Nations by Adam Smith, Thomas L Friedman, Thomas Malthus, transaction costs, transcontinental railway, trickle-down economics, urban sprawl, Washington Consensus, Yogi Berra, young professional, zero-sum game

Sunstein, Nudge: Improving Decisions about Health, Wealth, and Happiness (New Haven, Conn.: Yale University Press, 2008). 13. Press release from The Royal Swedish Academy of Sciences, October 9, 2002. 14. Jonathan Gruber, “Smoking’s ‘Internalities,’” Regulation, vol. 25, no. 4 (Winter 2002/2003). 15. Annamaria Lusardi, “The Importance of Financial Literacy,” NBER Reporter: Research Summary, no. 2 (2009). 16. Thomas Gilovich, Robert Vallone, and Amos Tversky, “The Hot Hand in Basketball: On the Misperception of Random Sequences,” Cognitive Psychology 17 (1985). CHAPTER 2. INCENTIVES MATTER 1. Costa Rican Embassy, Washington, D.C. 2. Ian Fisher, “Victims of War: The Jungle Gorillas, and Tourism,” New York Times, March 31, 1999. 3. Daniel Yergin and Joseph Stanislaw, The Commanding Heights (New York: Simon & Schuster, 1998), pp. 216–17. 4.

., lose weight, stop smoking, or save for retirement), then society could conceivably make them better off by helping (or coercing) them to do things they otherwise would not or could not do—the public policy equivalent of taking the cashew bowl away. The field of behavioral economics has evolved as a marriage between psychology and economics that offers sophisticated insight into how humans really make decisions. Daniel Kahneman, a professor in both psychology and public affairs at Princeton, was awarded the Nobel Prize in Economics in 2002 for his studies of decision making under uncertainty, and, in particular, “how human decisions may systematically depart from those predicted by standard economic theory.”13 Kahneman and others have advanced the concept of “bounded rationality,” which suggests that most of us make decisions using intuition or rules of thumb, kind of like looking at the sky to determine if it will rain, rather than spending hours poring over weather forecasts.

Weil, “Population, Technology, and Growth: From Malthusian Stagnation to the Demographic Transition and Beyond,” American Economic Review, vol. 20, no. 4 (September 2000). 3. Miriam Jordan, “Leprosy Remains a Foe in Country Winning the Fight Against AIDS,” Wall Street Journal, August 20, 2001. 4. Jane Spencer, “Why Beijing Is Trying to Tally the Hidden Costs of Pollution as China’s Economy Booms,” Wall Street Journal, October 2, 2006. 5. David Leonhardt, “If Richer Isn’t Happier, What Is?” New York Times, May 19, 2001. 6. Daniel Kahneman, Alan B. Krueger, David Schkade, Norbert Schwarz, and Arthur Stone, “Toward National Well-Being Accounts,” American Economic Review, vol. 94, no. 2 (May 2004). 7. “Economics Discovers Its Feelings,” The Economist, December 23, 2006. 8. Alexander Stille, “A Happiness Index with a Long Reach: Beyond GNP to Subtler Measures,” New York Times, May 20, 2000, p. A17. 9. Edward Hadas and Richard Beales, “Sarkozy Imagines: No GDP,” Wall Street Journal, January 10, 2008; David Jolly, “G.D.P.


pages: 742 words: 137,937

The Future of the Professions: How Technology Will Transform the Work of Human Experts by Richard Susskind, Daniel Susskind

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23andMe, 3D printing, additive manufacturing, AI winter, Albert Einstein, Amazon Mechanical Turk, Amazon Web Services, Andrew Keen, Atul Gawande, Automated Insights, autonomous vehicles, Big bang: deregulation of the City of London, big data - Walmart - Pop Tarts, Bill Joy: nanobots, business process, business process outsourcing, Cass Sunstein, Checklist Manifesto, Clapham omnibus, Clayton Christensen, clean water, cloud computing, commoditize, computer age, Computer Numeric Control, computer vision, conceptual framework, corporate governance, creative destruction, crowdsourcing, Daniel Kahneman / Amos Tversky, death of newspapers, disintermediation, Douglas Hofstadter, en.wikipedia.org, Erik Brynjolfsson, Filter Bubble, Frank Levy and Richard Murnane: The New Division of Labor, full employment, future of work, Google Glasses, Google X / Alphabet X, Hacker Ethic, industrial robot, informal economy, information retrieval, interchangeable parts, Internet of things, Isaac Newton, James Hargreaves, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Maynard Keynes: technological unemployment, Joseph Schumpeter, Khan Academy, knowledge economy, lifelogging, lump of labour, Marshall McLuhan, Metcalfe’s law, Narrative Science, natural language processing, Network effects, optical character recognition, Paul Samuelson, personalized medicine, pre–internet, Ray Kurzweil, Richard Feynman, Richard Feynman, Second Machine Age, self-driving car, semantic web, Shoshana Zuboff, Skype, social web, speech recognition, spinning jenny, strong AI, supply-chain management, telepresence, The Future of Employment, the market place, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, transaction costs, Turing test, Watson beat the top human players on Jeopardy!, young professional

See Lieberman, The Tyranny of the Experts, 275. 79 Anthony Kenny, What I Believe (2006), 123. 80 <http://www.kpmg.com>. 81 Our thinking on asymmetry of knowledge aligns to some extent with that of Durkheim, Parsons, and Abbott. 82 Herbert Hart, The Concept of Law (1994), 197. Original emphasis. 83 On the distinction between ‘knowing that’ and ‘knowing how’, see Gilbert Ryle, The Concept of Mind (1949), 28–32. 84 On tacit knowledge, see Michael Polanyi, ‘The Logic of Tacit Inference’, Philosophy, 41: 155 (1966), 1–18. 85 See e.g. Amos Tversky and Daniel Kahneman, ‘Judgment under Uncertainty: Heuristics and Biases’, Science, 185: 4157 (1974), 1124–31. They explore the problems with some of these rules of thumb. 86 Note the correspondence here with philosophical and psychological concepts of practical reason and practical reasoning. See Joseph Raz, Practical Reason and Norms (1999). 87 We are alive to a sophisticated challenge to this conception of knowledge, namely, a concern over what might be called the objectification of knowledge.

Trefis Team, ‘eBay: The Year 2013 in Review’, 26 Dec. 2013 <http://www.forbes.com/sites/greatspeculations/2013/12/26/ebay-the-year-2013-in-review/> (accessed 24 March 2015). Tuck, Richard, Free Riding (Cambridge, Mass.: Harvard University Press, 2008). Turing, Alan, ‘Computing Machinery and Intelligence’, Mind, 59: 236 (1950), 433–60. Turkle, Sherry, Alone Together (New York: Basic Books, 2011). Tversky, Amos, and Daniel Kahneman, ‘Judgment under Uncertainty: Heuristics and Biases’, Science, 185: 4157 (1974), 1124–31. Twilley, Nicola, ‘Artificial Intelligence Goes to the Arcade’, New Yorker, 25 Feb. 2015. UK Architectural Education Review Group, ‘Pathways and Gateways: The Structure and Regulation of Architectural Education’, Apr. 2013 <http://people.bath.ac.uk/absaw/files/> (accessed 8 March 2015). University of Hertfordshire, ‘Introducing Kaspar’, <http://www.herts.ac.uk/kaspar/introducing-kaspar> (accessed 6 March 2015).


pages: 518 words: 147,036

The Fissured Workplace by David Weil

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accounting loophole / creative accounting, affirmative action, Affordable Care Act / Obamacare, banking crisis, barriers to entry, business process, call centre, Carmen Reinhart, Cass Sunstein, Clayton Christensen, clean water, collective bargaining, commoditize, corporate governance, corporate raider, Corrections Corporation of America, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, declining real wages, employer provided health coverage, Frank Levy and Richard Murnane: The New Division of Labor, George Akerlof, global supply chain, global value chain, hiring and firing, income inequality, information asymmetry, intermodal, inventory management, Jane Jacobs, Kenneth Rogoff, law of one price, loss aversion, low skilled workers, minimum wage unemployment, moral hazard, Network effects, new economy, occupational segregation, Paul Samuelson, performance metric, pre–internet, price discrimination, principal–agent problem, Rana Plaza, Richard Florida, Richard Thaler, Ronald Coase, shareholder value, Silicon Valley, statistical model, Steve Jobs, supply-chain management, The Death and Life of Great American Cities, The Nature of the Firm, transaction costs, ultimatum game, union organizing, women in the workforce, Y2K, yield management

Kahn, Shulamit. 1997. “Evidence of Nominal Wage Stickiness from Microdata.” American Economic Review 87, no. 5: 993–1008. Kahneman, Daniel. 2011. Thinking, Fast and Slow. New York: Farrar, Straus and Giroux. Kahneman, Daniel, Jack Knetsch, and Richard Thaler. 1986. “Fairness as a Constraint on Profit Seeking: Entitlements in the Market.” American Economic Review 76, no. 4: 728–741. Kahneman, Daniel, and Amos Tversky. 1984. “Choices, Values, and Frames.” American Psychologist 34, no.4: 341-350. Kalleberg, Arne. 2011. Good Jobs / Bad Jobs: The Rise of Polarized and Precarious Employment Systems in the United States, 1970s to 2000s. New York: Russell Sage Foundation. Kalleberg, Arne, and Peter Marsden. 2005. “Externalizing Organizational Activities: Where and How U.S. Establishments Use Employment Intermediaries.”

Fairness perceptions affect all kinds of real-world interactions and relationships. Relationships are an intrinsic part of the workplace, and fairness perceptions are therefore basic to how decisions are made within it. The factors driving wage setting arise not just from an employer’s consideration of the additional output a worker might provide if given a higher wage, but on the worker’s perceptions of the fairness of that wage. For example, Daniel Kahneman, one of the pioneers of behavioral economics, showed that people’s perception of the fairness of a wage cut depends on why they feel it was done: cuts driven by increases in unemployment (and therefore more people looking for work) are viewed as unfair; a company that cuts wages because it is on the brink of bankruptcy is judged more favorably. Like the proposer in the ultimatum game, managers seem to understand this and seldom cut nominal wages in practice.12 Similarly, fairness considerations about compensation depend not only on how much I think I deserve to be paid on an absolute basis (given my experience, education, skills), but also on what I am paid relative to others.

In The Gloves-Off Economy: Workplace Standards at the Bottom of America’s Labor Market, edited by Annette Bernhardt, Heather Boushey, Laura Dresser, and Chris Tilly. Champaign, IL: University of Illinois Press, 91–109. Thornton, Dorothy, Neil Gunningham, and Robert Kagan. 2005. “General Deterrence and Corporate Environmental Behavior.” Law and Policy 27, no. 2: 262–288. Torgler, Benno. 2006. “The Importance of Faith: Tax Morale and Religiosity,” Journal of Economic Behavior and Organization 61, no. 1: 81–109. Tversky, Amos, and Daniel Kahneman. 1974. “Judgment under Uncertainty: Heuristics and Biases.” Science 185, no. 4157: 1125–1131. U.S. Department of Commerce, Bureau of Economic Analysis. 2011. National Income and Product Accounts. http://www.bea.gov/national/index.htm#gdp. U.S. Department of Labor. 1998a. “Full Hot Goods Compliance Program Agreement.” DOL Form FCPA(AB). CP1. Washington, DC: Wage and Hour Division, U.S. Department of Labor. ______. 1998b.


pages: 755 words: 121,290

Statistics hacks by Bruce Frey

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Bayesian statistics, Berlin Wall, correlation coefficient, Daniel Kahneman / Amos Tversky, distributed generation, en.wikipedia.org, feminist movement, game design, Hacker Ethic, index card, Milgram experiment, p-value, place-making, RFID, Search for Extraterrestrial Intelligence, SETI@home, Silicon Valley, statistical model, Thomas Bayes

Most people, however, even though they are rational, intelligent decision makers, will be drawn toward sentences that are conjunctions (i.e., that list two separate "facts"), as if the listing of the "facts" together makes them more likely to be true. Even if, and maybe especially if, the second "fact" by itself seems unlikely. Conjunction Junction, What's Your Function? Why do our minds tend to work this way? In the 1970s, Nobel Prize winner Daniel Kahneman and his colleague Amos Tversky presented college students with several problems in which one option was highly representative of a given personality description, one option was incongruent with the description, and one option included both the highly similar and the incongruent options. Perhaps the most well-known problem that demonstrates the conjunction fallacy is the now-famous (at least in cognitive psychology circles) Linda Problem: Linda is 31 years old, single, outspoken, and very bright.


pages: 407 words: 114,478

The Four Pillars of Investing: Lessons for Building a Winning Portfolio by William J. Bernstein

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asset allocation, Bretton Woods, British Empire, buy low sell high, carried interest, corporate governance, cuban missile crisis, Daniel Kahneman / Amos Tversky, Dava Sobel, diversification, diversified portfolio, Edmond Halley, equity premium, estate planning, Eugene Fama: efficient market hypothesis, financial independence, financial innovation, fixed income, George Santayana, German hyperinflation, high net worth, hindsight bias, Hyman Minsky, index fund, invention of the telegraph, Isaac Newton, John Harrison: Longitude, Long Term Capital Management, loss aversion, market bubble, mental accounting, money market fund, mortgage debt, new economy, pattern recognition, Paul Samuelson, quantitative easing, railway mania, random walk, Richard Thaler, risk tolerance, risk/return, Robert Shiller, Robert Shiller, South Sea Bubble, survivorship bias, The inhabitant of London could order by telephone, sipping his morning tea in bed, the various products of the whole earth, the rule of 72, transaction costs, Vanguard fund, yield curve, zero-sum game

Why, he wonders, do players usually go for the two-point shot when down by two points with seconds remaining? The two-point percentage is about 50%, meaning that your chance of winning is only 25%, since making the goal only serves to throw the game into overtime. A three-point shot wins the game and has a better success rate—about 33%. At about the same time in the early 1970s that Thaler and his friend were deciding whether or not to brave the snowstorm, two Israeli psychologists, Daniel Kahneman and Amos Tversky, were studying the imperfections in the human decision-making process in a far sunnier clime. They published a landmark paper in the prestigious journal Science, in which they outlined the basic errors made by humans in estimating probabilities. A typical riddle: “Steve is very shy and withdrawn, invariably helpful, but with little interest in people, or in the world of reality . . .”


pages: 629 words: 142,393

The Future of the Internet: And How to Stop It by Jonathan Zittrain

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A Declaration of the Independence of Cyberspace, Amazon Mechanical Turk, Andy Kessler, barriers to entry, book scanning, Brewster Kahle, Burning Man, c2.com, call centre, Cass Sunstein, citizen journalism, Clayton Christensen, clean water, commoditize, corporate governance, Daniel Kahneman / Amos Tversky, distributed generation, en.wikipedia.org, Firefox, game design, Hacker Ethic, Howard Rheingold, Hush-A-Phone, illegal immigration, index card, informal economy, Internet Archive, jimmy wales, John Markoff, license plate recognition, loose coupling, mail merge, national security letter, old-boy network, packet switching, peer-to-peer, Post-materialism, post-materialism, pre–internet, price discrimination, profit maximization, Ralph Nader, RFC: Request For Comment, RFID, Richard Stallman, Richard Thaler, risk tolerance, Robert Bork, Robert X Cringely, SETI@home, Silicon Valley, Skype, slashdot, software patent, Steve Ballmer, Steve Jobs, Ted Nelson, Telecommunications Act of 1996, The Nature of the Firm, The Wisdom of Crowds, web application, wikimedia commons, zero-sum game

See Cubby, Inc. v. CompuServe, Inc., 766 F. Supp. 135, 139—40 (S.D.N.Y. 1991) (discussing the nature of CompuServe’s involvement in running the forums). 18. See ADVANCES IN BEHAVIORAL ECONOMICS (Colin F. Camerer, George Loewenstein & Matthew Rabin eds., 2003); Christine Jolls, Cass R. Sunstein & Richard Thaler, A Behavioral Approach to Law and Economics, 50 STAN. L. REV. 1471 (1998); Daniel Kahne-man & Amos Tversky, Prospect Theory: An Analysis of Decision Under Risk, 47 ECONO-METRICA 263 (1979). 19. See Cass R. Sunstein, INFOTOPIA 80 (2006). 20. Tim Wu, Wireless Carterfone, 1 INT’L. J. COMM. 389, 404—15 (2007), available at http://ijoc.org/ojs/index.php/ijoc/article/view/152/96. 21. See id. at 419. 22. Andrew Currah, Hollywood, the Internet and the World: A Geography of Disruptive Innovation, 14 INDUSTRY & INNOVATION 359 (2007). 23.


pages: 561 words: 120,899

The Theory That Would Not Die: How Bayes' Rule Cracked the Enigma Code, Hunted Down Russian Submarines, and Emerged Triumphant From Two Centuries of Controversy by Sharon Bertsch McGrayne

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Bayesian statistics, bioinformatics, British Empire, Claude Shannon: information theory, Daniel Kahneman / Amos Tversky, double helix, Edmond Halley, Fellow of the Royal Society, full text search, Henri Poincaré, Isaac Newton, John Markoff, John Nash: game theory, John von Neumann, linear programming, meta analysis, meta-analysis, Nate Silver, p-value, Pierre-Simon Laplace, placebo effect, prediction markets, RAND corporation, recommendation engine, Renaissance Technologies, Richard Feynman, Richard Feynman, Richard Feynman: Challenger O-ring, Ronald Reagan, speech recognition, statistical model, stochastic process, Thomas Bayes, Thomas Kuhn: the structure of scientific revolutions, traveling salesman, Turing machine, Turing test, uranium enrichment, Yom Kippur War

Harsanyi often used Bayes to study competitive situations where people have incomplete or uncertain information about each other or about the rules. Harsanyi also showed that Nash’s equilibrium for games with incomplete or imperfect information was a form of Bayes’ rule. In 2002 Bayes won perhaps not an entire Nobel Prize but certainly part of one. Psychologists Amos Tversky, who died before the prize was awarded, and Daniel Kahneman showed that people do not make decisions according to rational Bayesian procedures. People answer survey questions depending on their phrasing, and physicians choose surgery or radiation for cancer patients depending on whether the treatments are described in terms of mortality or survival rates. Although Tversky was widely regarded as a philosophical Bayesian, he reported his results using frequentist methods.


pages: 437 words: 132,041

Alex's Adventures in Numberland by Alex Bellos

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Andrew Wiles, Antoine Gombaud: Chevalier de Méré, beat the dealer, Black Swan, Black-Scholes formula, Claude Shannon: information theory, computer age, Daniel Kahneman / Amos Tversky, Edward Thorp, family office, forensic accounting, game design, Georg Cantor, Henri Poincaré, Isaac Newton, Myron Scholes, pattern recognition, Paul Erdős, Pierre-Simon Laplace, probability theory / Blaise Pascal / Pierre de Fermat, random walk, Richard Feynman, Richard Feynman, Rubik’s Cube, SETI@home, Steve Jobs, The Bell Curve by Richard Herrnstein and Charles Murray, traveling salesman

Galton’s original insights helped make statistics a respectable field: ‘Some people hate the very name of statistics, but I find them full of beauty and interest,’ he wrote. ‘Whenever they are not brutalized, but delicately handled by the higher methods, and are warily interpreted, their power of dealing with complicated phenomena is extraordinary.’ In 2002 the Nobel Prize in Economics was not won by an economist. It was won by the psychologist Daniel Kahneman, who had spent his career (much of it together with his colleague Amos Tversky) stdying the cognitive factors behind decision-making. Kahneman has said that understanding regression to the mean led to his most satisfying ‘Eureka moment’. It was in the mid 1960s and Kahneman was giving a lecture to Israeli air-force flight instructors. He was telling them that praise is more effective than punishment for making cadets learn. On finishing his speech, one of the most experienced instructors stood up and told Kahneman that he was mistaken.

Culture and Prosperity: The Truth About Markets - Why Some Nations Are Rich but Most Remain Poor by John Kay

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Albert Einstein, Asian financial crisis, Barry Marshall: ulcers, Berlin Wall, Big bang: deregulation of the City of London, California gold rush, complexity theory, computer age, constrained optimization, corporate governance, corporate social responsibility, correlation does not imply causation, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, Donald Trump, double entry bookkeeping, double helix, Edward Lloyd's coffeehouse, equity premium, Ernest Rutherford, European colonialism, experimental economics, Exxon Valdez, failed state, financial innovation, Francis Fukuyama: the end of history, George Akerlof, George Gilder, greed is good, Gunnar Myrdal, haute couture, illegal immigration, income inequality, industrial cluster, information asymmetry, intangible asset, invention of the telephone, invention of the wheel, invisible hand, John Meriwether, John Nash: game theory, John von Neumann, Kenneth Arrow, Kevin Kelly, knowledge economy, labour market flexibility, late capitalism, light touch regulation, Long Term Capital Management, loss aversion, Mahatma Gandhi, market bubble, market clearing, market fundamentalism, means of production, Menlo Park, Mikhail Gorbachev, money: store of value / unit of account / medium of exchange, moral hazard, Myron Scholes, Naomi Klein, Nash equilibrium, new economy, oil shale / tar sands, oil shock, Pareto efficiency, Paul Samuelson, pets.com, popular electronics, price discrimination, price mechanism, prisoner's dilemma, profit maximization, purchasing power parity, QWERTY keyboard, Ralph Nader, RAND corporation, random walk, rent-seeking, Right to Buy, risk tolerance, road to serfdom, Ronald Coase, Ronald Reagan, second-price auction, shareholder value, Silicon Valley, Simon Kuznets, South Sea Bubble, Steve Jobs, telemarketer, The Chicago School, The Death and Life of Great American Cities, The Market for Lemons, The Nature of the Firm, the new new thing, The Predators' Ball, The Wealth of Nations by Adam Smith, Thorstein Veblen, total factor productivity, transaction costs, tulip mania, urban decay, Vilfredo Pareto, Washington Consensus, women in the workforce, yield curve, yield management

You have a ticket for a play that has cost $50. On arriving at the theater, you find that you have lost the ticket. Would you buy a new ticket? You have decided to see a play for which tickets cost $50 and on your way to the theater lose a $50 note. Do you still buy a ticket to the play? This is one of a set of pairs of questions posed in the 1970s by two Israeli psychologists, Dan Kahnemann and Amos Tversky, who created the subject now called behavioral economics. Kahneman and Tversky found that practically all their subjects would still go to the play if they had lost $50, but less than half would still go if they had lost the $50 ticket. Kahneman and Tversky did not simply challenge the standard economic assumption of rationality, but began to identify patterns of "irrationality." The ticket problem illustrates "framing."

Fogel USA 1993 Quantitative economic history Milton Friedman USA 1976 Macroeconomics Ragnar Frisch Norway 1969 Economic dynamics CWJ Granger UK 2003 Time series analysis Trygve Haavelmo Norway 1989 Econometrics John C. Harsanyi USA 1994 Game theory Friedrich von Hayek Austria/ UK 1974 Economic systems James J. Heckman USA 2000 Econometrics John R. Hicks UK 1972 General equilibrium theory Daniel Kahneman USA 2002 Behavioral economics Leonid Vitaliyevich Kantorovich USSR 1975 Optimization modeling Lawrence R. Klein USA 1980 Econometrics Tjalling C. Koopmans USA Simon Kuznets USA 1975 Optimization modeling 1971 Empirical studies of economic growth Wassily Leontief USA 1973 Input-output analysis Appendix { 359} Name Country Year Subject Arthur Lewis UK 1979 Development economics Robert E.


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Being Wrong: Adventures in the Margin of Error by Kathryn Schulz

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affirmative action, anti-communist, banking crisis, Bernie Madoff, car-free, Cass Sunstein, cognitive dissonance, colonial rule, conceptual framework, cosmological constant, cuban missile crisis, Daniel Kahneman / Amos Tversky, dark matter, desegregation, Johann Wolfgang von Goethe, lake wobegon effect, mandatory minimum, Pierre-Simon Laplace, Ronald Reagan, six sigma, stem cell, Steven Pinker, Tenerife airport disaster, the scientific method, The Wisdom of Crowds, theory of mind, Thomas Kuhn: the structure of scientific revolutions, trade route

Keeler’s The Problem of Error from Plato to Kant: A Historical and Critical Study (Apud Aedes Pontificiae Universitatis Gregorianae, 1934), 150: “We proceed wrongly in examining false judgments without first having first determined what knowledge is, for it is impossible to understand the former until the latter has been accurately defined.” “Mistakes may be defined.” James Reason, Human Error (Cambridge University Press, 1990), 9. Notwithstanding some dense prose, Reason does a deft and interesting job of ferreting out the practical applications of the insights of cognitive scientists (most famously Amos Tversky and Daniel Kahneman) about predictable failures of human cognition—so-called “cognitive illusions.” And he does so while recognizing that, even as such illusions make us err, they also make us swift and often reliable thinkers. See especially Chapter Five, “A Design for a Fallible Machine.” Iris Murdoch. Murdoch writes: “A portrayal of moral reflection and moral change (degeneration, improvement) is the most important part of any system of ethics.”


pages: 468 words: 123,823

A People's History of Poverty in America by Stephen Pimpare

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affirmative action, British Empire, car-free, clean water, cognitive dissonance, Columbine, Daniel Kahneman / Amos Tversky, deindustrialization, delayed gratification, dumpster diving, East Village, Frederick Winslow Taylor, George Gilder, hiring and firing, Howard Zinn, illegal immigration, impulse control, income inequality, index card, Jane Jacobs, low skilled workers, Mahatma Gandhi, mass incarceration, meta analysis, meta-analysis, moral panic, Naomi Klein, New Urbanism, payday loans, Ralph Waldo Emerson, Ronald Reagan, The Bell Curve by Richard Herrnstein and Charles Murray, The Death and Life of Great American Cities, The Wealth of Nations by Adam Smith, Thomas Malthus, union organizing, urban renewal, War on Poverty, white flight, working poor, Works Progress Administration

Jansson, The Reluctant Welfare State (Belmont, CA: Wadsworth, 2001); Christopher Jencks, Rethinking Social Policy (New York: HarperPerennial, 1992). 25 Robert H. Bremner, From the Depths: The Discovery of Poverty in the United States (New York: NYU Press, 1956 [1972]), 13. 26 Victoria Byerly, Hard Times Cotton Mill Girls: Personal Histories of Womanhood and Poverty in the South (Ithaca, NY: ILR Press, 1986), 6. 27 Richard Layard, Happiness: Lessons from a New Science (New York: Penguin, 2005), 48. 28 Daniel Kahneman and Amos Tversky, “Prospect Theory: An Analysis of Decision Under Risk,” Econometrica 47, no. 2 (March 1979): 263–92. 29 Amartya Sen, Development as Freedom (New York: Anchor, 1999), 89. Emphasis in original. 30 Still, if 40 percent of all Americans were poor in 1900, that represents some 30,397,830 souls; but a 13.8 percent poverty rate in 1995 means that 36,317,184 people were poor. More Americans were poor in 1995 than in 1900 (population figures from U.S.


pages: 624 words: 127,987

The Personal MBA: A World-Class Business Education in a Single Volume by Josh Kaufman

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Albert Einstein, Atul Gawande, Black Swan, business process, buy low sell high, capital asset pricing model, Checklist Manifesto, cognitive bias, correlation does not imply causation, Credit Default Swap, Daniel Kahneman / Amos Tversky, David Heinemeier Hansson, David Ricardo: comparative advantage, Dean Kamen, delayed gratification, discounted cash flows, Donald Knuth, double entry bookkeeping, Douglas Hofstadter, en.wikipedia.org, Frederick Winslow Taylor, George Santayana, Gödel, Escher, Bach, high net worth, hindsight bias, index card, inventory management, iterative process, job satisfaction, Johann Wolfgang von Goethe, Kevin Kelly, Lao Tzu, loose coupling, loss aversion, Marc Andreessen, market bubble, Network effects, Parkinson's law, Paul Buchheit, Paul Graham, place-making, premature optimization, Ralph Waldo Emerson, rent control, side project, statistical model, stealth mode startup, Steve Jobs, Steve Wozniak, subscription business, telemarketer, the scientific method, time value of money, Toyota Production System, tulip mania, Upton Sinclair, Vilfredo Pareto, Walter Mischel, Y Combinator, Yogi Berra

The best way to help your customers Visualize is to expose them to as much sensory information as possible—the information their mind uses to conclude, “I want this.” SHARE THIS CONCEPT: http://book.personalmba.com/visualization/ Framing Everything we hear is an opinion, not a fact. Everything we see is a perspective, not the truth. —MARCUS AURELIUS, ROMAN EMPEROR AND PHILOSOPHER In a famous experiment conducted by psychologists Amos Tversky and Daniel Kahneman, participants were asked to make a decision about administering medical treatment to a sick population of six hundred people. Participants in the study were given two options: Treatment A would save two hundred lives. Treatment B had a 33 percent chance of saving all six hundred people and a 66 percent possibility of saving no one. Treatment A and Treatment B are mathematically identical—statistically, there’s no difference in the expected outcome.

Evidence-Based Technical Analysis: Applying the Scientific Method and Statistical Inference to Trading Signals by David Aronson

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Albert Einstein, Andrew Wiles, asset allocation, availability heuristic, backtesting, Black Swan, capital asset pricing model, cognitive dissonance, compound rate of return, computerized trading, Daniel Kahneman / Amos Tversky, distributed generation, Elliott wave, en.wikipedia.org, feminist movement, hindsight bias, index fund, invention of the telescope, invisible hand, Long Term Capital Management, mental accounting, meta analysis, meta-analysis, p-value, pattern recognition, Paul Samuelson, Ponzi scheme, price anchoring, price stability, quantitative trading / quantitative finance, Ralph Nelson Elliott, random walk, retrograde motion, revision control, risk tolerance, risk-adjusted returns, riskless arbitrage, Robert Shiller, Robert Shiller, Sharpe ratio, short selling, source of truth, statistical model, systematic trading, the scientific method, transfer pricing, unbiased observer, yield curve, Yogi Berra

The good news is that common sense and intuitive interpretations of experience are mostly correct. The bad news is that human intelligence is maladapted to making accurate judgments in situations characterized by uncertainty. Under conditions of uncertainty, intuitive judgments and informally acquired knowledge are often wrong. Because financial market behavior is highly uncertain, erroneous knowledge in this domain is to be expected. The pioneering research of Daniel Kahneman, Paul Slovic, and Amos Tversky showed that illusory knowledge19 originates in two ways. First, people are plagued by various cognitive biases and illusions that distort what we experience and how we learn from that experience. Second, to compensate for the mind’s limited abilities to process information, human intelligence has evolved various mental shortcuts called judgment heuristics. These rules of thought, which operate quite automatically beneath our conscious awareness, are the basis of our intuitive judgments and probability assessments.

However, one factor that does not influence or predict the outcome is the player’s recent hit rate.”136 To understand why sports fans, athletes, and chart analysts fall prey to the illusion of trends and patterns in data that may in fact be random we must delve a bit deeper into the nature of intuitive judgment. THE INTUITIVE JUDGMENT AND THE ROLE OF HEURISTICS “To simplify, there are basically two types of thought processes: automatic and controlled.”137 “Intuition is automatic. It is our capacity for direct knowledge, for immediate insight without observation or reason.”138 It is perception-like, rapid, and effortless, notes Princeton University psychologist Daniel Kahneman. In contrast, “deliberate or controlled thinking is reasoning-like, critical, and analytic.”139 The prototype of controlled thought is scientific reasoning. The prototype of intuition is the brilliant medical diagnostician who always seems to sniff the underlying disease. Subjective technicians rely primarily on intuition, and they do so to their detriment. Human intelligence has limits. We can only pay attention to an extremely small fraction of the information that comes to us through our sensory organs.


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Behave: The Biology of Humans at Our Best and Worst by Robert M. Sapolsky

autonomous vehicles, Bernie Madoff, biofilm, blood diamonds, British Empire, Broken windows theory, Brownian motion, car-free, clean water, cognitive dissonance, corporate personhood, corporate social responsibility, Daniel Kahneman / Amos Tversky, delayed gratification, desegregation, double helix, Drosophila, Edward Snowden, en.wikipedia.org, epigenetics, Flynn Effect, framing effect, fudge factor, George Santayana, hiring and firing, illegal immigration, impulse control, income inequality, John von Neumann, Loma Prieta earthquake, long peace, loss aversion, Mahatma Gandhi, meta analysis, meta-analysis, Mohammed Bouazizi, mouse model, mutually assured destruction, Network effects, out of africa, Peter Singer: altruism, phenotype, placebo effect, publication bias, RAND corporation, risk tolerance, Rosa Parks, selective serotonin reuptake inhibitor (SSRI), self-driving car, Silicon Valley, stem cell, Steven Pinker, strikebreaker, theory of mind, transatlantic slave trade, traveling salesman, trickle-down economics, ultimatum game, Walter Mischel, wikimedia commons, zero-sum game

Mind you, this isn’t subjects reading either Christ’s Sermon on the Mount or Ayn Rand. Just an innocuous string of words. Words unconsciously shift thoughts and feelings. One person’s “terrorist” is another’s “freedom fighter”; politicians jockey to commandeer “family values,” and somehow you can’t favor both “choice” and “life.”*30 There are more examples. In Nobel Prize–winning research, Daniel Kahneman and Amos Tversky famously showed word framing altering decision making. Subjects decide whether to administer a hypothetical drug. If they’re told, “The drug has a 95 percent survival rate,” people, including doctors, are more likely to approve it than when told, “The drug has a 5 percent death rate.”*31 Embed “rude” or “aggressive” (versus “considerate” or “polite”) in word strings, and subjects interrupt people more immediately afterward.

Another example to watch out for is the human potential for irrational optimism. For example, while people might accurately assess the risk of a behavior, they tend toward distortive optimism when assessing risk to themselves—“Nah, that couldn’t happen to me.” Irrational optimism can be great; it’s why only about 15 percent instead of 99 percent of humans get clinically depressed. But as emphasized by the Nobel Prize–winning psychologist Daniel Kahneman, irrational optimism in warfare is disastrous. This can range from the theologically optimistic conviction that God is on your side to the tendency of military strategists to overestimate their side’s capabilities and underestimate those of the opposition—“piece of cake, full steam ahead” becomes the logical conclusion.42 A final domain of irrationality that must be recognized concerns chapter 15’s “sacred values,” where purely symbolic acts can count for more than hard-nosed material concessions.

This might also be a way to frame the explanation for why, in that cross-cultural study of small-scale societies discussed above, those with the most market integration had the most prosocial game play—what markets and cash economies do is shift a world of reciprocal altruism from the realm of social intuition to social calculation. * These themes bear a strong resemblance to those of the economics Nobel laureate Daniel Kahneman, in his best seller, Thinking, Fast and Slow—rather than framing things in a moral arena, his analysis is of the differing strengths and weaknesses of fast intuitive thinking and slow analytical thinking in the realm of economics. * Although the neuroscientist Sam Harris, in his book Lying, argues that all lying—even white lies, lies to spare someone’s feelings, lies accomplishing the proverbial heroics of, say, hiding a runaway slave—are wrong


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Extreme Money: Masters of the Universe and the Cult of Risk by Satyajit Das

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affirmative action, Albert Einstein, algorithmic trading, Andy Kessler, Asian financial crisis, asset allocation, asset-backed security, bank run, banking crisis, banks create money, Basel III, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Black Swan, Bonfire of the Vanities, bonus culture, Bretton Woods, BRICs, British Empire, capital asset pricing model, Carmen Reinhart, carried interest, Celtic Tiger, clean water, cognitive dissonance, collapse of Lehman Brothers, collateralized debt obligation, corporate governance, corporate raider, creative destruction, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, Daniel Kahneman / Amos Tversky, debt deflation, Deng Xiaoping, deskilling, discrete time, diversification, diversified portfolio, Doomsday Clock, Edward Thorp, Emanuel Derman, en.wikipedia.org, Eugene Fama: efficient market hypothesis, eurozone crisis, Fall of the Berlin Wall, financial independence, financial innovation, financial thriller, fixed income, full employment, global reserve currency, Goldman Sachs: Vampire Squid, Gordon Gekko, greed is good, happiness index / gross national happiness, haute cuisine, high net worth, Hyman Minsky, index fund, information asymmetry, interest rate swap, invention of the wheel, invisible hand, Isaac Newton, job automation, Johann Wolfgang von Goethe, John Meriwether, joint-stock company, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, Kevin Kelly, labour market flexibility, laissez-faire capitalism, load shedding, locking in a profit, Long Term Capital Management, Louis Bachelier, margin call, market bubble, market fundamentalism, Marshall McLuhan, Martin Wolf, mega-rich, merger arbitrage, Mikhail Gorbachev, Milgram experiment, money market fund, Mont Pelerin Society, moral hazard, mortgage debt, mortgage tax deduction, mutually assured destruction, Myron Scholes, Naomi Klein, negative equity, Network effects, new economy, Nick Leeson, Nixon shock, Northern Rock, nuclear winter, oil shock, Own Your Own Home, Paul Samuelson, pets.com, Philip Mirowski, Plutocrats, plutocrats, Ponzi scheme, price anchoring, price stability, profit maximization, quantitative easing, quantitative trading / quantitative finance, Ralph Nader, RAND corporation, random walk, Ray Kurzweil, regulatory arbitrage, rent control, rent-seeking, reserve currency, Richard Feynman, Richard Feynman, Richard Thaler, Right to Buy, risk-adjusted returns, risk/return, road to serfdom, Robert Shiller, Robert Shiller, Rod Stewart played at Stephen Schwarzman birthday party, rolodex, Ronald Reagan, Ronald Reagan: Tear down this wall, Satyajit Das, savings glut, shareholder value, Sharpe ratio, short selling, Silicon Valley, six sigma, Slavoj Žižek, South Sea Bubble, special economic zone, statistical model, Stephen Hawking, Steve Jobs, survivorship bias, The Chicago School, The Great Moderation, the market place, the medium is the message, The Myth of the Rational Market, The Nature of the Firm, the new new thing, The Predators' Ball, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, trickle-down economics, Turing test, Upton Sinclair, value at risk, Yogi Berra, zero-coupon bond, zero-sum game

Former risk manager Barry Schacter offered an alternative definition of VAR: “a number invented by purveyors of panaceas for pecuniary peril intended to mislead senior management and regulators into false confidence that market risk is adequately understood and controlled.”22 Everything Is Just Noise The new theories required that everyone has rational expectations, that is, the population is correct on average even if no individual person is. Behavioral economist Amos Tversky summed it up: “When we talk about individuals, especially policy makers, they all make errors in their decisions. But in aggregate, they all get it right?”23 Exceptions and anomalies increasingly undermined the theory of efficient markets. There was the turn-of-the-year effect, where stocks seemed to rise in January each year. Small-size firms outperformed large stocks—the small-firm effect. In the loser effect, stocks that had fallen significantly outperformed stocks that performed well in previous periods. There was little relationship between beta (risk) and return. Behavioural economists, such as Tversky, Daniel Kahneman and Richard Thaler, argued that efficient financial markets were rife with cognitive biases and errors in reasoning and information processing, including overconfidence, overreaction, representative bias, information bias, and the use of linear reasoning.


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The Blank Slate: The Modern Denial of Human Nature