Richard Thaler

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pages: 461 words: 128,421

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

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, business cycle, buy and hold, 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, Social Responsibility of Business Is to Increase Its Profits, South Sea Bubble, statistical model, stocks for the long run, 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

The Sveriges Riksbank Prize in Economic Sciences in Memory of Alfred Nobel 1978, press release, Oct. 16, 1978. 15. Daniel Kahneman and Amos Tversky, “Prospect Theory: An Analysis of Decision Under Risk,” Econometrica (March 1979): 263–92. 16. Richard H. Thaler, Quasi Rational Economics (New York: Russell Sage Foundation, 1991), xi–xii. 17. Justin Fox, “Is the Market Rational?” Fortune, Dec. 9, 2002, 120. 18. Richard H. Thaler, “Toward a Positive Theory of Consumer Choice,” Journal of Economic Behavior and Organization 1 (1980): 39–60. Reprinted in Thaler, Quasi Rational Economics. 19. Richard H. Thaler and H. M. Shefrin, “An Economic Theory of Self-Control,” Journal of Political Economy (April 1981): 392–406. 20. The best description of Chamberlin’s experiment, and of the rise of experimental economics in general, is in Ross M.

Cohen, “Separate Neural Systems Value Immediate and Delayed Rewards,” Science (Oct. 15, 2004): 503–7. 13. Richard Thaler and Shlomo Benartzi, “Save More Tomorrow: Using Behavioral Economics to Increase Employee Savings,” Journal of Political Economy (Feb. 2004): pt. 2, S164–S187. 14. Justin Fox, “Why Johnny Can’t Save for Retirement,” Fortune, March 21, 2005. 15. Richard H. Thaler, Cass R. Sunstein, Nudge: Improving Decisions About Health, Wealth, and Happiness (New Haven: Yale University Press, 2008). 16. Cass R. Sunstein, ed., Behavioral Law and Economics (Cambridge and New York: Cambridge University Press, 2000). 17. Aditya Chakrabortty, “From Obama to Cameron, why do so many politicians want a piece of Richard Thaler?” Guardian, July 12, 2008, 16. 18. Edward Glaeser, “Paternalism and Psychology,” University of Chicago Law Review (2006): 133–56. 19.

A slightly different version of the story can be found in Joseph Nocera, “The Quantitative, Data-Based, Risk-Massaging Road to Riches,” New York Times Magazine, June 5, 2005. 19. The October 2000 version is available for download at http://ssrn.com/abstract=240371. 20. Williams (1997), 188. 21. Clifford Asness, “Bubble Logic: Or, How to Learn to Stop Worrying and Love the Bull,” partial draft of an unpublished book, June 1, 2000. 22. Owen A. Lamont and Richard H. Thaler. “Can the Market Add and Subtract? Mispricing in Tech Stock Carve-Outs,” Journal of Political Economy (April 2003): 227–68. 23. Jeremy Siegel, “Big-Cap Tech Stocks Are a Sucker Bet,” Wall Street Journal, March 14, 2000. 24. Justin Fox, “9% Forever?” Fortune, Dec. 26, 2005. CHAPTER 15: MIKE JENSEN CHANGES HIS MIND ABOUT THE CORPORATION 1. Jack Willoughby, “Burning Up: Warning: Internet companies are running out of cash—fast,” Barron’s, March 20, 2000, 29. 2.


pages: 348 words: 83,490

More Than You Know: Finding Financial Wisdom in Unconventional Places (Updated and Expanded) by Michael J. Mauboussin

Albert Einstein, Andrei Shleifer, Atul Gawande, availability heuristic, beat the dealer, Benoit Mandelbrot, Black Swan, Brownian motion, butter production in bangladesh, buy and hold, capital asset pricing model, Clayton Christensen, clockwork universe, complexity theory, corporate governance, creative destruction, Daniel Kahneman / Amos Tversky, deliberate practice, demographic transition, discounted cash flows, disruptive innovation, diversification, diversified portfolio, dogs of the Dow, Drosophila, Edward Thorp, en.wikipedia.org, equity premium, Eugene Fama: efficient market hypothesis, fixed income, framing effect, functional fixedness, hindsight bias, hiring and firing, Howard Rheingold, index fund, information asymmetry, intangible asset, invisible hand, Isaac Newton, Jeff Bezos, Kenneth Arrow, Laplace demon, Long Term Capital Management, loss aversion, mandelbrot fractal, margin call, market bubble, Menlo Park, mental accounting, Milgram experiment, Murray Gell-Mann, Nash equilibrium, new economy, Paul Samuelson, Pierre-Simon Laplace, quantitative trading / quantitative finance, random walk, Richard Florida, Richard Thaler, Robert Shiller, Robert Shiller, shareholder value, statistical model, Steven Pinker, stocks for the long run, survivorship bias, The Wisdom of Crowds, transaction costs, traveling salesman, value at risk, wealth creators, women in the workforce, zero-sum game

An investor who is prepared to wait a long time before evaluating the outcome of the investment as a gain or a loss will find the risky asset more attractive than another investor who expects to evaluate the outcome soon. —Richard H. Thaler, Amos Tversky, Daniel Kahneman, and Alan Schwartz, “The Effect of Myopia and Loss Aversion on Risk Taking: An Experimental Test” Loss aversion . . . can be considered a fact of life. In contrast, the frequency of evaluations is a policy choice that presumably could be altered, at least in principle. —Shlomo Benartzi and Richard H. Thaler, “Myopic Loss Aversion and the Equity Premium Puzzle” One or One Hundred In the early 1960s, economist Paul Samuelson offered his lunch colleagues a bet where he would pay $200 for a correct call of a fair coin toss and he would collect $100 for an incorrect call.

In the six years that ended with 1993, Miller’s Special Investment Trust beat the market every year. 8. Time Is on My Side 1 Paul A. Samuelson, “Risk and Uncertainty: A Fallacy of Large Numbers,” Scientia 98 (1963): 108-13; reprinted at www.casact.org/pubs/forum/94sforum/94sf049.pdf. Shlomo Benartzi and Richard H. Thaler, “Myopic Loss Aversion and the Equity Premium Puzzle,” The Quarterly Journal of Economics 110, no. 1 (February 1995): 73-92, available from http://gsbwww.uchicago.edu/fac/richard.thaler/research/myopic.pdf, write: “Specifically, the theorem says that if someone is unwilling to accept a single play of a bet at any wealth level that could occur over the course of some number of repetitions of the bet, then accepting the multiple bet is inconsistent with expected utility theory.” 2 Daniel Kahneman and Amos Tversky, “Prospect Theory: An Analysis of Decision Under Risk,” Econometrica 47 (1979): 263-91. 3 Nicholas Barberis and Ming Huang, “Mental Accounting, Loss Aversion, and Individual Stock Returns,” Journal of Finance 56, no. 4 (August 2001): 1247-92. 4 Elroy Dimson, Paul Marsh, and Mike Staunton, “Global Evidence on the Equity Risk Premium,” Journal of Applied Corporate Finance 15, no. 4 (Fall 2003): 27-38. 5 Benartzi and Thaler, “Myopic Loss Aversion.” 6 This and following exhibits closely follow William J.

Beinhocker, Eric D. “Robust Adaptive Strategies.” Sloan Management Review 40, no. 3 (Spring 1999): 95-106. Belsky, Gary, and Thomas Gilovich. Why Smart People Make Big Money Mistakes —and How to Correct Them: Lessons from the New Science of Behavioral Economics. New York: Simon and Schuster, 1999. Benartzi, Shlomo, and Richard H. Thaler. “Myopic Loss Aversion and the Equity Premium Puzzle.” The Quarterly Journal of Economics (February 1995): 73-92. http://gsbwww.uchicago.edu/fac/richard.thaler/research/myopic.pdf. Bennis, Warren. “Will the Legacy Live On?” Harvard Business Review (February 2002): 95-99. Berkshire Hathaway. Annual Shareholder Letters. http://www.berkshirehathaway.com/letters/letters.html. Bernoulli, Daniel. “Exposition of a New Theory on the Measurement of Risk.” Econometrica 22 (January 1954): 23-36.


pages: 168 words: 46,194

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

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.

See Glaeser, supra note 10; Wright & Ginsburg, supra note 5. 34. See Glaeser, supra note 10, which has a rule-consequentialist flavor, but which is qualified through a recognition that (optional) nudging is justified in identifiable cases. 35. Mill, supra note 2. 36. For a valuable discussion, see Edna Ullmann-Margalit, Invisible Hand Explanations, 39 Synthese 263 (1978). 37. For discussion, see Richard H. Thaler & Cass R. Sunstein, Nudge: Improving Decisions About Health, Wealth, and Happiness (2008). Richard Thaler et al., Choice Architecture, in Behavioral Foundations of Policy 428, 428–31 (Eldar Shafir ed. 2012). I am bracketing here the potential effects of the kinds of choice architecture that are established by the basic rules of contract law, property law, tort law, and criminal law. 38. See Cass R. Sunstein, Simpler: The Future of Government (2013). 39.

To be sure, the individual mandate can be, and has been, powerfully defended on nonpaternalistic grounds; above all, it should be understood as an effort to overcome a free-rider problem that exists when people do not obtain health insurance (but are nonetheless subsidized in the event that they need medical help). 6. MILL, supra note 2. 7. Id. 8. Id. 9. An authoritative discussion is DANIEL KAHNEMAN, THINKING, FAST AND SLOW (2011). On behavioral economics and public policy, see CASS R. SUNSTEIN, SIMPLER: THE FUTURE OF GOVERNMENT (2013); RICHARD H. THALER & CASS R. SUNSTEIN, NUDGE: IMPROVING DECISIONS ABOUT HEALTH, WEALTH, and HAPPINESS (2008). 10. Richard A. Posner, Why Is There No Milton Friedman Today, 10 ECON. J. WATCH 210, 212 (2013), available at http://econjwatch.org/articles/why-is-there-no-milton-friedman-today-RP. 11. See David Laibson, Golden Eggs and Hyperbolic Discounting, 112 Q.J. ECON. 443, 445 (1997). 12. For a discussion of some of the foundational issues, see Pedro Bordalo, Nicola Gennaioli & Andrei Shleifer, Salience Theory of Choice Under Risk, 127 Q.J.


pages: 319 words: 106,772

Irrational Exuberance: With a New Preface by the Author by Robert J. Shiller

Andrei Shleifer, asset allocation, banking crisis, Benoit Mandelbrot, business cycle, buy and hold, computer age, correlation does not imply causation, Daniel Kahneman / Amos Tversky, demographic transition, diversification, diversified portfolio, equity premium, Everybody Ought to Be Rich, experimental subject, hindsight bias, income per capita, index fund, Intergovernmental Panel on Climate Change (IPCC), Joseph Schumpeter, Long Term Capital Management, loss aversion, mandelbrot fractal, market bubble, market design, market fundamentalism, Mexican peso crisis / tequila crisis, Milgram experiment, money market fund, moral hazard, new economy, open economy, pattern recognition, Ponzi scheme, price anchoring, random walk, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, Ronald Reagan, Small Order Execution System, spice trade, statistical model, stocks for the long run, survivorship bias, the market place, Tobin tax, transaction costs, tulip mania, urban decay, Y2K

Theodore Benna, executive vice-president of the Johnson Companies, an 240 NOT ES TO PAGES 33–39 employee benefits consulting firm, tested the IRS by creating the first 401(k) plan in 1981. The IRS announced in February 1982 that the tax benefits of such plans would be allowed. 22. See New York Stock Exchange, The Public Speaks to the Exchange Community (New York, 1955). 23. Shlomo Benartzi and Richard H. Thaler, “Naive Diversification Strategies in Defined Contribution Plans,” unpublished paper, University of Chicago, 1998. 24. Investment Company Institute, Mutual Fund Fact Book (Washington, D.C., 1999), http://www.ici.org. 25. See Hugh Bullock, The Story of Investment Companies (New York: Columbia University Press, 1959). 26. See Rudolph Weissman, The Investment Company and the Investor (New York: Harper and Brothers, 1951), p. 144. 27.

Securities and Exchange Commission, “Special Study: On-Line Brokerage: Keeping Apace of Cyberspace,” 1999, http://www.sec.gov/pdf/ cybrtrnd.pdf. 35. See Kenneth R. French and Richard Roll, “Stock Return Variances: The Arrival of Information and the Reaction of Traders,” Journal of Financial Economics, 17 (1986): 5–26; see also Richard Roll, “Orange Juice and Weather,” American Economic Review, 74 (1984): 861–80. 36. See Shlomo Benartzi and Richard H. Thaler, “Myopic Loss Aversion and the Equity Premium Puzzle,” Quarterly Journal of Economics, 110(1) (1995): 73–92. 37. Data are from the National Gambling Impact Study Commission, Final Report, Washington D.C., 1999, http://www.ngisc.gov/reports/exsum_1-7.pdf. 38. See also William N. Thompson, Legalized Gambling: A Reference Handbook (Santa Barbara, Calif.: ABC-CLIO, 1994), pp. 52–53. 39. Quantitative evidence on gambling behavior is hard to come by for the 1920s.

Bodo Schäfer, Der Weg zur finanziellen Freiheit: In sieben Jahren die erste Million (Frankfurt: Campus Verlag, 1999); Bernd Niquet, Keine Angst vorm nächsten Crash: Warum Aktien als Langfristanlage unschlagbar sind (Frankfurt: Campus Verlag, 1999). 11. Robert McGough, “Was Investor Survey a Rush to Judgment?” Wall Street Journal, October 27, 1997, p. C23. 12. See David E. Bell, “Regret in Decision Making Under Uncertainty,” Operations Research, 30(5) (1982): 961–81; and Graham Loomes and Robert Sugden, “Regret Theory: An Alternative Theory of Rational Choice under Uncertainty,” The Economic Journal, 92 (1982): 805–24. 13. See Richard H. Thaler and Eric J. Johnson, “Gambling with the House Money and Trying to Break Even: The Effect of Prior Outcomes on Risky Choice,” Management Science, 36 (1990): 643–60. 14. John Kenneth Galbraith, The Great Crash: 1929, 2nd ed. (Boston: Houghton Mifflin, 1961), p. 79. 15. Data from the National Association of Investors Corporation Web site, http://www.better-investing.org/member/history.html. 16.


pages: 121 words: 31,813

The Art of Execution: How the World's Best Investors Get It Wrong and Still Make Millions by Lee Freeman-Shor

Black Swan, buy and hold, 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, Richard Thaler, Robert Shiller, Robert Shiller, rolodex, Skype, South Sea Bubble, Stanford marshmallow experiment, Steve Jobs, technology bubble, The Wisdom of Crowds, too big to fail, tulip mania, zero-sum game

Many managers, once they’re up 30 or 40 percent, will book their year … The way to attain truly superior long-term returns is to grind it out until you’re up 30 or 40 percent, and then if you have the convictions, go for a 100 percent year.”60 * * * 34 Lynch (2000). 35 Ibid. 36 ‘Some Empirical Evidence on Dynamic Inconsistency’, Economic Letters, by Richard Thaler (1981). 37 ‘Anomalies: Intertemporal Choice’, Journal of Economic Perspectives, George Loewenstein and Richard H. Thaler (1989). 38 ‘Risk Aversion or Myopia? Choices in Repeated Gambles and Retirement Investments’, Management Science, by Shlomo Benartzi and Richard Thaler (1999). They showed that the pain of a short-term loss overpowers the pleasure of a long-term gain. This myopic (short-term) focus and a hatred of losing is what Thaler and Benartzi called myopic loss aversion. 39 ‘Online Investors: Do the Slow Die First?

Neuberger (1997). 21 The Wisdom of Crowds, by James Surowiecki (2005) 22 Predictably Irrational, by Dan Ariely (2009). “[T]o be a great investor you should have a clear maximum time for the idea to play out.” 23 The Dhandho Investor, by Mohnish Pabrai (2007). 24 ‘Gambling with the House Money and Trying to Break Even: The Effects of Prior Outcomes on Risky Choice’, Management Science, Richard H. Thaler and Eric J. Johnson, (1990). 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.

Various studies have shown that humans prefer $1 today versus $2 tomorrow, a phenomenon that has been termed hyperbolic discounting.36 Raiders are ‘present-biased’ without realising it. “In the morning, when temptation is remote, we vow to go to bed early, stick to our diet, and not to have too much to drink. That night we stay out until 3:00am, have two helpings of chocolate decadence, and a variety of Aquavit at a Norwegian restaurant.”37 4. Fear The research of Shlomo Benartzi and Richard Thaler also showed that the pain of a short-term loss overpowers the pleasure of a long-term gain. This myopic (short-term) focus and a hatred of losing they called myopic loss aversion.38 This produces a fear which turns many investors into Raiders when a share starts doing well. The findings of Terrance Odean suggest that this problem has grown thanks to the unprecedented immediacy of the internet.


pages: 654 words: 191,864

Thinking, Fast and Slow by Daniel Kahneman

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, hedonic treadmill, 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, Shai Danziger, Supply of New York City Cabdrivers, The Chicago School, The Wisdom of Crowds, Thomas Bayes, transaction costs, union organizing, Walter Mischel, Yom Kippur War

If the utility function for wealth is concave (bent down), the preference implies that the value of $1 has decreased by over 9% over an interval of $21! This is an extraordinarily steep decline and the effect increases steadily as the gambles become more extreme. “Even a lousy lawyer”: Matthew Rabin, “Risk Aversion and Expected-Utility Theory: A Calibration Theorem,” Econometrica 68 (2000): 1281–92. Matthew Rabin and Richard H. Thaler, “Anomalies: Risk Aversion,” Journal of Economic Perspectives 15 (2001): 219–32. economists and psychologists: Several theorists have proposed versions of regret theories that are built on the idea that people are able to anticipate how their future experiences will be affected by the options that did not materialize and/or by the choices they did not make: David E. Bell, “Regret in Decision Making Under Uncertainty,” Operations Research 30 (1982): 961–81.

communicate a reference point: Daniel Kahneman, “Reference Points, Anchors, Norms, and Mixed Feelings,” Organizational Behavior and Human Decision Processes 51 (1992): 296–312. “wins the contest”: John Alcock, Animal Behavior: An Evolutionary Approach (Sunderland, MA: Sinauer Associates, 2009), 278–84, cited by Eyal Zamir, “Law and Psychology: The Crucial Role of Reference Points and Loss Aversion,” working paper, Hebrew University, 2011. merchants, employers, and landlords: Daniel Kahneman, Jack L. Knetsch, and Richard H. Thaler, “Fairness as a Constraint on Profit Seeking: Entitlements in the Market,” The American Economic Review 76 (1986): 728–41. fairness concerns are economically significant: Ernst Fehr, Lorenz Goette, and Christian Zehnder, “A Behavioral Account of the Labor Market: The Role of Fairness Concerns,” Annual Review of Economics 1 (2009): 355–84. Eric T. Anderson and Duncan I. Simester, “Price Stickiness and Customer Antagonism,” Quarterly Journal of Economics 125 (2010): 729–65.

Johnson, Simon Gächter, and Andreas Herrmann, “Exploring the Nature of Loss Aversion,” Centre for Decision Research and Experimental Economics, University of Nottingham, Discussion Paper Series, 2006. Edward J. McCaffery, Daniel Kahneman, and Matthew L. Spitzer, “Framing the Jury: Cognitive Perspectives on Pain and Suffering,” Virginia Law Review 81 (1995): 1341–420. classic on consumer behavior: Richard H. Thaler, “Toward a Positive Theory of Consumer Choice,” Journal of Economic Behavior and Organization 39 (1980): 36–90. taboo tradeoff: Philip E. Tetlock et al., “The Psychology of the Unthinkable: Taboo Trade-Offs, Forbidden Base Rates, and Heretical Counterfactuals,” Journal of Personality and Social Psychology 78 (2000): 853–70. where the precautionary principle: Cass R. Sunstein, The Laws of Fear: Beyond the Precautionary Principle (New York: Cambridge University Press, 2005).


pages: 369 words: 128,349

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

3Com Palm IPO, Andrei Shleifer, asset allocation, buy and hold, 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

Froot, Kenneth A., and Richard H. Thaler. 1990. Anomalies: Foreign Exchange. Journal of Economic Perspectives 4(3), 179–92. Goetzmann, William, and Aloke Kumar. 2001. Equity Portfolio Diversification. Working paper, NBER. Haan, Marco. 1997. Where Are the Motives? A Problem with Evidence in the Work of Richard Thaler: A Reply. Journal of Economic Psychology 18(6), 705–9. Hong, Harrison, and Jeremy C. Stein. 1999. A Unified Theory of Underreaction, Momentum Trading, and Overreaction in Asset Markets. 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.

Also see http://www.tickdata.com http://www.federalreserve.gov/releases/H10/hist: Historical exchange rates with most of the world’s currencies are available at the Federal Reserve site. http://pacific.commerce.ubc.ca/xr: The Pacific Exchange rate service at the University of British Columbia provides the exchange rates in addition several other useful bits of information. References for Further Reading Baz, Jamil, Francis Breedon, Vasant Naik, and Joel Peress. 2001. Optimal Portfolios of Foreign Currencies. The Journal of Portfolio Management 28(1), 102–11. Engel, Charles. 1996. The Forward Discount Anomaly and the Risk Premium: A Survey of Recent Evidence. Journal of Empirical Finance 3(2), 123–92. Froot, Kenneth A., and Richard H. Thaler. 1990. Anomalies: Foreign Exchange. Journal of Economic Perspectives 4(3), 179–92. Meredith, Guy, and Menzie D. Chinn. 1998. Long Horizon Uncovered Interest Rate Parity. Working paper no. 6797, National Bureau of Economic Research. Razzak, Weshah A. 2000. The Forward Rate Unbiasedness Hypothesis Revisited. Working paper, Reserve Bank of New Zealand. Sercu, Piet, and Raman Uppal. 1995. International Financial Markets and the Firm (Cincinnati: South-Western College Publishing).

Journal of Finance 43, 113–27. Chay, Jong-Boon, and Charles A.Trzcinka. 1999. Managerial Performance and the Cross-Sectional Pricing of Closed-End Funds. Journal of Financial Economics 52, 379–408. Chen, Nai-Fu, Raymond Kan, and Merton Miller. 1993. Are the Discounts on Closed End Funds a Sentiment Index? Journal of Finance 48(2), 795–800. Chopra, Navin, Charles M. C. Lee, Andrei Shleifer, and Richard H. Thaler. 1993. Yes, Discounts on Closed-End Funds are a Sentiment Index. Journal of Finance 48(2), 801–8. Coles, Jeffrey L., Jose Suay, and Denise Woodbury. 2000. Fund Advisor Compensation in Closed-End Funds. Journal of Finance 55, 1385–414. Dimson, Elroy, and Carolina Minio-Kozeski. 1999. Closed-End Funds: A Survey. Financial Markets, Institutions and Instruments 8(2), 1–41. Garay, Urbi, and Philip Russell. 1999.


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Stocks for the Long Run 5/E: the Definitive Guide to Financial Market Returns & Long-Term Investment Strategies by Jeremy Siegel

Asian financial crisis, asset allocation, backtesting, banking crisis, Black-Scholes formula, break the buck, Bretton Woods, business cycle, buy and hold, buy low sell high, California gold rush, capital asset pricing model, carried interest, central bank independence, cognitive dissonance, compound rate of return, computer age, computerized trading, corporate governance, correlation coefficient, Credit Default Swap, Daniel Kahneman / Amos Tversky, Deng Xiaoping, discounted cash flows, diversification, diversified portfolio, dividend-yielding stocks, dogs of the Dow, equity premium, Eugene Fama: efficient market hypothesis, eurozone crisis, Everybody Ought to Be Rich, Financial Instability Hypothesis, fixed income, Flash crash, forward guidance, fundamental attribution error, housing crisis, Hyman Minsky, implied volatility, income inequality, index arbitrage, index fund, indoor plumbing, inflation targeting, invention of the printing press, Isaac Newton, joint-stock company, London Interbank Offered Rate, Long Term Capital Management, loss aversion, market bubble, mental accounting, money market fund, mortgage debt, Myron Scholes, new economy, Northern Rock, oil shock, passive investing, Paul Samuelson, Peter Thiel, Ponzi scheme, prediction markets, price anchoring, price stability, purchasing power parity, quantitative easing, random walk, Richard Thaler, risk tolerance, risk/return, Robert Gordon, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, short selling, Silicon Valley, South Sea Bubble, sovereign wealth fund, stocks for the long run, survivorship bias, technology bubble, The Great Moderation, the payments system, The Wisdom of Crowds, transaction costs, tulip mania, Tyler Cowen: Great Stagnation, Vanguard fund

For a reference to data mining, see Andrew Lo and Craig MacKinlay, “Data-Snooping Biases in Tests of Financial Asset Pricing Models,” Review of Financial Studies, vol. 3, no. 3 (Fall 1999), pp. 431-467. 17. See Nassim Taleb, Fooled by Randomness: The Hidden Role of Chance in Life and the Markets, 2005. 18. Dreman, Contrarian Investment Strategies. 19. Richard Thaler, “Mental Accounting and Consumer Choice,” Marketing Science, vol. 4, no. 3 (Summer 1985), pp. 199-214 and Nicholas Barberis, Ming Huang and Richard H. Thaler, “Individual Preferences, Monetary Gambles, and Stock Market Participation: A Case for Narrow Framing,” The American Economic Review, vol. 96, no. 4 (Sep., 2006), pp. 1069-1090. 20. Richard H. Thaler, “Mental Accounting Matters,” Journal of Behavioral Decision Making, vol. 12 (1999), pp. 183-206. 21. Hersh Shefrin and Meir Statman, “The Disposition to Sell Winners Too Early and Ride Losers Too Long: Theory and Evidence,” Journal of Finance, vol. 40, no. 3 (1985), pp. 777-792. 22.

Journal of Finance, vol. 53, no. 5 (October 1998), p. 1786. 26. Hersh Shefrin and Richard Thaler, “An Economic Theory of Self-Control,” Journal of Political Economy, vol. 89, no. 21 (1981), pp. 392-406. 27. See Paul Sloan, “Can’t Stop Checking Your Stock Quotes,” U.S. News & World Report, July 10, 2000. 28. Shlomo Bernartzi and Richard Thaler, “Myopic Loss Aversion and the Equity Premium Puzzle,” Quarterly Journal of Economics, 1995, pp. 73-91. 29. See Chapter 5 for a further description of the equity premium puzzle. 30. Humphrey B. Neill, The Art of Contrary Thinking, Caldwell, ID: Caxton Printers, 1954, p. 1. 31. Benjamin Graham and David Dodd, Security Analysis, New York: McGraw-Hill, 1934, p. 12. 32. A discussion of the VIX is found in Chapter 19. 33. Werner F. M. De Bondt and Richard H. Thaler, “Does the Stock Market Overreact?”

In 1993, Narasimhan Jegadeesh and Sheridan Titman found that stocks with the highest 10 percent returns over the past six months outperformed stocks with the lowest 10 percent returns by about 1 percent per month over the next six months.13, 14 Other technical strategies, such as buying stocks priced near their 52-week high, have also been shown to be successful.15 It should be emphasized that these momentum strategies work only in the short term and should not be part of a long-term strategy. In the Jegadeesh and Titman study, more than half of the excess returns generated in the first 12 months were lost over the following two years. Over the longer periods, the advantage of buying “winning” stocks is completely eliminated. In fact, an earlier study by Werner De Bondt and Richard Thaler found that stocks that performed poorly over the previous three- to five-year period significantly outperformed, over the next three to five years, those stocks that had done well, implying a mean reversion of longer-run stock returns.16 The success of momentum investing cannot be explained within an efficient market framework. It appears that investors initially underreact to information, which causes the stock price to continue to respond to the news over time rather than adjusting instantaneously to the new information.


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

"Robert Solow", 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, business cycle, 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, Kickstarter, 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, Stanford marshmallow experiment, statistical model, Steve Jobs, Supply of New York City Cabdrivers, 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

Journal of Financial Economics 9, no. 1: 3–18. Barbaro, Michael. 2007. “Given Fewer Coupons, Shoppers Snub Macy’s.” New York Times, September 29. Available at: http://www.nytimes.com/2007/09/29/business/29coupons.html. Barber, Brad M., and Terrance Odean. 2002. “Online Investors: Do the Slow Die First?” Review of Financial Studies 15, no. 2: 455–88. Barberis, Nicholas C., and Richard H. Thaler. 2003. “A Survey of Behavioral Finance.” In Nicholas Barberis, Richard H. Thaler, George M. Constantinides, M. Harris, and René Stulz, eds., Handbook of the Economics of Finance, vol. 1B, 1053–128. Amsterdam: Elsevier. Barberis, Nicholas, Ming Huang, and Tano Santos. 2001. “Prospect Theory and Asset Prices.” Quarterly Journal of Economics 116, no. 1: 1–53. Barner, Martin, Francesco Feri, and Charles R. Plott. 2005. “On the Microstructure of Price Determination and Information Aggregation with Sequential and Asymmetric Information Arrival in an Experimental Asset Market.”

American Economic Review 101, no. 5: 1912–32. Cutler, David M., James M. Poterba, and Lawrence H. Summers. 1989. “What Moves Stock Prices?” Journal of Portfolio Management 15, no. 3: 4–12. Daly, Mary, Bart Hobijn, and Brian Lucking. 2012. “Why Has Wage Growth Stayed Strong?” Federal Reserve Board of San Francisco: Economic Letter 10: 1–5. Dawes, Robyn M., and Richard H. Thaler. 1988. “Anomalies: Cooperation.” Journal of Economic Perspectives 2, no. 3: 187–97. De Bondt, Werner F. M., and Richard H. Thaler. 1985. “Does the Stock Market Overreact?” Journal of Finance 40, no. 3: 793–805. De Long, J. Bradford, Andrei Shleifer, Lawrence H. Summers, and Robert J. Waldmann. 1990. “Noise Trader Risk in Financial Markets.” Journal of Political Economy 98, no. 4: 703–38. DellaVigna, Stefano. 2009. “Psychology and Economics: Evidence from the Field.”

“Golden Eggs and Hyperbolic Discounting.” Quarterly Journal of Economics 112, no. 2: 443–78. Lakonishok, Josef, Andrei Shleifer, and Robert W. Vishny. 1994. “Contrarian Investment, Extrapolation, and Risk.” Journal of Finance 49, no. 5: 1541–78. Lamont, Owen A., and Richard H. Thaler. 2003. “Can the Market Add and Subtract? Mispricing in Tech Stock Carve-Outs.” Journal of Political Economy 111, no. 2: 227–68. Landsberger, Michael. 1966. “Windfall Income and Consumption: Comment.” American Economic Review 56, no. 3: 534–40. Lee, Charles, Andrei Shleifer, and Richard H. Thaler. 1991. “Investor Sentiment and the Closed-End Fund Puzzle.” Journal of Finance 46, no. 1: 75–109. Lester, Richard A. 1946. “Shortcomings of Marginal Analysis for Wage-Employment Problems.” American Economic Review, 36, no. 1: 63–82. Levitt, Steven, and John List. 2007.


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Work Rules!: Insights From Inside Google That Will Transform How You Live and Lead by Laszlo Bock

Airbnb, Albert Einstein, AltaVista, Atul Gawande, Black Swan, book scanning, Burning Man, call centre, Cass Sunstein, Checklist Manifesto, choice architecture, citizen journalism, clean water, correlation coefficient, crowdsourcing, Daniel Kahneman / Amos Tversky, deliberate practice, en.wikipedia.org, experimental subject, Frederick Winslow Taylor, future of work, Google Earth, Google Glasses, Google Hangouts, Google X / Alphabet X, Googley, helicopter parent, immigration reform, Internet Archive, longitudinal study, Menlo Park, mental accounting, meta analysis, meta-analysis, Moneyball by Michael Lewis explains big data, nudge unit, PageRank, Paul Buchheit, Ralph Waldo Emerson, Rana Plaza, random walk, Richard Thaler, Rubik’s Cube, self-driving car, shareholder value, side project, Silicon Valley, six sigma, statistical model, Steve Ballmer, Steve Jobs, Steven Levy, Steven Pinker, survivorship bias, TaskRabbit, The Wisdom of Crowds, Tony Hsieh, Turing machine, winner-take-all economy, Y2K

American Economic Review 91, no. 4 (2001): 832–857, http://www.econ.wisc.edu/~scholz/Teaching_742/Bernheim_Skinner_Weinberg.pdf. 231. James J. Choi, Emily Haisley, Jennifer Kurkoski, and Cade Massey, “Small Cues Change Savings Choices,” National Bureau of Economic Research Working Paper 17843, revised June 29, 2012, http://www.nber.org/papers/w17843. 232. Richard H. Thaler and Shlomo Benartzi, “Save More Tomorrow: Using Behavioral Economics to Increase Employee Savings,” Journal of Political Economy 112, no. 1 (2004): S 164–S 187, http://faculty.chicagobooth.edu/Richard.Thaler/research/pdf/SMarTJPE.pdf. 233. Yes, it’s really trademarked. 234. Todd had no way of knowing that later that year we’d announce Calico, a Google business led by Art Levinson, the former CEO of Genentech, with a goal of addressing the debilitating and inevitable consequences of aging. 235.

Jeffrey, “The Benefits of Tangible Non-Monetary Incentives” (unpublished manuscript, University of Chicago Graduate School of Business, 2003), http://theirf.org/direct/user/site/0/files/the%20benefits%20of%20tangible%20non%20monetary%20incentives.pdf. Scott A. Jeffrey and Victoria Shaffer, “The Motivational Properties of Tangible Incentives,” Compensation & Benefits Review 39, no. 3 (2007): 44–50. Erica Mina Okada, “Justification Effects on Consumer Choice of Hedonic and Utilitarian Goods,” Journal of Marketing Research 42, no. 1 (2005): 43–53. Richard H. Thaler, “Mental Accounting Matters,” Journal of Behavioral Decision Making 12, no. 3 (1999): 183–206. 187. This finding is consistent with the academic work, which focuses on purchases rather than gifts. People are happier when they buy experiences (trips, dinners) than when they buy things (clothes, electronics). Travis J. Carter and Thomas Gilovich, “The Relative Relativity of Material and Experiential Purchases,” Journal of Personality and Social Psychology 98, no. 1 (2010): 146–159. 188.

Belcove, “Steamy Wait Before a Walk in a Museum’s Rain,” New York Times, July 17, 2013, http://www.nytimes.com/2013/07/18/arts/steamy-wait-before-a-walk-in-a-museums-rain.html. 207. Michael Barbaro, “The Bullpen Bloomberg Built: Candidates Debate Its Future,” New York Times, March 22, 2013, http://www.nytimes.com/2013/03/23/nyregion/bloombergs-bullpen-candidates-debate-its-future.html. 208. Chris Smith, “Open City,” New York, September 26, 2010, http://nymag.com/news/features/establishments/68511/. 209. Richard H. Thaler and Cass R. Sunstein, Nudge (New Haven, CT: Yale University Press, 2008), 15. 210. An obvious difference between a nudge and a bonus plan is that the former is often not disclosed, while a bonus plan is explicitly set up to drive certain behaviors. But once you concede that a company can legitimately shape its employees’ behaviors, then you’re left with a more difficult question of where exactly the company crosses the line from “good” shaping to “bad” shaping.


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Wait: The Art and Science of Delay by Frank Partnoy

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, MITM: man-in-the-middle, 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, Stanford marshmallow experiment, statistical model, Steve Jobs, The Market for Lemons, the scientific method, The Wealth of Nations by Adam Smith, upwardly mobile, Walter Mischel

More specifically, the assumption was that humans discount exponentially in a time-consistent manner, meaning that for a given discount rate (r) over a specified time period (T), the value in today’s terms of a future payment ($) equals $ divided by (1 + r)T. For example, the “present value,” or value in today’s terms, of $110 in one year at a rate of 10 percent is $110/(1 + 0.1)1 = $100. 30. Richard A. Thaler, “Some Empirical Evidence of Dynamic Inconsistency,” Economics Letters 8(3, 1981): 201–207. 31. George Loewenstein and Richard H. Thaler, “Anomalies: Intertemporal Choice,” Journal of Economic Perspectives 3(1989): 181–193. 32. George Ainslie, Picoeconomics (Cambridge University Press, 1992). 33. George A. Akerlof, “Behavioral Microeconomics and Macroeconomic Behavior,” Nobel Prize Lecture, December 8, 2001. 34. James E. Mazur, “Tests of an Equivalence Rule for Fixed and Variable Reinforcer Delays,” Journal of Experimental Psychology: Animal Behavior Process 10(1984): 426–436; James E.

For a comprehensive discussion of legal issues related to procrastination, see Manuel Utset, “Procrastination and the Law,” in Andreou and White, The Thief of Time, pt. III(15). 53. The psychologist Piers Steel says this kind of planning can be helpful: “Impulsive people find it difficult to plan work ahead of time and even after they start, they are easily distracted. Procrastination inevitably follows.” Steel, The Procrastination Equation, p. 14. 54. Bertrand and Morse, Information Disclosure, Cognitive Biases, and Payday Borrowing. 55. Richard H. Thaler and Cass R. Sunstein, Nudge: Improving Decisions About Health, Wealth, and Happiness (Yale University Press, 2008). 56. See Henri C. Schouwenburg, Clarry H. Lay, and Timothy A. Pychyl, Counseling the Procrastinator in Academic Settings (American Psychological Association, 2004); Henri C. Schouwenburg and JanTjeerd Groenewoud, “Study Motivation Under Social Temptation: Effects of Trait Procrastination,” Personality and Individual Differences 30(2, 2001): 299–340.

For example, Shafir was recently part of a group that analyzed a direct-mail field experiment in South Africa to understand how different advertising approaches (including a photo of an attractive woman or describing how the loan proceeds might be used) affected people’s demand for loans. Marianne Bertrand, Dean Karlan, Sendhil Mullainathan, Eldar Shafir, and Jonathan Zinman, “What’s Advertising Content Worth? Evidence from a Consumer Credit Marketing Experiment,” Quarterly Journal of Economics 125(1, 2010): 263–306. Shafir also has studied, with economist Richard Thaler, some of the puzzles of how and why we delay gratification. Eldar Shafir and Richard Thaler, “Invest Now, Drink Later, Spend Never: On the Mental Accounting of Delayed Consumption,” Journal of Economic Psychology 27(5, 2006): 694–712. 3. Nassim Taleb in particular has demonstrated that human beings make all sorts of cognitive mistakes in assessing risk. See Nassim Nicholas Taleb, Fooled by Randomness: The Hidden Role of Chance in Life and Markets (Random House, 2008), and Taleb, The Black Swan. 4.


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Think Twice: Harnessing the Power of Counterintuition by Michael J. Mauboussin

affirmative action, asset allocation, Atul Gawande, availability heuristic, Benoit Mandelbrot, Bernie Madoff, Black Swan, butter production in bangladesh, Cass Sunstein, choice architecture, Clayton Christensen, cognitive dissonance, collateralized debt obligation, Daniel Kahneman / Amos Tversky, deliberate practice, disruptive innovation, Edward Thorp, experimental economics, financial innovation, framing effect, fundamental attribution error, Geoffrey West, Santa Fe Institute, George Akerlof, hindsight bias, hiring and firing, information asymmetry, libertarian paternalism, Long Term Capital Management, loose coupling, loss aversion, mandelbrot fractal, Menlo Park, meta analysis, meta-analysis, money market fund, Murray Gell-Mann, Netflix Prize, pattern recognition, Philip Mirowski, placebo effect, Ponzi scheme, prediction markets, presumed consent, Richard Thaler, Robert Shiller, Robert Shiller, statistical model, Steven Pinker, The Wisdom of Crowds, ultimatum game

Camilla Anderson, “Iceland Gets Help to Recover from Historic Crisis,” IMF Survey Online, December 2, 2008; and Michael Lewis, “Wall Street on the Tundra,” Vanity Fair, April 2009, 140–147, 173–177. 5. Keith E. Stanovich, What Intelligence Tests Miss: The Psychology of Rational Thought (New Haven, CT: Yale University Press, 2009), 2–3. 6. Richard H. Thaler, “Anomalies: The Winner’s Curse,” The Journal of Economic Perspectives 2, no. 1 (1988): 191–202. 7. Max H. Bazerman, Judgment in Managerial Decision Making, 6th ed. (New York: John Wiley & Sons, 2006), 33–35. 8. Rosemarie Nagel, “Unraveling in Guessing Games: An Experimental Study,” American Economic Review 85, no. 5 (1995): 1313–1326. Also, Richard H. Thaler, “From Homo Economicus to Homo Sapiens,” The Journal of Economic Perspectives 14, no. 1 (2000): 133–141. I have run this experiment in my own class for years. In descending order, the most popular responses are 0, 22, 1, and 33.

Holland, Merel Hendriks, and Henk Aarts, “Smells Like Clean Spirit: Nonconscious Effects of Scent on Cognition and Behavior,” Psychological Science 16, no. 9 (2005): 689–693. 15. Naomi Mandel and Eric J. Johnson, “When Web Pages Influence Choice: Effects of Visual Primes on Experts and Novices,” Journal of Consumer Research 29, no. 2 (2002): 235–245. 16. Eric J. Johnson and Daniel Goldstein, “Do Defaults Save Lives?” Science 302 (November 21, 2003): 1338–1339. 17. Richard H. Thaler and Cass R. Sunstein, Nudge: Improving Decisions About Health, Wealth, and Happiness (New Haven, CT: Yale University Press, 2008); Daniel G. Goldstein, Eric J. Johnson, Andreas Herrmann, and Mark Heitmann, “Nudge Your Customers Toward Better Choices,” Harvard Business Review, December 2008, 99–105; and Dan Ariely, Predictably Irrational: The Hidden Forces That Shape Our Decisions (New York: Harper, 2008), 1–6. 18.

If my ability matches my confidence, then I would expect the correct answers to fall within that range nine times out of ten. But, in fact, most people are correct only 40 to 60 percent of the time, reflecting their overconfidence.7 Even though I didn’t know the answers to those ten questions, I had a sense of where I might go wrong, so I adjusted my initial estimates. I won that contest and got a book. The second experiment showed the failure of pure rationality. Here, Richard Thaler, one of the world’s foremost behavioral economists, asked us to write down a whole number from zero to one hundred, with the prize going to the person whose guess was closest to two-thirds of the group’s average guess. In a purely rational world, all participants would coolly carry out as many levels of deduction as necessary to get to the experiment’s logical solution—zero. But the game’s real challenge involves considering the behavior of the other participants.


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

addicted to oil, asset allocation, backtesting, Black-Scholes formula, Bretton Woods, business cycle, buy and hold, 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, dogs of the Dow, equity premium, Eugene Fama: efficient market hypothesis, Everybody Ought to Be Rich, 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, stocks for the long run, survivorship bias, technology bubble, The Great Moderation, The Wisdom of Crowds, transaction costs, tulip mania, Vanguard fund

I thought that buying more stock would increase my chances of recouping my losses. IC: You and millions of other investors. In 1982, Leroy Gross wrote a manual for stockbrokers in which he called this phenomenon the “geteven-itis disease.”21 He claimed get-even-itis has probably caused more destruction to portfolios than any other mistake. 18 Richard Thaler, “Mental Accounting and Consumer Choice,” Marketing Science, vol. 4, no. 3 (Summer 1985), pp. 199–214. 19 Richard H Thaler, “Mental Accounting Matters,” Journal of Behavioral Decision Making, vol. 12 (1999), pp. 183–206. 20 Hersh Shefrin and Meir Statman, “The Disposition to Sell Winners Too Early and Ride Losers Too Long: Theory and Evidence,” Journal of Finance, vol. 40, no. 3 (1985), pp. 777–792. 21 Leroy Gross, The Art of Selling Intangibles, New York: New York Institute of Finance, 1982. 330 PART 4 Stock Fluctuations in the Short Run It is hard for us to admit we’ve made a bad investment, and it is even harder for us to admit that mistake to others.

CHAPTER 19 Behavioral Finance and the Psychology of Investing TABLE 335 19–1 Investor Confidence and Subsequent Dow Price Returns: Sentiment = Bull/(Bull + Bear) Bull and Bear from Investors Intelligence, New Rochelle, New York 1970 - 2006 Sentiment 0.2 - 0.3 0.3 - 0.4 0.4 - 0.5 0.5 - 0.6 0.6 - 0.7 0.7 - 0.8 0.8 - 0.9 0.9 - 1.0 Overall Frequency 1.14% 8.34% 15.28% 27.29% 27.60% 15.95% 3.83% 0.57% 100.00% 1990 - 2006 Sentiment .30 - .35 .35 - .40 .40 - .45 .45 - .50 .50 - .55 .55 - .60 .60 - .65 .65 - .70 .70 - .75 .75 - .80 Overall Frequency 1.28% 3.27% 4.78% 7.12% 15.17% 17.97% 24.85% 14.35% 8.63% 2.57% 100.00% Annualized Returns Subsequent to Sentiment Readings (January 2, 1970 - June 2, 2006) Three Month 18.52% 12.24% 20.30% 15.98% 8.61% 10.45% -0.39% 0.35% 12.72% Six Month 15.40% 13.79% 15.02% 13.61% 6.75% 7.17% 0.23% -3.87% 10.35% Nine Month 22.79% 16.52% 13.06% 11.10% 6.66% 7.03% -3.32% -9.17% 9.45% Twelve Month 20.74% 15.82% 13.43% 10.21% 6.03% 6.74% -1.79% -10.18% 9.02% Annualized Returns Subsequent to Sentiment Readings Three Month 20.43% 16.69% 30.10% 33.39% 21.80% 12.92% 4.65% 5.37% 10.64% 3.03% 13.19% Six Month 15.83% 18.19% 22.52% 18.61% 17.98% 11.61% 5.67% 5.34% 7.04% 6.86% 11.04% Nine Month 15.51% 18.63% 20.99% 15.25% 15.74% 11.36% 6.91% 4.38% 6.63% 4.51% 10.38% Twelve Month 20.66% 20.85% 21.24% 15.24% 14.81% 11.05% 6.25% 5.35% 6.43% 5.02% 10.33% Out-of-Favor Stocks and the Dow 10 Strategy Dave: Can you use contrarian strategy to pick individual stocks? IC: Yes. Contrarians believe that the swings of optimism and pessimism infect individual stocks as well as the overall markets. Therefore, buying out-of-favor stocks can be a winning strategy. Werner De Bondt and Richard Thaler examined portfolios of both past stock winners and losers to see if investors became overly optimistic or pessimistic about future returns from studying the returns of the recent past.31 Portfolios of winning and losing stocks were analyzed 31 Werner F. M. De Bondt and Richard H. Thaler, “Does the Stock Market Overreact?” Journal of Finance, vol. 49, no. 3 (1985), pp. 793–805. 336 PART 4 Stock Fluctuations in the Short Run FIGURE 19–1 Investors Intelligence Sentiment Indicator, 1986 to 2007 0.90 0.80 0.70 0.60 0.50 October 0.40 Market Crash 0.30 0.20 0.10 Asian Crisis Iraqi Invasion of Bond Kuwait Market Crash LTCM/ Russia Terrorist Attacks Bear Market Bottom Fears of Crash Induced by Decline 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 over five-year intervals.

Since over longer periods, the probability of stocks showing a loss is much smaller, investors influenced by loss aversion would be more likely to hold stocks if they monitored their performance less frequently. Dave: That’s so true. When I look at stocks in the very short run, they seem so risky that I wonder why anyone holds them. But over the long run, the superior performance of equities is so overwhelming, I wonder why anyone doesn’t hold stocks! IC: Exactly. Shlomo Bernartzi and Richard Thaler claim that myopic loss aversion is the key to solving the equity premium puzzle.27 For years, econ26 Shlomo Bernartzi and Richard Thaler, “Myopic Loss Aversion and the Equity Premium Puzzle,” Quarterly Journal of Economics, 1995, pp. 73–91. 27 See Chapter 8 for a further description of the equity premium puzzle. CHAPTER 19 Behavioral Finance and the Psychology of Investing 333 omists have been trying to figure out why stocks have returned so much more than fixed-income investments.


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

"Robert Solow", Albert Einstein, Alvin Roth, Andrew Wiles, Antoine Gombaud: Chevalier de Méré, Bayesian statistics, Big bang: deregulation of the City of London, Bretton Woods, business cycle, buttonwood tree, buy and hold, 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, Norman Macrae, Paul Samuelson, Philip Mirowski, probability theory / Blaise Pascal / Pierre de Fermat, random walk, Richard Thaler, Robert Shiller, Robert Shiller, spectrum auction, statistical model, stocks for the long run, 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

David, Florence Nightingale, 1962. Games, Gods, and Gambling. New York: Hafner Publishing Company.* Davidson, Paul, 1991. "Is Probability Theory Relevant for Uncertainty? A Post Keynesian Perspective." Journal of Economic Perspectives, Vol. 5, No. 1 (Winter), pp. 129-143. Davidson, Paul, 1996. "Reality and Economic Theory." Journal of Post Keynesian Economics, Summer. Forthcoming. DeBondt, Werner, and Richard H. Thaler, 1986. "Does the Stock Market Overreact?" Journal of Finance, Vol. XL, No. 3, pp. 793-807. Dewey, Donald, 1987. "The Uncertain Place of Frank Knight in Chicago Economics." A paper prepared for the American Economic Association, Chicago, December 30, 1987. Dewey, Donald, 1990. "Frank Knight before Cornell: Some Light on the Dark Years." In Research in the History of Economic Thought and Methodology, Vol. 8, pp. 1-38.

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. The Money Managers. New York: Random House. Kelves, Daniel J., 1985. In the Name of Eugenics. New York: Knopf. Kemp, Martin, 1981. Leonardo da Vinci: The Marvellous Works of Nature and Man. Cambridge, Massachusetts: Harvard University Press.

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. Here they are: Theodore Aronson, Peter Brodsky, Jay Eliasberg, Robert Heilbroner, Peter Kinder, Charles Kindleberger, Mark Kritzman, and Stephen Stigler.


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

"Robert Solow", affirmative action, Affordable Care Act / Obamacare, airline deregulation, Andrei Shleifer, banking crisis, barriers to entry, Basel III, battle of ideas, Berlin Wall, business cycle, 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, 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

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.

The “Swift boat” attack on Senator Kerry is a legendary example of “marketing” with no basis in fact, which nonetheless was extraordinarily effective. For a discussion of this case and a list of resources from the New York Times, see the New York Times “Times Topic” on “Swift Veterans for Truth,” available at http://topics.nytimes.com/topics/reference/timestopics/organizations/s/swift_boat_veterans_for_truth/index.html (accessed March 4, 2012). 31. See Richard H. Thaler, “When Business Can’t Foresee Outrage,” New York Times, November 19, 2011, p. BU4. See Daniel Kahneman, Jack Knetsch, and Richard H. Thaler, “Fairness and the Assumptions of Economics,” Journal of Business 59, no 4 (1986): S285–300. Amelie Goosens and Pierre-Guillaume Meon, “The Impact of Studying Economics, and Other Disciplines, on the Belief That Voluntary Exchange Makes Everyone Better Off,” University of Brussels working paper, 2010, show that there are both selection and learning effects.

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. I have always benefited a great deal from discussing ideas as I formulate them with my students, and I want to single out Miguel Morin, a current student, and Anton Korinek, a recent one.


pages: 519 words: 104,396

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

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, social intelligence, starchitect, Steve Jobs, The Chicago School, The Wealth of Nations by Adam Smith, ultimatum game, working poor

“Representativeness Revisited: Attribute Substitution in Intuitive Judgment.” In T. Gilovich, D. Griffin, and D. Kahneman (eds.), Heuristics and Biases: The Psychology of Intuitive Judgment. New York: Cambridge University Press. ———, Jack L. Knetsch, and Richard Thaler. (1986a). “Fairness as a Constraint on Profit Seeking: Entitlements in the Market.” The American Economic Review 76, 728–41. ———, Jack L. Knetsch, and Richard Thaler. (1986b). “Fairness and the Assumptions of Economics.” The Journal of Business 59, S285–S300. ———, Jack L. Knetsch, and Richard Thaler (1991). “Anomalies: The Endowment Effect, Loss Aversion, and the Status Quo Bias.” The Journal of Economic Perspectives 5, 193–206. ———, Ilana Ritov, and David A. Schkade (1999). “Economic Preferences or Attitude Expressions? An Analysis of Dollar Responses to Public Issues.”

“Springsteen Ticketmaster Troubles.” WABC News. Available at abclocal.go.com/wabc/story?section–ews/7_on_your_side&id=6641540&rss=rss wabc-article-6641540. Plautus, trans. by E. F. Watling (1964). The Rope and Other Plays. London: Penguin. Plous, Scott (1993). The Psychology of Judgment and Decision Making. Philadelphia: Temple University Press. Post, Thierry, Martijn J. van den Assem, Guido Baltussen, and Richard H. Thaler (2008). “Deal or No Deal? Decision Making Under Risk in a Large-Payoff Game Show.” The American Economic Review 98, 38–71. Purcell, Frank (1969). “Roulette Bet May Decide Man’s Fate.” Las Vegas Review-Journal, March 2, 1969. Quattrone, G. A., C. P. Lawrence, S. E. Finkel, and D. C. Andrus (1984). “Explorations in Anchoring: The Effects of Prior Range, Anchor Extremity, and Suggestive Hints.”

Marketers and salespeople knew too well that what a customer was willing to pay was changeable and that there was money to be made from that fact. Economist Donald Cox has gone so far as to say that much of behavioral economics is “old hat to marketing experts, who have long since booted homo economicus out of their focus groups.” Today there is a symbiosis between psychologists studying prices and the marketing and price consultant communities. Many leading theorists, including Tversky, Kahneman, Richard Thaler, and Dan Ariely, have published important work in marketing journals. Price consultant Simon-Kucher & Partners has an academic advisory board with scholars from three continents. Today’s marketers talk up anchoring and coherent arbitrariness—and their somewhat unnerving power. “Many people like myself who teach marketing start the course by saying, ‘We’re not about manipulating consumers, we’re about discovering needs and meeting them,’ ” said Eric Johnson of Columbia University.


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

"Robert Solow", affirmative action, Andrei Shleifer, asset-backed security, bank run, banking crisis, business cycle, buy and hold, 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

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.” Journal of Business 59(4, part 2):S285–300. “Kaiser Argentine Car Plant Hit by Faulty Parts, Strikes, Delays.” 1958. New York Times, April 28, p. 33. Kashyap, Anil K., Raghuram G. Rajan, and Jeremy C. Stein. 2008.

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.” Journal of Money, Credit and Banking 27(3):798–805. Shefrin, Hersh, and Richard H. Thaler. 1988. “The Behavioral Life-Cycle Hypothesis.” Economic Inquiry 24:609–43. Shiller, Robert J. 1981. “Do Stock Prices Move Too Much to Be Justified by Subsequent Changes in Dividends?” American Economic Review 7(3):421–36. ———. 1982. “Consumption, Asset Markets and Macroeconomic Fluctuations.” Carnegie-Rochester Conference Series on Public Policy 17:203–38. ———. 1984. “Stock Prices and Social Dynamics.”

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. Is that acceptable or unfair?


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

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, price discrimination, 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

NUDGE NUDGE * * * Improving Decisions About Health, Wealth, and Happiness * * * Richard H. Thaler Cass R. Sunstein Yale University Press New Haven & London A Caravan book. For more information, visit www.caravanbooks.org. Copyright © 2008 by Richard H. Thaler and Cass R. Sunstein. All rights reserved. This book may not be reproduced, in whole or in part, including illustrations, in any form (beyond that copying permitted by Sections 107 and 108 of the U.S. Copyright Law and except by reviewers for the public press), without written permission from the publishers. Set in Galliard and Copperplate 33 types by The Composing Room of Michigan, Inc. Printed in the United States of America. Library of Congress Cataloging-in-Publication Data Thaler, Richard H., 1945– Nudge : improving decisions about health, wealth, and happiness / Richard H.

In Gilovich, Griffin, and Kahneman (2002), 49–81. Kahneman, Daniel, Barbara L. Fredrickson, Charles A. Schreiber, and Donald A. Redelmeier. “When More Pain Is Preferred to Less: Adding a Better End.” Psychological Science 4 (1993): 401–5. Kahneman, Daniel, Jack L. Knetsch, and Richard H. Thaler. “Experimental Tests of the Endowment Effect and the Coase Theorem.” Journal of Political Economy 98 (1990): 1325–48. ———. “Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias.” Journal of Economic Perspectives 5, no. 1 (1991): 193–206. Kahneman, Daniel, and Richard H. Thaler. “Anomalies: Utility Maximization and Experienced Utility.” Journal of Economic Perspectives 20, no. 1 (2006): 221–34. Kahneman, Daniel, and Amos Tversky, eds. Choices, Values, and Frames. Cambridge: Cambridge University Press, 2000. Kahneman, Daniel, Peter.

Library of Congress Cataloging-in-Publication Data Thaler, Richard H., 1945– Nudge : improving decisions about health, wealth, and happiness / Richard H. Thaler and Cass R. Sunstein. p. cm. Includes bibliographical references and index. ISBN 978-0-300-12223-7 (cloth : alk. paper) 1. Economics— Psychological aspects. 2. Choice (Psychology)—Economic aspects. 3. Decision making—Psychological aspects. 4. Consumer behavior. I. Sunstein, Cass R. II. Title. HB74.P8T53 2008 330.01’9—dc22 2007047528 A catalogue record for this book is available from the British Library. The paper in this book meets the guidelines for permanence and durability of the Committee on Production Guidelines for Book Longevity of the Council on Library Resources. 10 9 8 7 6 5 4 3 2 1 For France, who makes everything in life better, even this book —RHT For Ellyn, who knows when to nudge her father —CRS CONTENTS Acknowledgments Introduction PART I HUMANS AND ECONS 1 Biases and Blunders 2 Resisting Temptation 3 Following the Herd 4 When Do We Need a Nudge?


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Retirementology: Rethinking the American Dream in a New Economy by Gregory Brandon Salsbury

Albert Einstein, asset allocation, buy and hold, carried interest, Cass Sunstein, credit crunch, Daniel Kahneman / Amos Tversky, diversification, estate planning, financial independence, fixed income, full employment, hindsight bias, housing crisis, loss aversion, market bubble, market clearing, mass affluent, Maui Hawaii, mental accounting, mortgage debt, mortgage tax deduction, negative equity, new economy, RFID, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, side project, Silicon Valley, Steve Jobs, the rule of 72, Yogi Berra

Martin’s Press, 1991, p. 137. 8 Aging Well Magazine, “Boomerang Burdens: Back to the Nest,” Vol. 1 No. 3, Summer 2008. 9 Forbes, “The Biggest Market Losers: The Boomers,” May 14, 2009. 10 USA Today, “Becoming “parent of your parent’ an emotionally wrenching process,” June 24, 2007. 11 AARP, “Exclusive AARP Bulletin Poll Reveals New Trends in Multigenerational Housing,” March 3, 2009. 12 Heath, Chip, and Amos Tversky, “Preference and Belief: Ambiguity and Competence in Choice under Uncertainty,” Journal of Risk and Uncertainty, 1991. 13 Benartzi, Shlomo, and Richard H. Thaler, National Bureau of Economic Research, “Heuristics and Biases in Retirement Savings Behavior,” 2007. 14 Science Direct, “Information friction and investor home bias: A perspective on the effect of global IFRS adoption on the extent of equity home bias,” October 30, 2008. 15 Internal Revenue Service, Publication 950 – Introduction to Estate and Gift Taxes, December 2009. 16 National Opinion Research Center at the University of Chicago, “Social comparisons and health: can having richer friends and neighbors make you sick?”

The point is, it is important to distinguish between decisions that should be made by intuition and those that require careful thought and calculation. I highly recommend you explore this field in more detail, as the scholars of behavioral finance have put years of sweat equity into fascinating research and study. Notably, I recommend Choices, Values, and Frames by Kahneman and Tversky; Beyond Greed and Fear by Hersh Shefrin; Nudge, written by Richard Thaler and Cass Sunstein; the investor behavior studies on 401(k)s by Shlomo Benartzi; articles, books and research by Meir Statman; Against the Gods, The Remarkable Story of Risk by Peter Bernstein, as a keen understanding of risk is more relevant than ever given the current economy; and Investment Madness by John Nofsinger, which is a good introductory book on behavioral finance written for the “lay” reader.

However, by automating your contributions, you can better assess how much money you have to spend on day-to-day items. Remember, a retirement nest egg is like a bar of soap; the more you touch it, the smaller it gets. Don’t peek and keep it out of reach. Regularly Increase Your Contribution Rate The automatic payroll deduction structure of 401(k) accounts can help investors stick to a more disciplined retirement plan. Professor Richard Thaler of the University of Chicago, and Professor Shlomo Benartzi of UCLA, took this strategy one step further. They created a program called Save More Tomorrow (SMarT), which is currently being adopted by some 401(k) providers. Under this program, workers agree to boost their 401(k) contributions automatically by two to three percentage points with each annual raise. During a four-year test of the SMarT Plan at a mid-sized corporation, participants’ average contribution rates jumped from 3.5% of their pretax pay to 11.6%.38 With the passage of the Pension Protection Act (PPA) of 2006, companies began using automation to increase participation in their qualified plans.


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Mindware: Tools for Smart Thinking by Richard E. Nisbett

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, Kickstarter, lake wobegon effect, libertarian paternalism, longitudinal study, loss aversion, low skilled workers, Menlo Park, meta analysis, meta-analysis, quantitative easing, Richard Thaler, Ronald Reagan, selection bias, Shai Danziger, 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

Basseches, Michael. “Dialectical Schemata: A Framework for the Empirical Study of the Development of Dialectical Thinking.” Human Development 23 (1980): 400–21. ______. Dialectical Thinking and Adult Development. Norwood, NJ: Ablex, 1984. Beccuti, Guglielmo, and Silvana Pannain. “Sleep and Obesity.” Current Open Clinical Nutrition and Metabolic Care 14 (2011): 402–12. Benartzi, Shlomo, and Richard H. Thaler. “Heuristics and Biases in Retirement Savings Behavior.” Journal of Economic Perspectives 21 (2007): 81–104. Berger, Jonah, and Gráinne M. Fitzsimons. “Dogs on the Street, Pumas on Your Feet.” Journal of Marketing Research 45 (2008): 1–14. Berger, Jonah, M. Meredith, and S. C. Wheeler. “Contextual Priming: Where People Vote Affects How They Vote.” Proceedings of the National Academy of Science 105 (2008): 8846–49.

“Female Hurricanes Are Deadlier Than Male Hurricanes.” Proceedings of the National Academy of Science (2014). Published electronically June 2, 2014. Kahn, Robert. “Our Long-Term Unemployment Challenge (in Charts).” 2013. http://blogs.cfr.org/kahn/2013/04/17/our-long-term-unemployment-challenge-in-charts/. Kahneman, Daniel. Thinking, Fast and Slow. New York: Farrar, Straus and Giroux, 2011. Kahneman, Daniel, Jack L. Knetch, and Richard H. Thaler. “Experimental Tests of the Endowment Effect and the Coase Theorem.” In Tastes for Endowment, Identity, and the Emotions, vol. 3 of The New Behavioral Economics, edited by E. L. Khalil, 119–42. International Library of Critical Writings in Economics. Cheltenham, U.K.: Elgar, 2009. Kalev, Alexandra, Frank Dobbin, and Erin Kelley. “Best Practices or Best Guesses? Assessing the Efficacy of Corporate Affirmative Action and Diversity Policies.”

Giving teachers the same amount of money at the beginning of the term and telling them they would have to pay back that amount if their students failed to meet a specified target resulted in a significant positive effect on student performance.4 It’s not possible to justify the endowment effect in cost-benefit terms. I should be willing to sell a commodity at the same or slightly higher price than I paid for it. Even economists are susceptible to a range of biases, including the endowment effect bias, which prevent them from being fully rational in cost-benefit terms. The endowment effect concept, in fact, first occurred to the economist Richard Thaler when he thought about the behavior of an economist colleague who was a wine enthusiast. The man never paid more than thirty-five dollars for a bottle of wine but was sometimes unwilling to sell a bottle bought at that price even for amounts as large as one hundred dollars.5 Having such a large spread between buying price and selling price can’t be defended in terms of the normative rules of cost-benefit theory.


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Alchemy: The Dark Art and Curious Science of Creating Magic in Brands, Business, and Life by Rory Sutherland

3D printing, Alfred Russel Wallace, barriers to entry, basic income, Black Swan, butterfly effect, California gold rush, call centre, Captain Sullenberger Hudson, Cass Sunstein, cognitive dissonance, Daniel Kahneman / Amos Tversky, Dava Sobel, delayed gratification, Donald Trump, double helix, Downton Abbey, Elon Musk, Firefox, George Akerlof, gig economy, Google Chrome, Google X / Alphabet X, Grace Hopper, Hyperloop, Ignaz Semmelweis: hand washing, IKEA effect, information asymmetry, James Dyson, John Harrison: Longitude, loss aversion, low cost airline, Mason jar, Murray Gell-Mann, Peter Thiel, placebo effect, race to the bottom, Richard Feynman, Richard Thaler, Rory Sutherland, shareholder value, Silicon Valley, social intelligence, Steve Jobs, supply-chain management, the map is not the territory, The Market for Lemons, The Wealth of Nations by Adam Smith, ultimatum game, universal basic income, Upton Sinclair, US Airways Flight 1549, Veblen good

.”, Don Norman, The Design of Everyday Things (1988). ‘In the word of Jonathan Haidt . . .’ The Righteous Mind (2012). ‘. . . offered a possible evolutionary explanation.’, Colin Barras, ‘Evolution could explain the placebo effect’, New Scientist (6 September 2012). ‘. . . and more by our perception of it’, ‘The Vodka-Red-Bull Placebo Effect’, Atlantic (8 June 2017). ‘. . . the father of ‘Nudge Theory’, Richard ThalerRichard H. Thaler and Cass R. Sunstein, Nudge: Improving Decisions about Health, Wealth, and Happiness (2008). ‘. . . often outdone by the taste of the latter’.’, Lucas Derks and Jaap Hollander, Essenties van NLP (1996). ‘. . . for leather car seats than for books on tape.”, Daniel Kahneman, ‘Focusing Illusion’, Edge (2011). About the Author RORY SUTHERLAND is vice chairman of Ogilvy. A columnist for The Spectator, he is former president of the Institute of Practitioners in Advertising, the professional body for advertising, media, and marketing communications agencies in the United Kingdom.

When I told one economist that you can often increase the sales of a product by increasing its price, the reaction was one not of curiosity but of anger. It was as though I had insulted his dog or his favourite football team. Imagine if it were impossible to get a well-paid job, or to hold political office, unless you supported the New York Yankees or Chelsea Football Club. We would regard such partisanship as absurd, yet devoted fans of logic control the levers of power everywhere. The Nobel Prize-winning behavioural scientist Richard Thaler said, ‘As a general rule the US Government is run by lawyers who occasionally take advice from economists. Others interested in helping the lawyers out need not apply.’ Today it sometimes seems impossible to get a job without first demonstrating that you are in thrall to logic. We flatter such people through our education system, we promote them to positions of power and are subjected every day to their opinions in the newspapers.

.* Adam Smith was as much a behavioural economist as an economist – The Wealth of Nations (1776) doesn’t contain a single equation. But, strange though it may seem, the study of economics has long been detached from how people behave in the real world, preferring to concern itself with a parallel universe in which people behave as economists think they should. It is to correct this circular logic that behavioural economics – made famous by experts such as Daniel Kahneman, Amos Tversky, Dan Ariely and Richard Thaler – has come to prominence. In many areas of policy and business there is much more value to be found in understanding how people behave in reality than how they should behave in theory.* Behavioural economics might well be described as the study of the nonsensical and the non-sensical aspects of human behaviour. Sometimes our behaviour is nonsensical because we evolved for conditions different to those we now find ourselves in.* However, much ‘irrational’ human behaviour is not really nonsensical at all; it is non-sensical.


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Pound Foolish: Exposing the Dark Side of the Personal Finance Industry by Helaine Olen

American ideology, asset allocation, Bernie Madoff, buy and hold, Cass Sunstein, Credit Default Swap, David Brooks, delayed gratification, diversification, diversified portfolio, Donald Trump, Elliott wave, en.wikipedia.org, estate planning, financial innovation, Flash crash, game design, greed is good, high net worth, impulse control, income inequality, index fund, London Whale, longitudinal study, Mark Zuckerberg, money market fund, mortgage debt, oil shock, payday loans, pension reform, Ponzi scheme, post-work, quantitative easing, Ralph Nader, RAND corporation, random walk, Richard Thaler, Ronald Reagan, Saturday Night Live, Stanford marshmallow experiment, stocks for the long run, too big to fail, transaction costs, Unsafe at Any Speed, upwardly mobile, Vanguard fund, wage slave, women in the workforce, working poor, éminence grise

David Saylor: author interview. the largest seller of indexed annuities in the United States: Zeke Faux and Margaret Collins, “Indexed Annuities Can Yield Surprises,” Business Week, February 24, 2011, http://www.businessweek.com/magazine/content/11_10/b4218045699286.htm. Shlomo Benartzi: Anderson Graduate School of Management at UCLA: http://www.anderson.ucla.edu/x5515.xml. But Allianz scored a public relations coup: Richard H. Thaler, “The Annuity Puzzle,” New York Times, June 4, 2011, http://www.nytimes.com/2011/06/05/business/economy/05view.html; Paul J. Isaac, letter to the New York Times, June 11, 2011, http://www.nytimes.com/2011/06/12/business/12backpage-THEANNUITYQU_LETTERS.html. Cathy Smith: author interview. There are, according to Money magazine: Lisa Gibbs, “Index Annuities Are a Safety Trap,” Money, January 7, 2011, http://money.cnn.com/2011/01/17/pf/index_annuities_safety_trap.moneymag/index.htm.

id=D000022305&year=2012; Fidelity PAC, OpenSecrets.org, 2012 PAC Summary, http://www.opensecrets.org/pacs/lookup2.php?strID=C00215046. “Fee transparency could create”: Robert Powell, “401(k) Changes Give Savers a Brighter Future,” MarketWatch, December 16, 2010, http://articles.marketwatch.com/2010-12-16/finance/30737091_1_fee-disclosure-plan-sponsors-fees-and-expenses. As a remedy: “Should Policies Nudge People to Save?” Wall Street Journal Econblog (Richard Thaler comments), May 25, 2007, http://online.wsj.com/article/SB117977357721809835.html; Richard Thaler and Cass Sunstein, Nudge: Improving Decisions about Health, Wealth and Happiness (New Haven: Yale University Press, 2008); African Americans: Diversity and Defined Contribution Plans, The Role of Automatic Plan Features, Vanguard study, September 12, 2011, https://institutional.vanguard.com/VGApp/iip/site/institutional/researchcommentary/article/RetResDiversity; take-up increased: Regina Lewis, “The Pros and Cons of Automatic 401(k) Enrollment,” DailyFinance, July 11, 2011, http://www.dailyfinance.com/2011/07/11/401k-automatic-enrollment-pros-cons/.

Many of those offering testimony tried to remain optimistic. Secretary of Labor Robert Reich suggested Americans could be coached to manage their professional lives in order to “make their own way in the economy, learn new skills throughout your career, be ready to apply them in new ways and in new settings,” and thus raise their salaries, beat income inequality, and avoid both unplanned retirement and inadequate savings. Behavioral economics star Richard Thaler, then a professor at Cornell University’s business school, testified that he believed, over time, both 401(k) and individual retirement accounts would push up the nation’s savings rate, since they penalized people who took the money out early, though he did not address how this would happen given that both plans had existed for more than a decade during which savings rates had fallen, not risen.


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To Save Everything, Click Here: The Folly of Technological Solutionism by Evgeny Morozov

3D printing, algorithmic trading, Amazon Mechanical Turk, Andrew Keen, augmented reality, Automated Insights, Berlin Wall, big data - Walmart - Pop Tarts, Buckminster Fuller, call centre, carbon footprint, Cass Sunstein, choice architecture, citizen journalism, cloud computing, cognitive bias, creative destruction, crowdsourcing, data acquisition, Dava Sobel, disintermediation, East Village, en.wikipedia.org, Fall of the Berlin Wall, Filter Bubble, Firefox, Francis Fukuyama: the end of history, frictionless, future of journalism, game design, Gary Taubes, Google Glasses, illegal immigration, income inequality, invention of the printing press, Jane Jacobs, Jean Tirole, Jeff Bezos, jimmy wales, Julian Assange, Kevin Kelly, Kickstarter, license plate recognition, lifelogging, lone genius, Louis Pasteur, Mark Zuckerberg, market fundamentalism, Marshall McLuhan, moral panic, Narrative Science, Nelson Mandela, Nicholas Carr, packet switching, PageRank, Parag Khanna, Paul Graham, peer-to-peer, Peter Singer: altruism, Peter Thiel, pets.com, placebo effect, pre–internet, Ray Kurzweil, recommendation engine, Richard Thaler, Ronald Coase, Rosa Parks, self-driving car, Silicon Valley, Silicon Valley ideology, Silicon Valley startup, Skype, Slavoj Žižek, smart meter, social graph, social web, stakhanovite, Steve Jobs, Steven Levy, Stuxnet, technoutopianism, the built environment, The Chicago School, The Death and Life of Great American Cities, the medium is the message, The Nature of the Firm, the scientific method, The Wisdom of Crowds, Thomas Kuhn: the structure of scientific revolutions, Thomas L Friedman, transaction costs, urban decay, urban planning, urban sprawl, Vannevar Bush, WikiLeaks

You’re on Casino Camera,” Associated Press, February 11, 2009, http://www.cbsnews.com/2100–205_162–274604.html. 198 Canadian casinos have recently solved: Ashlee Vance, “A Privacy-Friendly Way to Ban Gambling Addicts from Casinos,” Bloomberg Businessweek, August 29, 2012, http://www.businessweek.com/articles/2012–08–29/a-privacy-friendly-way-to-ban-gambling-addicts-from-casinos. 198 what Cass Sunstein and Richard Thaler call “nudges”: Richard H. Thaler and Cass R. Sunstein, Nudge: Improving Decisions about Health, Wealth, and Happiness, updated ed. (New York: Penguin Books, 2009). 199 as some recent studies speculate: F. Godlee, “Obesity and Climate Change,” British Medical Journal 345 (2012), http://www.bmj.com/content/345/bmj.e6516. 200 “Moral communities need to keep debating”: Brownsword, “Lost in Translation,” 1356. 200 John Dewey expressed almost a century earlier: the best short introduction to Dewey’s thought on technology and paternalism (from which most of the Dewey quotes in the book are taken) is Tan Sor Hoon, “Paternalism—a Deweyan Perspective,” Journal of Speculative Philosophy 13, no. 1 (January 1, 1999): 56–70.

., “Understanding the Participatory News Consumer,” Pew Internet, March 1, 2010, http://www.pewinternet.org/Reports/2010/Online-News.aspx. 301 “The route to enhancing meaningful civic life”: Elizabeth Theiss-Morse and John R. Hibbing, “Citizenship and Civic Engagement,” Annual Review of Political Science 8, no. 1 (2005): 227–249. 301 “if governments want to encourage good citizenship”: Richard H. Thaler, “Making Good Citizenship Fun,” New York Times, February 13, 2012, http://www.nytimes.com/2012/02/14/opinion/making-good-citizenship-fun.html?_r=0. 302 “anything can be fun”: quoted in Chorney, “Taking the Game out of Gamification,” 8. 302 “governments typically use two tools”: Thaler, “Making Good Citizenship Fun.” 302 “relating to the duties or activities”: “Civic,” Oxford Dictionaries, http://oxforddictionaries.com/definition/english/civic. 302 into two categories: for some reviews of the motivation literature in psychology and economics, see Roland Bénabou and Jean Tirole, “Intrinsic and Extrinsic Motivation,” Review of Economic Studies 70, no. 3 (July 1, 2003): 489–520, and Richard M.

Perhaps shifting the registers will result in greater efficiency or utility or less crime—in which case we are back to SCP and Kerr’s digital locks. Or perhaps the regulators believe that you are subject to the same cognitive biases and limitations as the rest of us humans; as such, you might be tempted to do the wrong thing even if you really don’t want to. This last set of assumptions accounts for the proliferation of what Cass Sunstein and Richard Thaler call “nudges”: clever manipulations of default settings—what the authors call “choice architecture”—to get you to eat healthy foods or save money for retirement. Nudging is to manipulation what public relations is to advertising: it gets things done while making all the background tinkering implicit and invisible. The most effective nudges give agents a semblance of agency without giving them much choice.


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

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

Hovland, Social Judgment: Assimilation and Contrast Effects in Communication and Attitude Change (New Haven: Yale University Press, 1961), 188 (discussing manner in which individuals filter information to conform to their preexisting positions). 69. Forsythe et al., Wishes, 94. 70. Berg et al., “Accuracy and Forecast Standard Error of Prediction Markets,” 42. 71. Forsythe et al., Wishes, 99–100. The term “quasi-rational” comes from Richard H. Thaler, Quasi-Rational Economics (New York: Russell Sage Foundation, 1991), xxi. 72. See Richard H. Thaler and William T. Ziemba, “Anomalies: Parimutuel Betting Markets: Racetracks and Lotteries,” Journal of Economic Perspectives 2 (1988): 163 (exploring favorite–long shot bias); see also Charles F. Manski, “Interpreting the Predictions of Prediction Markets” (unpublished manuscript, Feb. 2004) (summarizing horse race data findings), available at http://faculty.econ.nwu.edu/faculty/manski/ prediction_markets.pdf. 73.

Leighton Vaughan Williams (Cambridge, UK: Cambridge University Press, 2005), 374. 60. See, e.g., ibid.; Hersh Shefrin, Beyond Greed and Fear: Understanding Behavioral Finance and the Psychology of Investing (Oxford: Oxford University Press, 1999) (exploring markets’ susceptibility to cognitive errors); Shiller, Irrational Exuberance, 245 (discussing cognitive errors and their effects on market prices); Richard H. Thaler, ed., Advances in Behavioral Finance (New York: Russell Sage Foundation, 1993) (investigating effects of how investors actually behave). 61. For good discussions, see Hanson, “Designing Real Terrorism Futures,” 11–14; Abramowicz, “Prediction Markets, Administrative Decisionmaking, and Predictive Cost-Benefit Analysis,” 972–76. 62. Klarreich, “Best Guess,” 251, 253. 63. For an overview of optimistic bias, see Christine Jolls, “Behavioral Economics Analysis of Redistributive Legal Rules,” Vanderbilt Law Review 51 (1998): 1658–63. 64.

Friedrich Hayek, “The Origins and Effects of Our Morals: A Problem for Science,” in The Essence of Hayek, 318, 330. 45. See Robert MacCoun et al., Drug War Heresies: Learning from Other Vices, Times, and Places (New York: Cambridge University Press, 2001). 46. The Federalist No. 14 (James Madison). 47. For a good overview, see Andrei Shleifer, Inefficient Markets: An Introduction to Behavioral Finance (Oxford: Oxford University Press, 2000). 48. See Richard Thaler, ed., Advances in Behavioral Finance, vol. 2 (Princeton, NJ: Princeton University Press, 2005). 49. In fact, some rigorous tests have raised doubts about it. See ibid. 50. Robert Shiller, Irrational Exuberance, 2d ed. (Princeton, NJ: Princeton University Press, 2005), 2, 5. 51. Ibid., 11. 52. See Erica Klarreich, “Best Guess,” Science News, Oct. 18, 2003, 252, available at http://www.sciencenews.org/articles/20031018/ bob9.asp.


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Dollars and Sense: How We Misthink Money and How to Spend Smarter by Dr. Dan Ariely, Jeff Kreisler

accounting loophole / creative accounting, Airbnb, Albert Einstein, bitcoin, Burning Man, collateralized debt obligation, Daniel Kahneman / Amos Tversky, delayed gratification, endowment effect, experimental economics, hedonic treadmill, IKEA effect, invisible hand, loss aversion, mental accounting, mobile money, placebo effect, price anchoring, Richard Thaler, sharing economy, Silicon Valley, Snapchat, Stanford marshmallow experiment, Steve Jobs, TaskRabbit, the payments system, Uber for X, ultimatum game, Walter Mischel, winner-take-all economy

Daniel Kahneman (Princeton), Jack L. Knetsch (Simon Fraser University), and Richard H. Thaler (University of Chicago), “The Endowment Effect: Evidence of Losses Valued More than Gains,” Handbook of Experimental Economics Results (2008). 2. Michael I. Norton (Harvard Business School), Daniel Mochon (University of California, San Diego), and Dan Ariely (Duke University), “The IKEA Effect: When Labor Leads to Love,” Journal of Consumer Psychology 22, no. 3 (2012): 453-460. 3. Ziv Carmon (INSEAD) and Dan Ariely (MIT), “Focusing on the Forgone: How Value Can Appear So Different to Buyers and Sellers,” Journal of Consumer Research 27, no. 3 (2000): 360–370. 4. Daniel Kahneman (UC Berkeley), Jack L. Knetsch (Simon Fraser University), and Richard Thaler (Cornell), “Experimental Tests of the Endowment Effect and the Coarse Theorem,” Journal of Political Economy 98 (1990): 1325–1348. 5.

Peter McGraw (University of Colorado), “Emotional Accounting: How Feelings About Money Influence Consumer Choice,” Journal of Marketing Research 46, no. 1 (2009): 66–80. 3. Ibid. 4. Amar Cheema (Washington University, St. Louis) and Dilip Soman (University of Toronto), “Malleable Mental Accounting: The Effect of Flexibility on the Justification of Attractive Spending and Consumption Decisions,” Journal of Consumer Psychology 16, no. 1 (2006): 33–44. 5. Ibid. 6. Eldar Shafir (Princeton) and Richard H. Thaler (University of Chicago), “Invest Now, Drink Later, Spend Never: On the Mental Accounting of Delayed Consumption,” Journal of Economic Psychology 27, no. 5 (2006): 694–712. CHAPTER 6: WE AVOID PAIN 1. Donald A. Redelmeier (University of Toronto), Joel Katz (University of Toronto), and Daniel Kahneman (Princeton), “Memories of Colonoscopy: A Randomized Trial,” Pain 104, nos. 1–2 (2003): 187–194. 2.

Daniel Kahneman (University of British Columbia) and Amos Tversky (Stanford), “Prospect Theory: An Analysis of Decision under Risk,” Econometrica: Journal of Econometric Society 47, no. 2 (1979): 263–291. 7. Belsky and Gilovich, Why Smart People Make Big Money Mistakes. 8. Dawn K. Wilson (Vanderbilt), Robert M. Kaplan (UC San Diego), and Lawrence J. Schneiderman (UC San Diego), “Framing of Decisions and Selection of Alternatives in Health Care,” Social Behaviour 2 (1987): 51–59. 9. Shlomo Benartzi (UCLA) and Richard H. Thaler (University of Chicago), “Risk Aversion or Myopia? Choices in Repeated Gambles and Retirement Investments,” Management Science 45, no. 3 (1999): 364–381. 10. Belsky and Gilovich, Why Smart People Make Big Money Mistakes. 11. Hal R. Arkes (Ohio University) and Catherine Blumer (Ohio University), “The Psychology of Sunk Cost,” Organizational Behavior and Human Decision Processes 35, no. 1 (1985): 124–140.


Deep Value by Tobias E. Carlisle

activist fund / activist shareholder / activist investor, Andrei Shleifer, availability heuristic, backtesting, business cycle, buy and hold, corporate governance, corporate raider, creative destruction, Daniel Kahneman / Amos Tversky, discounted cash flows, fixed income, intangible asset, joint-stock company, margin call, passive investing, principal–agent problem, Richard Thaler, riskless arbitrage, Robert Shiller, Robert Shiller, Rory Sutherland, shareholder value, Sharpe ratio, South Sea Bubble, statistical model, The Myth of the Rational Market, The Wealth of Nations by Adam Smith, Tim Cook: Apple

If earnings were also mean reverting, then extreme stock price increases and decreases might, paradoxically, be predictive of mean reversion not just in stock prices, but in earnings too (paradoxically because we would ordinarily expect earnings to lead prices, and not the other way around). In other 82 DEEP VALUE 0.20 0.15 Loser Portfolio 0.10 C A 0.05 R 0.00 –0.05 Winner Porfolio –0.10 0 5 10 15 20 25 30 MONTHS AFTER PORTFOLIO FORMATION 35 FIGURE 5.1â•… Cumulative Average Returns for Winner and Loser Portfolios of 35 Stocks over 36 months (1933 to 1982) Source: Werner F.M. De Bondt and Richard H. Thaler. “Does the Stock Market Overreact?” Journal of Finance 40 (3) (1985): 793–805. words, a stock price that has fallen a great deal becomes a good candidate for subsequent earnings growth, and a stock that has gone up a lot is likely to see earnings contract. Using data for the period 1966 to 1983, De Bondt and Thaler replicated the original experiment, forming portfolios of extreme winners and losers measured by the increase or decrease in stock prices over the three-year period prior to the selection date.

As they had theorized, the Loser 83 A Clockwork Market 400 Earnings Per Share Index 350 300 250 200 Loser Portfolio Winner Portfolio 150 100 50 0 t-3 t-2 t-1 Selection Date t+1 t+2 t+3 t+4 FIGURE 5.2â•… Change in Average Earnings Per Share for Stocks in Winner and Loser Portfolios (1966 to 1983) Source: Eyquem Investment Management LLC using data from Werner F.M. De Bondt and Richard H. Thaler. “Further Evidence on Investor Overreaction and Stock Market Seasonality?” Journal of Finance 42 (3) (1987): 557–581. portfolio—the stocks with the largest market price declines—saw far superior earnings performance in comparison to the Winner portfolio—the stocks with the largest increases in market price. The Loser portfolio also delivered superior stock price performance in the four years after the selection date, gaining a cumulative 24.6 percent over the market.

Figure 5.3 shows the change in average earnings per share for the Undervalued and Overvalued 84 DEEP VALUE 150 Earnings Per Share Index 140 130 120 110 100 90 80 Undervalued Portfolio Overvalued Portfolio 70 60 t-3 t-2 t-1 Portfolio Selection Date t+1 t+2 t+3 t+4 FIGURE 5.3â•… Change in Average Earnings Per Share for Undervalued and Overvalued Portfolios (1926 to 1983) Source: Eyquem Investment Management LLC using data from Werner F.M. DeBondt and Richard H. Thaler. “Further Evidence on Investor Overreaction and Stock Market Seasonality?” Journal of Finance 42 (3) (1987): 557–581. portfolios in the three years leading up to the selection date and in the four years following the selection date. Figure 5.3 demonstrates that earnings grew faster for the Undervalued portfolio after the selection date than they did for the Overvalued portfolio. The stocks in the Undervalued portfolio, which had seen earnings fall 30 percent in the preceding three years, saw earnings increase 24.4 percent in the following four years.


pages: 339 words: 95,988

Freakonomics: A Rogue Economist Explores the Hidden Side of Everything by Steven D. Levitt, Stephen J. Dubner

airport security, Broken windows theory, crack epidemic, desegregation, Exxon Valdez, feminist movement, George Akerlof, information asymmetry, Joseph Schumpeter, Kenneth Arrow, longitudinal study, mental accounting, moral hazard, More Guns, Less Crime, oil shale / tar sands, Paul Samuelson, peak oil, pets.com, profit maximization, Richard Thaler, school choice, sensible shoes, Steven Pinker, Ted Kaczynski, The Chicago School, The Market for Lemons, Thorstein Veblen, twin studies, War on Poverty

Levitt, “What the Bagel Man Saw,” The New York Times Magazine, June 6, 2004. Levitt has also written an academic paper about Feldman’s bagel operation: “An Economist Sells Bagels: A Case Study in Profit Maximization,” National Bureau of Economic Research working paper, 2006. / 43 The “Beer on the Beach” study is discussed in Richard H. Thaler, “Mental Accounting and Consumer Choice,” Marketing Science 4 (Summer 1985), pp. 119–214; also worth reading is Richard H. Thaler, The Winner’s Curse: Paradoxes and Anomalies of Economic Life (New York: Free Press, 1992). 2. HOW IS THE KU KLUX KLAN LIKE A GROUP OF REAL-ESTATE AGENTS? SPILLING THE KLAN’S SECRETS: This section has been substantially revised since the original version of Freakonomics was published, owing to the authors’ discovery that Stetson Kennedy—in both his memoir, The Klan Unmasked, and in interviews with the authors—had misrepresented his role in personally infiltrating and attacking the Klan.

But just as crime tends to be low on a street where a police car is parked, the 95 percent rate was artificially high: Feldman’s presence had deterred theft. Not only that, but those bagel eaters knew the provider and had feelings (presumably good ones) about him. A broad swath of psychological and economic research has shown that people will pay different amounts for the same item depending on who is providing it. The economist Richard Thaler, in his 1985 “Beer on the Beach” study, showed that a thirsty sunbather would pay $2.65 for a beer delivered from a resort hotel but only $1.50 for the same beer if it came from a shabby grocery store. In the real world, Feldman learned to settle for less than 95 percent. He came to consider a company “honest” if its payment rate was above 90 percent. He considered a rate between 80 and 90 percent “annoying but tolerable.”

Trilby and I then ate, fairly happily, though the taste of the rancid chicken remained with me; in fact, it remains with me still. Trilby had had a glass of wine before we ordered, and took another glass with her meal, sauvignon blanc. I drank water. When the waitress cleared our plates, she asked again if we wanted free dessert. Just coffee, we said. As Trilby and I talked, I mentioned that not long ago I had interviewed Richard Thaler, the godfather of behavioral economics, a fairly new field of study that tries to explain why the psychology of money is so complicated. I mentioned the behavioralists’ concept of “anchoring”—a concept that used-car salesmen in particular know so well: establish a price that may be 100 percent more than what you need in order to ensure that you’ll still walk away with, say, a 50 percent profit.


pages: 459 words: 103,153

Adapt: Why Success Always Starts With Failure by Tim Harford

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, disruptive innovation, 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). Available at: http://ssrn.com/abstract=636508. Having written about Thaler’s research before, and even presented a radio documentary on the show, I am indebted to Jonah Lehrer and his book How We Decide (Boston, MA: Houghton Mifflin Harcourt, 2009) for emphasising how striking this result really is. 35 Unfortunately, selling winners and holding on to losers: Terrance Odean, ‘Are Investors Reluctant to Realize Their Losses?’

I asked my wife whether she would accept such an offer. Of course not. She was feeling far too sick to go to Paris. She forced a faint smile as she realised what I was telling her, and we went home. (As if to confirm that we had made the right decision, the nice people at Eurostar refunded our tickets anyway. And a few months later, my wife somewhat more pregnant, we got to Paris in the end.) The behavioural economist Richard Thaler, with a team of co-authors, has found the perfect setting to analyse the way we respond to losses. He studied the TV game show Deal or No Deal, which is a great source of data because the basic game is repeated incessantly, with similar rules, for high stakes, in over fifty countries. Deal or No Deal offers contestants a choice of between twenty and twenty-six numbered boxes, each containing some prize money, ranging from pennies to hundreds of thousands of dollars, pounds or euros.

The root cause of the loophole problem is something we also met with the Merton Rule: the crucial difference between the letter and the spirit of the law. This point was hammered home to me over a world-saving coffee (I had an espresso; he had a soya cappuccino) with the environmental economist Prashant Vaze, author of The Economic Environmentalist. Vaze was waxing lyrical about the concept of the ‘nudge’, proposed by the behavioural economist Richard Thaler and polymath legal scholar Cass Sunstein. The idea is that subtle influences could be used to direct thoughtless behaviour, while preserving individual rights consciously to choose. For example, incandescent light bulbs – which are a very wasteful way to produce light, but preferred by people with partial sight and certain light-sensitive skin conditions – could be removed from open shelves, but available from storage on request.


pages: 487 words: 151,810

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

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, longitudinal study, loss aversion, medical residency, meta analysis, meta-analysis, Monroe Doctrine, Paul Samuelson, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, school vouchers, six sigma, social intelligence, Stanford marshmallow experiment, 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

Hallinan, Why We Make Mistakes: How We Look Without Seeing, Forget Things in Seconds, and Are All Pretty Sure We Are Way Above Average (New York: Broadway Books, 2009), 92–93. 4 In department stores Paco Underhill, Call of the Mall: The Geography of Shopping by the Author of Why We Buy (New York: Simon & Schuster, 2004), 49–50. 5 pairs of panty hose Timothy D. Wilson, Strangers to Ourselves (Cambridge, MA: Belknap Press, 2002), 103. 6 At restaurants, people eat more Richard H. Thaler and Cass R. Sunstein, Nudge: Improving Decisions About Health, Wealth, and Happiness (Ann Arbor, MI: Caravan Books, 2008), 64. 7 Marketing people also realize Hallinan, 99. 8 Capital Pacific Homes David Brooks, “Castle in a Box,” The New Yorker, March 26, 2001, http://www.newyorker.com/archive/2001/03/26/010326fa_fact_brooks. 9 For all of human history Steven E. Landsburg, “The Theory of the Leisure Class,” Slate, March 9, 2007, http://www.slate.com/id/2161309. 10 the owls John Medina, Brain Rules: 12 Principles for Surviving and Thriving at Work, Home, and School (Seattle, WA: Pear Press, 2008), 163. 11 As Angela Duckworth Jonah Lehrer, “The Truth about Grit,” Boston Globe, August 2, 2009, http://www.boston.com/bostonglobe/ideas/articles/2009/08/02/the_truth_about_grit/. 12 M.

Stephen Copley and Andrew Edgar (Oxford: Oxford University Press, 2008), 182. 2 Long-term unemployment Don Peck, “How a New Jobless Era Will Transform America,” The Atlantic, March 2010, http://www.theatlantic.com/magazine/archive/2010/03/how-a-new-jobless-era-will-transform-america/7919/. 3 Ninety percent of drivers Robert H. Frank, The Economic Naturalist: In Search of Explanations for Everyday Enigmas (New York: Basic Books, 2007), 129. 4 Ninety-four percent of college professors Andrew Newburg and Mark Robert Waldman, Why We Believe What We Believe: Uncovering Our Biological Need for Meaning, Spirituality, and Truth (New York: Free Press, 2006), 73. 5 Ninety percent of entrepreneurs Richard H. Thaler and Cass R. Sunstein, Nudge: Improving Decisions About Health, Wealth, and Happiness (Ann Arbor, MI: Caravan Books, 2008), 32. 6 Ninety-eight percent of students Keith E. Stanovich, What Intelligence Tests Miss: The Psychology of Rational Thought (New Haven, CT: Yale University Press, 2009), 109. 7 College students vastly overestimate Daniel Gilbert, Stumbling on Happiness (New York: Vintage, 2007), 18. 8 Golfers on the PGA tour Joseph T.

Augustine’s Press, 2000), 39. 2 “Reason is and ought only” David Hume, A Treatise of Human Nature, bk. 2, sect. 3 (Ithaca, NY: Cornell University Press, 2009), 286. 3 “We are generally” Edmund Burke, Reflections on the Revolution in France (Oxford: Oxford University Press, 1999), 87. 4 “senses and imagination captivate” Gertrude Himmelfarb, The Roads to Modernity: The British, French, and American Enlightenments (New York: Vintage, 2005), 76. 5 Level 2 is like Mr. Spock Richard H. Thaler and Cass R. Sunstein, Nudge: Improving Decisions About Health, Wealth, and Happiness (Ann Arbor, MI: Caravan Books, 2008), 22. 6 The recall process James Le Fanu, Why Us?: How Science Rediscovered the Mystery of Ourselves (New York: Vintage, 2010), 213. 7 Half had significant errors Robert A. Burton, On Being Certain: Believing You Are Right Even When You’re Not (New York: St. Martin’s Press, 2008), 10. 8 201 prisoners in the United States Joseph T.


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Scarcity: The True Cost of Not Having Enough by Sendhil Mullainathan

American Society of Civil Engineers: Report Card, Andrei Shleifer, Cass Sunstein, clean water, computer vision, delayed gratification, double entry bookkeeping, Exxon Valdez, fault tolerance, happiness index / gross national happiness, impulse control, indoor plumbing, inventory management, knowledge worker, late fees, linear programming, mental accounting, microcredit, p-value, payday loans, purchasing power parity, randomized controlled trial, Report Card for America’s Infrastructure, Richard Thaler, Saturday Night Live, Walter Mischel, Yogi Berra

., “The Miracle of Microfinance? Evidence from a Randomized Evaluation” (MIT working paper, 2010). do not undo hard work: Some of this argument can be made without resort to the psychology of scarcity. Much of policy design makes the presumption of rationality. Simply allowing for people to have natural psychological limitations already can improve policy making. This view has recently been wonderfully articulated by Richard H. Thaler and Cass R. Sunstein, Nudge: Improving Decisions about Health, Wealth, and Happiness (New Haven, Conn.: Yale University Press, 2008). See also Eldar Shafir, ed., The Behavioral Foundations of Public Policy (Princeton, N.J.: Princeton University Press, 2012). We have previously used this logic to argue that we can better understand poverty just by understanding that the poor can have the same psychological quirks that affect everyone else: Marianne Bertrand, Sendhil Mullainathan, and Eldar Shafir, “A Behavioral-Economics View of Poverty,” American Economic Review (2004): 419–23.

Square B has a different background from square A. Not only is it surrounded by darker squares; it also sits in the cylinder’s apparent shadow. Because things in shadows look darker, the eye will correct for the shadow, making the item appear lighter. Perceived color, much like perceived distance, depends on surrounding cues. And as it turns out, so does perceived value. A classic experiment once reported by the economist Richard Thaler does the equivalent of this optical illusion for money. We re-created this experiment along with Anuj Shah. We had subjects consider two scenarios that differ only in the bracketed words—a grocery store in one case, a fancy resort in the other: Imagine you are lying on the beach on a hot day. All you have to drink is ice water. For the last hour you have been thinking about how much you would enjoy a nice cold bottle of your favorite brand of beer.

To experience this and other such illusions you can go to http://web.mit.edu/persci/people/adelson/checkershadow_illusion.html. For a more detailed discussion of the cognitive mechanisms underlying illusions such as these, see Edward H. Adelson, “Lightness Perception and Lightness Illusions,” The New Cognitive Neurosciences (1999): 339. Imagine you are lying on the beach on a hot day: This is based on Richard Thaler, “Mental Accounting and Consumer Choice,” Marketing Science 4, no. 3 (1985): 199–214. Data collected with Anuj Shah in 2012. The well off showed a significant difference between frames, whereas the poor did not; p < .01 (N = 148). when gasoline prices go up: J. Hastings and J. M. Shapiro, Mental Accounting and Consumer Choice: Evidence from Commodity Price Shocks (Cambridge, Mass.: National Bureau of Economic Research, Working Paper No. 18248, 2012).


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The Impulse Society: America in the Age of Instant Gratification by Paul Roberts

2013 Report for America's Infrastructure - American Society of Civil Engineers - 19 March 2013, 3D printing, accounting loophole / creative accounting, activist fund / activist shareholder / activist investor, Affordable Care Act / Obamacare, American Society of Civil Engineers: Report Card, asset allocation, business cycle, business process, Cass Sunstein, centre right, choice architecture, collateralized debt obligation, collective bargaining, computerized trading, corporate governance, corporate raider, corporate social responsibility, creative destruction, crony capitalism, David Brooks, delayed gratification, disruptive innovation, double helix, factory automation, financial deregulation, financial innovation, fixed income, full employment, game design, greed is good, If something cannot go on forever, it will stop - Herbert Stein's Law, impulse control, income inequality, inflation targeting, invisible hand, job automation, John Markoff, Joseph Schumpeter, knowledge worker, late fees, Long Term Capital Management, loss aversion, low skilled workers, mass immigration, new economy, Nicholas Carr, obamacare, Occupy movement, oil shale / tar sands, performance metric, postindustrial economy, profit maximization, Report Card for America’s Infrastructure, reshoring, Richard Thaler, rising living standards, Robert Shiller, Robert Shiller, Rodney Brooks, Ronald Reagan, shareholder value, Silicon Valley, speech recognition, Steve Jobs, technoutopianism, the built environment, The Predators' Ball, the scientific method, The Wealth of Nations by Adam Smith, Thorstein Veblen, too big to fail, total factor productivity, Tyler Cowen: Great Stagnation, Walter Mischel, winner-take-all economy

Household Deleveraging and Future Consumption Growth, Federal Reserve Bank of San Francisco Economic Letter, May 15, 2009, http://www.frbsf.org/publications/economics/letter/2009/el2009-16.html; and “U.S., World’s Growing HouseholdDebt,” research paper, June/July 2004, http://www.marubeni.com/dbps_data/_material_/maruco_en/data/research/pdf/0407.pdf. 4. White, “Bankruptcy Reform and Credit Cards.” 5. Richard H. Thaler, Quasi Rational Economics, p. 78. 6. Smith, “The Theory of Moral Sentiments.” In “Adam Smith, Behavioral Economist”, Carnegie Mellon University, www.cmu.edu/dietrich/sds/docs/loewenstein/AdamSmith.pdf. 7. Personal communication. 8. Ibid. 9. Michael E. Lara, “The New Science of Emotion: From Neurotransmittersto Neural Networks,” SlideShare, http://www.slideshare.net/mlaramd/science-of-emotion-from-neurotransmitters-to-social-networks. 10.

Alas, intertemporal choices are also among our most fraught. Time and again, we get them wrong, opting to enjoy an immediate reward (or to defer an immediate cost), even when we know, with utter clarity, that any short-term pleasure will be dwarfed by long-term pain. Human history is littered with the carnage of bad intertemporal choices. Why are intertemporal decisions so difficult? In 1980 an economist at Cornell University named Richard Thaler came up with an explanation. The only rational way to understand our intertemporal irrationality, Thaler argued, was to imagine the human mind not as a single decision-making entity, but as a fractious joint venture between “two semiautonomous selves.” One of these selves Thaler dubbed the “myopic Doer,” concerned only with fast, efficient gratification. The other was a farsighted “Planner,” tasked with managing, or trying to manage, the Doer.

Subtler efforts, drawing on behavioral science to help us compensate for our obsolete neural wiring, show some promise. Walter Mischel, the researcher behind the famous “marshmallow study” from the 1970s, has developed effective strategies to train impatient children to be patient—an important success, given that impatient children have a high likelihood of growing up to be impatient adults.14 There are other potentially fruitful ventures, such as what Richard Thaler (of the two-self model) and coauthor Cass Sunstein call “choice architecture.” The term refers to carefully designed technologies, infrastructure, and other pieces of the built environment that subtly “nudge” us to act with more patience and long-term thought. An example: smartphone apps that automatically track our daily expenses and warn us when we’re exceeding our budget. But such efforts are swimming upstream against a current of world-historic proportions.


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Radical Markets: Uprooting Capitalism and Democracy for a Just Society by Eric Posner, E. Weyl

3D printing, activist fund / activist shareholder / activist investor, Affordable Care Act / Obamacare, Airbnb, Amazon Mechanical Turk, anti-communist, augmented reality, basic income, Berlin Wall, Bernie Sanders, Branko Milanovic, business process, buy and hold, carbon footprint, Cass Sunstein, Clayton Christensen, cloud computing, collective bargaining, commoditize, Corn Laws, corporate governance, crowdsourcing, cryptocurrency, Donald Trump, Elon Musk, endowment effect, Erik Brynjolfsson, Ethereum, feminist movement, financial deregulation, Francis Fukuyama: the end of history, full employment, George Akerlof, global supply chain, guest worker program, hydraulic fracturing, Hyperloop, illegal immigration, immigration reform, income inequality, income per capita, index fund, informal economy, information asymmetry, invisible hand, Jane Jacobs, Jaron Lanier, Jean Tirole, Joseph Schumpeter, Kenneth Arrow, labor-force participation, laissez-faire capitalism, Landlord’s Game, liberal capitalism, low skilled workers, Lyft, market bubble, market design, market friction, market fundamentalism, mass immigration, negative equity, Network effects, obamacare, offshore financial centre, open borders, Pareto efficiency, passive investing, patent troll, Paul Samuelson, performance metric, plutocrats, Plutocrats, pre–internet, random walk, randomized controlled trial, Ray Kurzweil, recommendation engine, rent-seeking, Richard Thaler, ride hailing / ride sharing, risk tolerance, road to serfdom, Robert Shiller, Robert Shiller, Ronald Coase, Rory Sutherland, Second Machine Age, second-price auction, self-driving car, shareholder value, sharing economy, Silicon Valley, Skype, special economic zone, spectrum auction, speech recognition, statistical model, stem cell, telepresence, Thales and the olive presses, Thales of Miletus, The Death and Life of Great American Cities, The Future of Employment, The Market for Lemons, The Nature of the Firm, The Rise and Fall of American Growth, The Wealth of Nations by Adam Smith, Thorstein Veblen, trade route, transaction costs, trickle-down economics, Uber and Lyft, uber lyft, universal basic income, urban planning, Vanguard fund, women in the workforce, Zipcar

However, under the optimal COST rate, individuals would price their possessions above the amount they would be willing to accept and thus a purchase would still be mutually beneficial, just not in as imbalanced a manner as at present. Some individuals might severely understate asset values and try to hide or degrade them to avoid forced sales, but such antisocial strategies could and should be socially sanctioned, just as tax avoidance is; see below in the text. 19. Gary Becker, The Economics of Discrimination (University of Chicago Press, 2d ed., 2010). 20. See Richard H. Thaler & Cass R. Sunstein, Nudge: Improving Decisions About Health, Wealth, and Happiness (Penguin, 2009). Epilogue. After Markets? 1. F. A. Hayek, The Use of Knowledge in Society, 35 American Economic Review 519 (1945). 2. Ludwig von Mises, Economic Calculation in the Socialist Commonwealth 19–23 (S. Adler trans., Ludwig von Mises Institute, 1990) (1920). 3. Leonard E. Read, I, Pencil (Foundation for Economic Education, 2010) (1958), https://fee.org/media/14940/read-i-pencil.pdf. 4.

The possessor may thus demand a high price for the car not only because she guesses the buyer may be willing to pay it, but also because a high price signals she is reluctant to part with it, a ploy to convince the buyer the car must be valuable. Such signaling is one of the oldest tricks in the bargaining book. Anyone who has haggled in a marketplace is familiar with the elaborate stories a seller tells to illustrate an item’s supposed value. By taxing signaling, a COST minimizes its harms. Another barrier to trade, highlighted by another Nobel Laureate, Richard Thaler, is the “endowment effect.”52 Thaler found that people’s minimum willingness to pay to buy an object is usually lower than their minimum willingness to accept to part with it, even if they have never actually touched or used it. Even just owning an object in the abstract seems to make a person value it more. Some recent evidence shows that the endowment effect is less a fundamental psychological attachment and more a heuristic used to jockey for position in bargaining.

A team of researchers led by Nikhil Naik is already using image analysis to conduct automated property assessments for real estate, so this idea is not as farfetched as it may at first sound. 51. George A. Akerlof, The Market for “Lemons”: Quality, Uncertainty and the Market Mechanism, 84 Quarterly Journal of Economics 488 (1970); Michael Spence, Job Market Signaling, 87 Quarterly Journal of Economics 355 (1973). 52. Richard Thaler, Toward a Positive Theory of Consumer Choice, 1 Journal of Economics, Behavior, and Organizations 39 (1980). 53. John A. List, Neoclassical Theory versus Prospect Theory: Evidence from the Marketplace, 72 Econometrica 615 (2004); Coren L. Apicella, Eduardo M. Azevedo, Nicholas A. Christakis, & James H. Fowler, Evolutionary Origins of the Endowment Effect: Evidence from Hunter-Gatherers, 104 American Economic Review 1793 (2014). 54.


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

"Robert Solow", affirmative action, Albert Einstein, Andrei Shleifer, barriers to entry, Berlin Wall, Bernie Madoff, Bretton Woods, business cycle, buy and hold, 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, 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, Sam Peltzman, 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

Michael Cooper, “Transit Use Hit Five-Decade High in 2008 as Gas Prices Rose,” New York Times, March 9, 2009. 10. Fernando A. Wilson, Jim Stimpson, and Peter E. Hilsenrath, “Gasoline Prices and Their Relationship to Rising Motorcycle Fatalities, 1990–2007,” American Journal of Public Health, vol. 99, no. 10 (October 2009). 11. Jaime Sneider, “Good Propaganda, Bad Economics,” New York Times, May 16, 2000, p. A31. 12. Richard H. Thaler and Cass R. 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.

It also happens to be twice an average Vietnamese worker’s annual income.11 Indeed, sweatshops played an important role in the development of countries like South Korea and Taiwan, as we will explore in Chapter 12. Given that economics is built upon the assumption that humans act consistently in ways that make themselves better off, one might reasonably ask: Are we really that rational? Not always, it turns out. One of the fiercest assaults on the notion of “strict rationality” comes from a seemingly silly observation. Economist Richard Thaler hosted a dinner party years ago at which he served a bowl of cashews before the meal. He noticed that his guests were wolfing down the nuts at such a pace that they would likely spoil their appetite for dinner. So Thaler took the bowl of nuts away, at which point his guests thanked him.12 Believe it or not, this little vignette exposes a fault in the basic tenets of microeconomics: In theory, it should never be possible to make rational individuals better off by denying them some option.

As a practical matter, those mistakes often do spill over to affect the rest of us, as we saw in the real estate collapse and the accompanying mortgage mess. And there is a range of views in between (e.g., you’re allowed to sniff glue and roll down the steps but only while wearing a helmet). One intriguing and practical middle ground is the notion of “libertarian paternalism,” which was advanced in an influential book called Nudge by Richard Thaler, a professor of behavioral science and economics at the University of Chicago, and Cass Sunstein, a Harvard Law School professor now serving in the Obama administration. The idea behind benign paternalism is that individuals do make systematic errors of judgment, but society should not force you to change your behavior (that’s the libertarian part); instead, we should merely point you in the right direction (that’s the paternalism part).


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

barriers to entry, Berlin Wall, big-box store, business cycle, 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, 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, Monkeys Reject Unequal Pay, 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

Available at SSRN: http://ssrn.com/abstract=1080202. 82 had their money returned: Christopher Shea, “eBay-nomics: Modern Economists Have Assumed That People in Auctions Behave Rationally. Then Came eBay,” Boston Globe, June 10, 2007. 82 “profit-leaking paradox”: Rafi Mohammed, The Art of Pricing (New York: Crown, 2005), 24. 82 “opposition to one of their various judgments”: Janet Landman, Regret: The Persistence of the Possible (New York: Oxford University Press, 1993), 116. 85 the response was a resounding no: Daniel Kahneman, Jack L. Knetsch, and Richard H. Thaler, “Fairness as a Constraint on Profit Seeking: Entitlements in the Market,” American Economic Review 76 (September 1986): 728-41. 85 got pretty much the same response: Raymond Gorman and James B. Kehr, “Fairness as a Constraint on Profit Seeking: Comment,” American Economic Review 82, no. 1 (1992): 355-58. 85 “biggest mistake was getting caught”: David Wessel, “How Technology Tailors Price Tags,” Wall Street Journal, June 21, 2001. 86 early birds deserved to pay more: On the Wired magazine blog network, one gleeful “late adapter” wrote: “The early iPhone buyers paid a premium precisely to be among the first and the ‘coolest.’

Of course this question does not address the larger and more important question of how best to make money, but how best to make money is a question we are reluctant to face, in particular when we are currently not making any. “If the question is difficult and an answer doesn’t immediately come to mind, we ask ourselves a related question that is easy to answer,” Kahneman said. “Generally speaking, the easy question is the wrong question.” Tversky and Kahneman may have made less practical sense of such psychological insights had they not teamed up with the promising young economist Richard Thaler. Today a professor of behavioral science and economics in the Graduate School of Business at the University of Chicago, Thaler was, when they met in the late 1970s, a newly minted visiting professor at the National Bureau of Economic Research at Stanford University. Tversky and Kahneman were fellows at the Stanford Institute of Advanced Studies in Behavioral Sciences, and Thaler translated their psychological research into a hardheaded consideration of consumer behavior.

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. See Richard Thaler, The Winner’s Cure: Paradoxes and Anomalies of Economic Life (New York: The Free Press, 1992). My description of the Ultimatum Game was informed by Thaler’s chapter on the subject (pp. 21-36) and also by conversations with Dr. Patrick Kaufman, chairman of marketing at Boston University School of Management. 66 Emotion, Reason, and the Human Brain: Antonio R. Damasio, Descartes’ Error: Emotion, Reason, and the Human Brain (New York: Harper Perennial, 1995). 66 true not only for humans: There is a rich scientific literature giving evidence that humans are biologically programmed or “hardwired” to be fair and to demand fairness in others.


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

"Robert Solow", Andrei Shleifer, availability heuristic, bank run, Black Swan, business cycle, 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

Before joining Harvard, he was a faculty member at the University of Chicago Law School from 1981 to 2008. Sunstein’s many books include After the Rights Revolution (Harvard University Press, 1990), Risk and Reason (Cambridge University Press, 2002), Laws of Fear: Beyond the Precautionary Principle (Cambridge University Press, 2005), Worst-Case Scenarios (Harvard University Press, 2007), and Nudge: Improving Decisions About Health, Wealth, and Happiness, with Richard H. Thaler (Yale University Press, 2008). He is also co-author of leading casebooks in both constitutional law and administrative law, with academic specialties in these two fields as well as in regulatory policy. W. Kip Viscusi, Vanderbilt University Law School Kip Viscusi is Vanderbilt’s first University Distinguished Professor, with appointments in the Owen Graduate School of Management and the Department of Economics as well as in the Law School.

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.

Many people do not appreciate how much a company with a given name can change through time, or how many ways there are to debase its value. Stocks that nobody really believes in but that retain value are the Delicious Apples of the investment world. RECOMMENDED READING Allen, Franklin, Stephen Morris, and Hyung Song Shin (2002). “Beauty Contests, Bubbles, and Iterated Expectations in Asset Markets.” Unpublished paper, Yale University. Barberis, Nicholas, and Richard Thaler (2003). “A Survey of Behavioral Finance.” In George Constantinides, Milton Harris, and René Stulz, eds. Handbook of the Economics of Finance. New York: Elsevier Science. Campbell, John Y., and Robert J. Shiller (1987). “Cointegration and Tests of Present Value Models.” Journal of Political Economy 97, no. 5: 1062-1088. Higgins, Adrian (2005). “Why the Red Delicious No Longer Is.” Washington Post, August 5, p.


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

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, IKEA effect, 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

James Heyman, Yesim Orhun, and Dan Ariely, “Auction Fever: The Effect of Opponents and Quasi-Endowment on Product Valuations,” Journal of Interactive Marketing (2004). RELATED READINGS Richard Thaler, “Toward a Positive Theory of Consumer Choice,” Journal of Economic Behavior and Organization (1980). Jack Knetsch, “The Endowment Effect and Evidence of Nonreversible Indifference Curves,” American Economic Review, Vol. 79 (1989), 1277–1284. Daniel Kahneman, Jack Knetsch, and Richard Thaler, “Experimental Tests of the Endowment Effect and the Coase Theorem,” Journal of Political Economy (1990). Daniel Kahneman, Jack Knetsch, and Richard H. Thaler, “Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias,” Journal of Economic Perspectives, Vol. 5 (1991), 193–206. Chapter 8: Keeping Doors Open BASED ON Jiwoong Shin and Dan Ariely, “Keeping Doors Open: The Effect of Unavailability on Incentives to Keep Options Viable,” Management Science (2004).

It’s Unconscious Bias,” Harvard Business Review (2002). Maurice Schweitzer and Chris Hsee, “Stretching the Truth: Elastic Justification and Motivated Communication of Uncertain Information,” Journal of Risk and Uncertainty (2002). Chapter 13: Beer and Free Lunches BASED ON Dan Ariely and Jonathan Levav, “Sequential Choice in Group Settings: Taking the Road Less Traveled and Less Enjoyed,” Journal of Consumer Research (2000). Richard Thaler and Shlomo Benartzi, “Save More Tomorrow: Using Behavioral Economics to Increase Employee Savings,” Journal of Political Economy (2004). RELATED READINGS Eric J. Johnson and Daniel Goldstein, “Do Defaults Save Lives?” Science, (2003). Searchable Terms Note: Entries in this index, carried over verbatim from the print edition of this title, are unlikely to correspond to the pagination of any given e-book reader.


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

asset allocation, backtesting, Bernie Madoff, buy and hold, 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

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. Thaler, “Deal or No Deal? Decision Making under Risk in a Large-Payoff Game Show,” American Economic Review 98, no. 1 (March 2008): 38–71. 8. Calmetta Coleman, “Beardstown Ladies Fess Up to Big Goof,” Wall Street Journal, Mar. 18, 1998, cl. 9. William N. Goetzmann and Nadav Peles, “Cognitive Dissonance and Mutual Fund Investors,” Journal of Financial Research 20, no. 2 (1997): 145–58. 10. John Maynard Keynes. The General Theory of Employment, Interest and Money (1936; repr., Boston: Houghton Mifflin Harcourt, 1964), 148. 11. Richard H. Thaler, “Toward a Positive Theory of Consumer Choice,” Journal of Economic Behavior and Organization 1, no. 1 (1980): 39–60. 12.

Most providers of fund databases have since fixed the survivorship biases by adding back the performance. bThe S&P Persistence Score Card is available at http://www.indexresearch.standardandpoors.com. CHAPTER 8 Active and Passive Asset Allocation People exaggerate their own skills. They are overoptimistic about their prospects and overconfident about their guesses, including which managers to pick. —Richard Thaler, University of Chicago It isn’t what we know that gives us trouble. It’s what we think we know that just ain’t so. —Will Rogers The second part of the active versus passive debate goes beyond mutual fund selection into the timing of purchases and sales. Asset allocation is how and when an investor diversifies among different types of investments in a portfolio. An investor following a tactical asset allocation strategy attempts to beat the market by changing asset class weights using market valuation forecasts or price trends.


The Darwin Economy: Liberty, Competition, and the Common Good by Robert H. Frank

carbon footprint, carried interest, Cass Sunstein, clean water, congestion charging, corporate governance, deliberate practice, full employment, income inequality, Intergovernmental Panel on Climate Change (IPCC), invisible hand, Paul Samuelson, plutocrats, Plutocrats, positional goods, profit motive, Ralph Nader, rent control, Richard Thaler, Ronald Coase, Ronald Reagan, sealed-bid auction, smart grid, The Nature of the Firm, The Wealth of Nations by Adam Smith, Thomas Malthus, transaction costs, trickle-down economics, ultimatum game, winner-take-all economy

This claim merits qualification to the extent that it is relative speed among gazelles that determines which ones are caught and eaten. An old joke describes a camper who awoke to see his friend frantically putting on his running shoes as an angry bear approached their campsite. “Why bother?” he asked. “Don’t you know there’s no way you’ll be able to outrun that bear?” “I don’t have to outrun him,” the friend responded, “I just need to outrun you.” 5. Richard H. Thaler and Cass R. Sunstein, Nudge, New Haven, CT: Yale University Press, 2007. 6. See, for example, Peter Richerson and Robert Boyd, Not by Genes Alone: How Culture Transformed Human Evolution, Chicago: University of Chicago Press, 2004. NOTES TO PAGES 24–31 219 7. See, for example, Richard Rorty, “The Brain as Hardware, Culture as Software,” Inquiry 47(3), 2004: 219–235. 8. The question of how such motives might have evolved in relentlessly competitive environments was the subject of my 1988 book, Passions within Reason: The Strategic Role of the Emotions, New York: W.

For present purposes, the important point is that traits favored because they confer advantage at the individual level are often disadvantageous to larger groups. 10. Burney J. Le Boeuf, “Male-Male Competition and Reproductive Success in Elephant Seals,” American Zoologist 14(1), 1974: 163–176. 11. Thomas C. Schelling, Micromotives and Macrobehavior, New York: W. W. Norton, 1978. 12. See, for example, Richard Thaler and Cass Sunstein, Nudge, New Haven, CT: Yale University Press, 2007. 13. John Stuart Mill, On Liberty, State College, PA: Penn State University, 1998 (originally published in 1859). 14. Others have offered cogent objections to the principle. See, for example, Joel Feinberg, Harm to Others, New York: Oxford University Press, 1987. 15. See, for example, the statement of Congressman Dan Burton (R, IN): http:// burton.house.gov/issues/tax-reform.

For detailed discussions of Walmart’s labor practices, see Steven Greenhouse, The Big Squeeze, New York: Knopf, 2008; and in Nelson Lichtenstein, The Retail Revolution, New York: Metropolitan, 2009. 8. On this point see Bethany Moreton, To Serve God and Wal-Mart, Cambridge, MA: Harvard University Press, 2009. 9. For a more detailed account of this explanation, see chapter 8 of my 1985 book, Choosing the Right Pond: Human Behavior and the Quest for Status, New York: Oxford University Press. 10. Richard Thaler and Cass Sunstein, Nudge, New Haven, CT: Yale University Press, 2007, p. 251. 11. Thomas C. Schelling, Micromotives and Macrobehavior, New York: W. W. Norton, 1978. 12. Karl Marx, Capital, New York: Modern Library, 1936, pp. 708–709. 13. See, for example, the title essay in my 2004 book, What Price the Moral High Ground? Princeton, NJ: Princeton University Press. 14. Paul Samuelson, “A Note on the Pure Theory of Consumers’ Behaviour,” Economica 5, 1938: 61–71.


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Expected Returns: An Investor's Guide to Harvesting Market Rewards by Antti Ilmanen

Andrei Shleifer, asset allocation, asset-backed security, availability heuristic, backtesting, balance sheet recession, bank run, banking crisis, barriers to entry, Bernie Madoff, Black Swan, Bretton Woods, business cycle, buy and hold, buy low sell high, capital asset pricing model, capital controls, Carmen Reinhart, central bank independence, collateralized debt obligation, commoditize, commodity trading advisor, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, debt deflation, deglobalization, delta neutral, demand response, discounted cash flows, disintermediation, diversification, diversified portfolio, dividend-yielding stocks, equity premium, Eugene Fama: efficient market hypothesis, fiat currency, financial deregulation, financial innovation, financial intermediation, fixed income, Flash crash, framing effect, frictionless, frictionless market, G4S, George Akerlof, global reserve currency, Google Earth, high net worth, hindsight bias, Hyman Minsky, implied volatility, income inequality, incomplete markets, index fund, inflation targeting, information asymmetry, interest rate swap, invisible hand, Kenneth Rogoff, laissez-faire capitalism, law of one price, London Interbank Offered Rate, Long Term Capital Management, loss aversion, margin call, market bubble, market clearing, market friction, market fundamentalism, market microstructure, mental accounting, merger arbitrage, mittelstand, moral hazard, Myron Scholes, negative equity, New Journalism, oil shock, p-value, passive investing, Paul Samuelson, performance metric, Ponzi scheme, prediction markets, price anchoring, price stability, principal–agent problem, private sector deleveraging, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, random walk, reserve currency, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, riskless arbitrage, Robert Shiller, Robert Shiller, savings glut, selection bias, Sharpe ratio, short selling, sovereign wealth fund, statistical arbitrage, statistical model, stochastic volatility, stocks for the long run, survivorship bias, systematic trading, The Great Moderation, The Myth of the Rational Market, too big to fail, transaction costs, tulip mania, value at risk, volatility arbitrage, volatility smile, working-age population, Y2K, yield curve, zero-coupon bond, zero-sum game

Barberis, Nicholas; and Andrei Shleifer (2003), “Style investing,” Journal of Financial Economics 68, 161–199. Barberis, Nicholas; Andrei Shleifer; and Robert Vishny (1998), “A model of investor sentiment,” Journal of Financial Economics 49, 307–345. Barberis, Nicholas; Andrei Shleifer; and Jeffrey Wurgler (2005), “Comovement,” Journal of Financial Economics 75, 283–317. Barberis, Nicholas; and Richard H. Thaler (2003), “A survey of behavioral finance,” in Handbook of the Economics of Finance (G. Constantinides, R. Stulz, M. Harris, Eds.), Amsterdam: North Holland. Barro, Robert J. (1995), “Inflation and economic growth,” NBER working paper 5326. Barro, Robert J. (2006), “Rare disasters and asset markets in the twentieth century,” Quarterly Journal of Economics 121(3), 823–866. Barro, Robert J.; and José F.

Jiang (2008), “Separating up from down: New evidence on the idiosyncratic volatility-return relation,” working paper, available at SSRN: http://ssrn.com/ abstract = 970875 Friedman, Milton (1953), “The case for flexible exchange rates,” in Essays in Positive Economics, University of Chicago Press. Friesen, Geoffrey; and Travis Sapp (2007), “Mutual fund flows and investor returns: An empirical examination of fund investor timing ability,” Journal of Banking & Finance 31, 2796–2816. Froot, Kenneth A. (1989), “New hope for the expectations hypothesis of the term structure of interest rates,” Journal of Finance 44, 283–305. Froot, Kenneth A.; and Richard H. Thaler (1990), “Anomalies: Foreign exchange,” Journal of Economic Perspectives 4(3), 179–192. Fu, Fangjian (2009), “Idiosyncratic risk and the cross-section of expected stock returns,” Journal of Financial Economics 91, 24–37. Fuertes, Ana; Joelle Miffre; and Giorgios Rallis (2010), “Tactical allocation in commodity futures markets: Combining momentum and term structure signals,” forthcoming in the Journal of Banking and Finance.

Jaeger, Lars (2008), Alternative Beta Strategies and Hedge Fund Replication, Chichester, U.K.: John Wiley & Sons Ltd. Jegadeesh, Narasimhan; and Sheridan Titman (1993), “Returns to buying winners and selling losers: Implications for stock market efficiency,” Journal of Finance 48(1), 65–91. Jegadeesh, Narasimhan; and Sheridan Titman (2005), “Momentum: A review,” in Advances on Behavioral Finance, Volume II (Richard H. Thaler, Ed.), Russell Sage Foundation and Princeton University Press. Jensen, Gerald R.; and Theodore C. Moorman (2010), “Inter-temporal variation in the illiquidity premium,” forthcoming in the Journal of Financial Economics. Jung, Jeeman; and Robert J. Shiller (2005), “Samuelson’s dictum and the stock market,” Economic Inquiry 43(2), 221–228. Jurek, Jakub W. (2009), “Crash-neutral currency carry trades,” Princeton University working paper.


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Competition Overdose: How Free Market Mythology Transformed Us From Citizen Kings to Market Servants by Maurice E. Stucke, Ariel Ezrachi

affirmative action, Airbnb, Albert Einstein, Andrei Shleifer, Bernie Sanders, Boeing 737 MAX, Cass Sunstein, choice architecture, cloud computing, commoditize, corporate governance, Corrections Corporation of America, Credit Default Swap, crony capitalism, delayed gratification, Donald Trump, en.wikipedia.org, George Akerlof, gig economy, Goldman Sachs: Vampire Squid, Google Chrome, greed is good, hedonic treadmill, income inequality, income per capita, information asymmetry, invisible hand, job satisfaction, labor-force participation, late fees, loss aversion, low skilled workers, Lyft, mandatory minimum, Mark Zuckerberg, market fundamentalism, mass incarceration, Menlo Park, meta analysis, meta-analysis, Milgram experiment, mortgage debt, Network effects, out of africa, payday loans, Ponzi scheme, precariat, price anchoring, price discrimination, profit maximization, profit motive, race to the bottom, Richard Thaler, ride hailing / ride sharing, Robert Bork, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, Shoshana Zuboff, Silicon Valley, Snapchat, Social Responsibility of Business Is to Increase Its Profits, Stanford prison experiment, Stephen Hawking, The Chicago School, The Market for Lemons, The Myth of the Rational Market, The Wealth of Nations by Adam Smith, Thomas Davenport, Thorstein Veblen, Tim Cook: Apple, too big to fail, transaction costs, Uber and Lyft, uber lyft, ultimatum game, Vanguard fund, winner-take-all economy

., anonymous market transactions], a half-century of experimental gaming research demonstrates that in many other contexts, people simply refuse to behave like the ‘rational maximizers’ economic theory says they should be”). 37.Keith Jensen, Josep Call, and Michael Tomasello, “Chimpanzees Are Rational Maximizers in an Ultimatum Game,” Science 318, no. 5847 (October 5, 2007): 107, DOI:10.1126/science.1145850. 38.Richard H. Thaler, The Winner’s Curse: Paradoxes and Anomalies of Economic Life (New York: Free Press, 1992), 21–25; Werner Güth, Rolf Schmittberger, and Bernd Schwarze, “An Experimental Analysis of Ultimatum Bargaining,” Journal of Economic Behavior and Organization 3, no. 4 (December 1982): 367, 371–74, 375, tables 4–5, https://doi.org/10.1016/0167-2681(82)90011-7; Daniel Kahneman, Jack Knetsch, and Richard Thaler, “Fairness and the Assumptions of Economics,” Journal of Business 59, no. 4 (November 1986): S285, S291, table 2, Persistent link: https://EconPapers.repec.org/RePEc:ucp:jnlbus:v:59:y:1986:i:4:p:s285-300. 39.Maurice E.

For Smith, benevolence, which causes individuals to act, at times, out of goodness, even when they derive nothing financially from it, was not simply one of mankind’s “splendid virtues,” but an expression of basic “principles in his nature.”33 And fairness and altruism weren’t just qualities without any practical value, but virtues that “played an essential role in market interactions, allowing trust, repeated transactions and material gains to occur.”34 Fairness he viewed as the “main pillar that upholds the whole edifice. If it is removed, the great, the immense fabric of human society . . . must in a moment crumble to atoms.”35 These sentiments are as much a part of classical economic theory as those expressed in The Wealth of Nations. Thus, Smith has become the patron saint of a new wave of economists—known as the behavioral economists—like recent Nobel Prize laureates Daniel Kahneman and Richard Thaler. Looking at the empirical evidence, they conclude that most people are not as purely “self-interested” as the Chicago School’s theorists suppose. On the micro level, we actually care about treating others—and being treated—fairly. And on a macro level, the empirical evidence does not support the idea that greed is a prerequisite for a successful market economy.36 Societies with greedier citizens do not necessarily have stronger economies.

Thaler, The Winner’s Curse: Paradoxes and Anomalies of Economic Life (New York: Free Press, 1992), 21–25; Werner Güth, Rolf Schmittberger, and Bernd Schwarze, “An Experimental Analysis of Ultimatum Bargaining,” Journal of Economic Behavior and Organization 3, no. 4 (December 1982): 367, 371–74, 375, tables 4–5, https://doi.org/10.1016/0167-2681(82)90011-7; Daniel Kahneman, Jack Knetsch, and Richard Thaler, “Fairness and the Assumptions of Economics,” Journal of Business 59, no. 4 (November 1986): S285, S291, table 2, Persistent link: https://EconPapers.repec.org/RePEc:ucp:jnlbus:v:59:y:1986:i:4:p:s285-300. 39.Maurice E. Stucke, “Behavioral Economists at the Gate: Antitrust in the Twenty-First Century,” Loyola University of Chicago Law Journal 38, no. 3 (Spring 2007): 513, 530 n.79, https://ssrn.com/abstract=981530. 40.Christine Jolls, Cass R. Sunstein, and Richard Thaler, “A Behavioral Approach to Law and Economics,” Stanford Law Review 50, no. 3 (May 1998): 1471, 1492, https://www.law.harvard.edu/programs/olin_center/papers/pdf/236.pdf. Even when the game is repeated ten times to allow for learning, the results are similar. 41.Joseph Henrich et al., “In Search of Homo Economicus: Behavioral Experiments in 15 Small-Scale Societies,” American Economic Review 91, no. 2 (May 2001): 73, 73–76, https://www.aeaweb.org/articles?id=10.1257/aer.91.2.73. 42.Joseph Henrich et al., “Markets, Religion, Community Size, and the Evolution of Fairness and Punishment,” Science 327, no. 5972 (March 19, 2010): 1480, 1480–84, https://science.sciencemag.org/content/327/5972/1480.full. 43.Varda Liberman, Steven M.


pages: 350 words: 103,270

The Devil's Derivatives: The Untold Story of the Slick Traders and Hapless Regulators Who Almost Blew Up Wall Street . . . And Are Ready to Do It Again by Nicholas Dunbar

asset-backed security, bank run, banking crisis, Basel III, Black Swan, Black-Scholes formula, bonus culture, break the buck, buy and hold, capital asset pricing model, Carmen Reinhart, Cass Sunstein, collateralized debt obligation, commoditize, Credit Default Swap, credit default swaps / collateralized debt obligations, delayed gratification, diversification, Edmond Halley, facts on the ground, financial innovation, fixed income, George Akerlof, implied volatility, index fund, interest rate derivative, interest rate swap, Isaac Newton, John Meriwether, Kenneth Rogoff, Kickstarter, Long Term Capital Management, margin call, market bubble, money market fund, Myron Scholes, Nick Leeson, Northern Rock, offshore financial centre, Paul Samuelson, price mechanism, regulatory arbitrage, rent-seeking, Richard Thaler, risk tolerance, risk/return, Ronald Reagan, shareholder value, short selling, statistical model, The Chicago School, Thomas Bayes, time value of money, too big to fail, transaction costs, value at risk, Vanguard fund, yield curve, zero-sum game

See the remarks by Goldman’s then head of firmwide risk, Bob Litzenberger, in Nicholas Dunbar, Inventing Money: The Story of Long-Term Capital Management and the Legends Behind It (Chichester: Wiley, 2000), 203. 12. The BIS actually further liberalized the VAR-based capital rules in 1998, introducing a so-called specific risk amendment that a Federal Reserve official described in 2009 as “the kiss of death.” 13. For example, see the chapter on consumer credit in Richard H. Thaler and Cass R. Sunstein, Nudge: Improving Decisions About Health, Wealth, and Happiness (New Haven, CT: Yale University Press, 2008). 14. The products are normally sold to intermediaries such as small banks or insurance companies before passing into the hands of the consumer. 15. An edited version of my interview with Sartori di Borgoricco was published in “The Key to Successful Client Solutions,” Risk, October 2004, 53. 16.

They were envisaged as gifted beings who could frame their beliefs about potential investments in the form of detailed probability distributions, including the correlations between investments. In a footnote to his paper, Markowitz said, “This paper does not consider the difficult question of how investors do (or should) form their probability beliefs.” Since then, analysts have typically assumed that beliefs are formed purely from historical statistics. 13. Richard H. Thaler and Cass R. Sunstein, Nudge: Improving Decisions About Health, Wealth, and Happiness (New Haven, CT: Yale University Press, 2008). 14. Barclays issued an emerging market CDO structured by Usi’s group named RF Alts Finance in January 2000. 15. E-mail evidence presented at Banca Popolare di Intra and Barclays Bank PLC, transcript of High Court Hearing, February 9, 2010; and witness statement of Stefano Silocchi quoted in Barclays’ pre-trial argument to the High Court. 16.

Since this flavor of diversification protects against falls in prices, justifying it requires plenty of historical price data and deft use of statistics.12 Then there is a third type of diversification, the joker in the pack. Behavioral economists call it naive diversification, in part because it seems to be hardwired into the human psyche. Psychological experiments show that when people are not restricted to a single choice on a menu, they will spread their allocation across whatever is available. For example, in an experiment cited by Cass Sunstein and Richard Thaler in their book Nudge, children who are offered multiple brands of chocolate will almost always divide their picks so that they can taste all the chocolates rather than sticking with a single brand.13 In the same way, and with no more justification for doing so, investors who are offered a menu of different retirement funds blindly split their allocations across the menu, even when it is not in their interests to do so.


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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

"Robert Solow", Andrei Shleifer, asset-backed security, Bernie Madoff, business cycle, 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, desegregation, 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, market bubble, 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, short selling, 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

(London: William Tegg, 1849): “I endeavour as much as I can, to deliver myself from those fallacies, which we are apt to put upon our selves, by taking words for things” (p. 104). 8. Gary Smith, Standard Deviations: Flawed Assumptions, Tortured Data, and Other Ways to Lie with Statistics (New York: Duckworth Overlook, 2014). 9. Jesse Kornbluth, Highly Confident: The Crime and Punishment of Michael Milken (New York: William Morrow, 1992), p. 45. 10. Hickman, Corporate Bond Quality and Investor Experience, p. 10. 11. Jeremy J. Siegel and Richard H. Thaler, “Anomalies: The Equity Premium Puzzle,” Journal of Economic Perspectives 11, no. 1 (Winter 1997): 191. 12. United States Federal Deposit Insurance Corporation et al. v. Michael R. Milken et al. (1991), Southern District of New York (January 18), Amended Complaint Class Action, Civ. No. 91-0433 (MP), pp. 70–71. 13. See James B. Stewart, Den of Thieves (New York: Simon and Schuster, 1992), pp. 521–22; and Benjamin Stein, A License to Steal: The Untold Story of Michael Milken and the Conspiracy to Bilk the Nation (New York: Simon and Schuster, 1992). 14.

“Breach of Trust in Hostile Takeovers.” In Corporate Takeovers: Causes and Consequences, edited by Alan J. Auerbach, pp. 33–68. Chicago: University of Chicago Press, 1988. Shleifer, Andrei, and Robert W. Vishny. “The Takeover Wave of the 1980s.” Science 249, no. 4970 (1990): 745–49. Sidel, Robin. “Credit Card Issuers Are Charging Higher.” Wall Street Journal, October 12, 2014. Siegel, Jeremy J., and Richard H. Thaler. “Anomalies: The Equity Premium Puzzle.” Journal of Economic Perspectives 11, no. 1 (Winter 1997): 191–200. Sinclair, Upton. The Jungle. Mineola, NY: Dover Thrift Editions, 2001; originally published 1906. __________. Letter to the New York Times. May 6, 1906. Singh, Gurkirpal. “Recent Considerations in Nonsteroidal Anti-Inflammatory Drug Gastropathy.” American Journal of Medicine 105, no. 1, supp. 2 (July 27, 1998): 31S–38S.

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 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. Richard Thaler, with whom Bob has been organizing behavioral economics workshops for twenty-five years, has also been an influence; he initially suggested more than twenty years ago that we two ought to work together. He was our matchmaker. We are hugely indebted to him. Mario Small and Michele Lamont cued us into thinking about how people’s decisions depend largely on the subconscious rather than the conscious.


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Think Like a Freak by Steven D. Levitt, Stephen J. Dubner

Albert Einstein, Anton Chekhov, autonomous vehicles, Barry Marshall: ulcers, call centre, Cass Sunstein, colonial rule, Edward Glaeser, Everything should be made as simple as possible, food miles, Gary Taubes, income inequality, Internet Archive, Isaac Newton, medical residency, Metcalfe’s law, microbiome, prediction markets, randomized controlled trial, Richard Thaler, Scramble for Africa, self-driving car, Silicon Valley, Tony Hsieh, transatlantic slave trade, éminence grise

Krueger, What Makes a Terrorist (Princeton University Press, 2007); Claude Berrebi, “Evidence About the Link Between Education, Poverty and Terrorism Among Palestinians,” Princeton University Industrial Relations Section working paper, 2003; and Krueger and Jita Maleckova, “Education, Poverty and Terrorism: Is There a Causal Connection?” Journal of Economic Perspectives 17, no. 4 (Fall 2003). / 172 Trying to keep a public men’s room clean?: See Richard H. Thaler and Cass R. Sunstein, Nudge (Yale University Press, 2008). / 172 “. . . We are also blind to our blindness”: See Daniel Kahneman, Thinking, Fast and Slow (2011, Farrar, Straus and Giroux). / 173 “It’s easier to jump out of a plane”: Kareem Abdul-Jabbar, “20 Things Boys Can Do to Become Men,” Esquire.com, October 2013. 173 HOW MUCH DID THE ANTI-DRUG CAMPAIGN CUT DRUG USE?: See Robert Hornik, Lela Jacobsohn, Robert Orwin, Andrea Piesse, Graham Kalton, “Effects of the National Youth Anti-Drug Media Campaign on Youths,” American Journal of Public Health 98, no. 12 (December 2008). 174 SELF-DRIVING CARS: Among the many people who informed our thinking on the driverless-car future, we are especially indebted to Raj Rajkumar and his colleagues at Carnegie Mellon, who let us ride in their driverless vehicle and answered every question. / 175 Google has already driven its fleet of autonomous cars: See Angela Greiling Keane, “Google’s Self-Driving Cars Get Boost from U.S.

And so, based on their emotion or instinct, and perhaps a reaction to a bit of information gleaned long ago, people chose a position and stuck with it. When someone is heavily invested in his or her opinion, it is inevitably hard to change the person’s mind. So you might think it would be pretty easy to change the minds of people who haven’t thought very hard about an issue. But we’ve seen no evidence of this. Even on a topic that people don’t care much about, it can be hard to get their attention long enough to prompt a change. Richard Thaler and Cass Sunstein, pioneers of the “nudge” movement, recognized this dilemma. Rather than try to persuade people of the worthiness of a goal—whether it’s conserving energy or eating better or saving more for retirement—it’s more productive to essentially trick people with subtle cues or new default settings. Trying to keep a public men’s room clean? Sure, go ahead and put up signs urging people to pee neatly—or, better, paint a housefly on the urinal and watch the male instinct for target practice take over.


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The Age of the Infovore: Succeeding in the Information Economy by Tyler Cowen

Albert Einstein, Asperger Syndrome, business cycle, Cass Sunstein, cognitive bias, David Brooks, en.wikipedia.org, endowment effect, Flynn Effect, framing effect, Google Earth, impulse control, informal economy, Isaac Newton, loss aversion, Marshall McLuhan, Naomi Klein, neurotypical, new economy, Nicholas Carr, pattern recognition, phenotype, placebo effect, Richard Thaler, selection bias, Silicon Valley, social intelligence, the medium is the message, The Wealth of Nations by Adam Smith, theory of mind

FURTHER READING AND REFERENCES CHAPTER 1: THE FUTURE OF THINKING DIFFERENTLY On Mark Donohoo, see “One Man’s Story: When an Autistic Child Grows Up,” April 1, 2008, www.cnn.com/2008/HEALTH/conditions/04/01/autism.jeffs.story/index.html. For the story of Ethan, see Michael D. Powers and Janet Poland, Asperger Syndrome and Your Child: A Parent’s Guide (New York: Collins Living, 2003), chapter 2. To the best of my knowledge, the phrase “infovores” originates with USC professor Irving Biederman. For a good presentation of framing effects, see for instance Richard H. Thaler and Cass R. Sunstein, Nudge: Improving Decisions About Health, Wealth, and Happiness (New Haven: Yale University Press, 2008). For the Steve Hofstetter quotation, see “Thinking Man: Steve Hofstetter is Your Friend,” November 14, 2005, www.collegehumor.com/article:1632255. On “Facebook-like” services for the very young, see Camille Sweeney, “Twittering from the Cradle,” The New York Times, September 11, 2008.

Whereas the Stoics sought to understand the psychology of the Roman Empire, exile, and the slave whip, and Smith studied the pin factory, I am looking at Facebook, Google, and the iPod. The later and more general movement of “behavioral economics” has brought psychology very directly into economics. In addition to all the formal research, behavioral economics is represented by such popular books as Dan Ariely’s Predictably Irrational, Richard Thaler and Cass Sunstein’s Nudge, and Ori and Rom Brafman’s Sway. In the most general terms, behavioral economics suggests that human decision-making is often far from rational. For instance maybe we overestimate our prospects of success when we start a new business or maybe we are very bad at evaluating risks with very small probabilities. In the behavioral view we are ruled by emotions and often we use dysfunctional decision-making procedures and rules.


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The Unbanking of America: How the New Middle Class Survives by Lisa Servon

Affordable Care Act / Obamacare, Airbnb, basic income, Build a better mousetrap, business cycle, Cass Sunstein, choice architecture, creative destruction, Credit Default Swap, employer provided health coverage, financial exclusion, financial independence, financial innovation, gender pay gap, George Akerlof, gig economy, income inequality, informal economy, Jane Jacobs, Joseph Schumpeter, late fees, Lyft, M-Pesa, medical bankruptcy, microcredit, Occupy movement, payday loans, peer-to-peer lending, precariat, Ralph Nader, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Reagan, sharing economy, too big to fail, transaction costs, unbanked and underbanked, underbanked, universal basic income, Unsafe at Any Speed, We are the 99%, white flight, working poor, Zipcar

Luke Shaefer, $2.00 a Day: Living on Almost Nothing in America (New York: Houghton Mifflin Harcourt, 2015). 167 a strong safety net: Michael S. Barr, Sendhil Mullainathan, and Eldar Shafir, “Behaviorally Informed Regulation,” in No Slack: The Financial Lives of Low-Income Americans, edited by Michael S. Barr (Washington, DC: Brookings Institution Press, 2012). 169 “choice architecture”: Richard H. Thaler and Cass R. Sunstein, Nudge: Improving Decisions About Health, Wealth, and Happiness (New Haven, CT: Yale University Press, 2008). simply changing the default option: John Beshears et al., “The Importance of Default Options for Retirement Savings Outcomes: Evidence from the United States,” NBER Working Paper No. 12009 (Cambridge, MA: National Bureau of Economic Research, February 2006). how to “nudge” people: Barr, No Slack; Thaler and Sunstein, Nudge. 170 “favoring bank profitability”: Mehrsa Baradaran, How the Other Half Banks: Exclusion, Exploitation, and the Threat to Democracy (Cambridge, MA: Harvard University Press, 2015), p. 7. 171 enable them to borrow: International Monetary Fund, “Big Banks Benefit from Government Subsidies,” IMF Survey Magazine, March 31, 2014. http://www.imf.org/external/pubs/ft/survey/so/2014/POL033114A.htm 172 through the postal service: Mehrsa Baradaran endorses this idea in How the Other Half Banks.

Remember Ariane, the teller I worked with at Check Center, who took out five payday loans to fix her car so she could get to work? The situation she found herself in—choosing between taking out payday loans or losing her job—overrode her knowledge; as she told me, “I know it’s bad.” The upside of this finding is that the effect of context on decision making is predictable. We can find ways to protect people at vulnerable moments. The way choices are presented—what the economists Richard Thaler and Cass Sunstein call “choice architecture”—is also critical to making a good decision. Employee enrollment in retirement plans provides a good illustration. When a worker is lucky enough to get a job that includes a retirement plan, she must usually make several decisions—whether to participate, how much to contribute, how to allocate contributions across different investments. Most plans require workers to “opt in”—in other words, you have to choose to participate.


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

"Robert Solow", airport security, availability heuristic, Bayesian statistics, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, big-box store, Black Swan, Broken windows theory, business cycle, buy and hold, 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, global pandemic, haute cuisine, Henri Poincaré, high batting average, housing crisis, income per capita, index fund, information asymmetry, 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, Laplace demon, 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

Marko Kolanovic, Davide Silvestrini, Tony SK Lee, and Michiro Naito, “Rise of Cross-Asset Correlations,” Global Equity Derivatives and Delta One Strategy, J.P. Morgan, May 16, 2011. http://www.cboe.com/Institutional/JPMCrossAssetCorrelations.pdf. 77. Richard H. Thaler, “Anomalies: The Winner’s Curse,” Journal of Economic Perspectives, 2, no. 1 (1998), pp. 191–202. http://econ.ucdenver.edu/Beckman/Econ%204001/thaler-winner’s%20curse.pdf. 78. Daniel Kahneman, Thinking, Fast and Slow (New York: Farrar, Straus and Giroux, 2011), pp. 261–262. 79. Odean, “Do Investors Trade Too Much?” 80. Owen A. Lamont and Richard H. Thaler, “Can the Market Add and Subtract? Mispricing in Tech Stock Carve-outs,” Journal of Political Economy, 111, 2 (2003), pp. 227–268. http://faculty.chicagobooth.edu/john.cochrane/teaching/Empirical_Asset_Pricing/lamont%20and%20thaler%20add%20and%20subtract%20jpe.pdf. 81.

Moreover, since the investor loaning you the stocks knows that you may have to dig into your savings to pay her back, she will charge you a steep interest rate for the privilege. Bubbles can take months or years to deflate. As John Maynard Keynes said, “The market can stay irrational longer than you can stay solvent.” The Price Isn’t Right At other times, investors may not have the opportunity to short stocks at all. One somewhat infamous example, documented by the University of Chicago economists Richard Thaler and Owen Lamont,80 is when the company 3Com spun off shares of its mobile phone subsidiary Palm into a separate stock offering. 3Com kept most of Palm’s shares for itself, however, so a trader could also invest in Palm simply by buying 3Com stock. In particular, 3Com stockholders were guaranteed to receive three shares in Palm for every two shares in 3Com that they held. This seemed to imply Palm shares could trade at an absolute maximum of two-thirds the value of 3Com shares.

Thank you to my bosses and colleagues at the New York Times, especially Megan Liberman, Jim Roberts, David Leonhardt, Lisa Tozzi, Gerry Mullany, Rick Berke, Dick Stevenson, Derek Willis, Matt Ericson, Greg Veis, and Hugo Lindgren, who trusted me to manage the demands of the book production cycle along with those of the news cycle. Thank you to Bill Keller, Gerry Marzorati, and Jill Abramson for bringing me into the New York Times family. Thank you to John Sides, Andrew Gelman, Tom Schaller, Ed Kilgore, Renard Sexton, Brian McCabe, Hale Stewart, and Sean Quinn for their contributions to the FiveThirtyEight blog. Thank you to Richard Thaler and Anil Kashyap, of the University of Chicago, for reviewing the chapters related to economics and finance. Thank you to David Carr, Kathy Gauldin, and Page Ashley for reminding me of the importance of finishing the book, and to Will Repko for helping to instill that work ethic that might get it there. Thank you to Gary Huckabay, Brandon Adams, Rafe Furst, Kevin Goldstein, Keith Urbahn, Matthew Vogel, Rachel Hauser, Jennifer Bloch, Thom Shanker, Kyu-Young Lee, and Mark Goldstein for serving as connectors and facilitators at key points along the way.


pages: 695 words: 194,693

Money Changes Everything: How Finance Made Civilization Possible by William N. Goetzmann

Albert Einstein, Andrei Shleifer, asset allocation, asset-backed security, banking crisis, Benoit Mandelbrot, Black Swan, Black-Scholes formula, Bretton Woods, Brownian motion, business cycle, capital asset pricing model, Cass Sunstein, collective bargaining, colonial exploitation, compound rate of return, conceptual framework, corporate governance, Credit Default Swap, David Ricardo: comparative advantage, debt deflation, delayed gratification, Detroit bankruptcy, disintermediation, diversified portfolio, double entry bookkeeping, Edmond Halley, en.wikipedia.org, equity premium, financial independence, financial innovation, financial intermediation, fixed income, frictionless, frictionless market, full employment, high net worth, income inequality, index fund, invention of the steam engine, invention of writing, invisible hand, James Watt: steam engine, joint-stock company, joint-stock limited liability company, laissez-faire capitalism, Louis Bachelier, mandelbrot fractal, market bubble, means of production, money market fund, money: store of value / unit of account / medium of exchange, moral hazard, Myron Scholes, new economy, passive investing, Paul Lévy, Ponzi scheme, price stability, principal–agent problem, profit maximization, profit motive, quantitative trading / quantitative finance, random walk, Richard Thaler, Robert Shiller, Robert Shiller, shareholder value, short selling, South Sea Bubble, sovereign wealth fund, spice trade, stochastic process, the scientific method, The Wealth of Nations by Adam Smith, Thomas Malthus, time value of money, too big to fail, trade liberalization, trade route, transatlantic slave trade, tulip mania, wage slave

“British investment overseas 1870–1913: A modern portfolio theory approach.” Review of Finance 10(2): 261–300. 3. Klapper, Leora, Víctor Sulla, and Dimitri Vittas. 2004. “The development of mutual funds around the world.” Emerging Markets Review 5(1): 1–38. 4. Bhattacharya, Utpal, and Neal Galpin. 2011. “The global rise of the value-weighted portfolio.” Journal of Financial and Quantitative Analysis 46(3): 737. 5. Benartzi, Shlomo, and Richard H. Thaler. 2001. “Naive diversification strategies in defined contribution saving plans.” American Economic Review 91(1): 79–98 6. Thaler, Richard H. and Cass R. Sustein. 2008. Nudge: Improving Decisions About Health, Wealth and Happiness. New Haven: Yale University Press. BIBLIOGRAPHY Aeschylus. 1926. Aeschylus, with an English Translation by Herbert Weir Smyth, vol. 1: Persians. Cambridge, MA.

Publicans and Sinners: Private Enterprise in the Service of the Roman Republic. Ithaca, NY: Cornell University Press. Bailey, Paul. 2013. Strengthen the Country and Enrich the People: The Reform Writings of Ma Jianzhong. London: Routledge. Banner, Stuart. 1998. Anglo-American Securities Regulation. Cambridge: Cambridge University Press. Barnish, S.J.B. 1985. “The wealth of Julius Argentarius.” Byzantion 55: 5–38. Benartzi, Shlomo, and Richard H. Thaler. 2001. “Naive diversification strategies in defined contribution saving plans.” American Economic Review (Evanston) 91(1): 79–98. Bernoulli, Jacob, and Edith Dudley Sylla. 2006. The Art of Conjecturing, Together with Letter to a Friend on Sets in Court Tennis. Baltimore: Johns Hopkins University Press. Bernstein, Peter L. 1998. Against the Gods: The Remarkable Story of Risk. New York: John Wiley & Sons.

The institutionalization of savings, beginning with the emergence of state-owned pension funds and now sovereign funds, drives a wedge between savers and financial markets. DELEGATED DECIDING The good thing about institutionalizing investment is that it saves people from themselves. We know that most investors think they are good at stock selection, but they are not. We know that indexing is the smart thing to do for the vast majority of investors, but human nature stands in the way of rational choice. Richard Thaler, professor at the University of Chicago, is one of the leading lights of behavioral finance. He and Shlomo Benartzi of the University of California in Los Angeles did a study of investor decisions about pension fund options.5 They found a disappointing pattern. People seemed not to understand the difference between stocks and bonds. They tended to divide their portfolio equally across the choices presented in their 401(k) plans, regardless of whether there were more bond funds or stock funds.


Virtual Competition by Ariel Ezrachi, Maurice E. Stucke

Airbnb, Albert Einstein, algorithmic trading, barriers to entry, cloud computing, collaborative economy, commoditize, corporate governance, crony capitalism, crowdsourcing, Daniel Kahneman / Amos Tversky, David Graeber, demand response, disintermediation, disruptive innovation, double helix, Downton Abbey, Erik Brynjolfsson, experimental economics, Firefox, framing effect, Google Chrome, index arbitrage, information asymmetry, interest rate derivative, Internet of things, invisible hand, Jean Tirole, John Markoff, Joseph Schumpeter, Kenneth Arrow, light touch regulation, linked data, loss aversion, Lyft, Mark Zuckerberg, market clearing, market friction, Milgram experiment, multi-sided market, natural language processing, Network effects, new economy, offshore financial centre, pattern recognition, prediction markets, price discrimination, price stability, profit maximization, profit motive, race to the bottom, rent-seeking, Richard Thaler, ride hailing / ride sharing, road to serfdom, Robert Bork, Ronald Reagan, self-driving car, sharing economy, Silicon Valley, Skype, smart cities, smart meter, Snapchat, social graph, Steve Jobs, supply-chain management, telemarketer, The Chicago School, The Myth of the Rational Market, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, Travis Kalanick, turn-by-turn navigation, two-sided market, Uber and Lyft, Uber for X, uber lyft, Watson beat the top human players on Jeopardy!, women in the workforce, yield management

Office of Fair Trading, Consumer Behavioural Biases in Competition: A Survey, Final Report, OFT1324 (May 2011), 3.10–3.201.11. 51. E. Vis and J. Toth, “ The Abolition of the No-Discrimination Rule,” (Amsterdam: ITM Research, March 2000), 7–10, http://www.creditslips.org/fi les /netherlands-no-discrimination-rule-study.pdf. Notes to Pages 111–115 293 52. Daniel Kahneman, Jack L. Knetsch, and Richard H. Thaler, “Fairness as a Constraint on Profit Seeking: Entitlements in the Market,” in Advances in Behavioral Economics, Colin F. Camerer, George Loewenstein, and Matthew Rabin, eds. (Princeton, NJ: Princeton University Press, December 28, 2003), 252, 257. 53. Organisation for Economic Co-operation and Development, Competition and Regulation in Agriculture: Monopsony Buying and Joint Selling, DAF/ COMP(2005)44 (December 21, 2005), 8, http://www.oecd.org/competition /abuse/35910977.pdf. 54.

Horton, “Unraveling the Chicago/ Harvard Antitrust Double Helix: Applying Evolutionary Theory to Guard Competitors and Revive Antitrust Jury Trials,” University of Baltimore Law Review 41 (2012): 615, 653–654 (citing research on how “ ‘fairness evolved as a stable strategy for maintaining social harmony’ in our economic relation- Notes to Pages 123–125 22. 23. 24. 25. 26. 27. 28. 29. 30. 31. 32. 33. 34. 299 ships” and how “[n]eurobiological studies have found that ‘the sense of fairness fundamental to distributive justice’ is rooted in humans’ emotional processing”), quoting Joan Roughgarden, The Genial Gene: Deconstructing Darwinian Selfishness (Berkeley: University of California Press, 2009), 160; Michael Shermer, The Mind of the Market: Compassionate Apes, Competitive Humans, and Other Tales from Evolutionary Economics (New York: Times Books, 2008), 11. 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, 735. Ellen Garbarino and Sarah Maxwell, “Consumer Response to NormBreaking Pricing Events in E-Commerce,” Journal of Business Research 63 (2010): 1066, 1069. Lan Xia and Kent B. Monroe, “Is a Good Deal Always Fair? Examining the Concepts of Transaction Value and Price Fairness,” Journal of Economic Psychology 31 (2010): 884, 891.

(April 23, 2015), https://www.ftc.gov/system/fi les/documents/public _ statements/638351/150423nomicommissionstatement.pdf. 47. Federal Trade Commission, Data Brokers: A Call for Transparency and Accountability (May 2014), ii–iii, https://www.ftc.gov/system/fi les/documents /reports/data-brokers-call-transparency-accountability-report-federal-trade -commission-may-2014/140527databrokerreport.pdf. 48. Ibid. 49. Kahneman, Thinking, Fast and Slow. 50. Richard Thaler, Misbehaving: The Making of Behavioral Economics (New York: W. W. Norton, 2015), chap. 7. 51. G. B. Northcraft and M. A. Neale, “Experts, Amateurs, and Real Estate: An Anchoring-and-Adjustment Perspective on Property Pricing Decisions,” Organizational Behavior and Human Decision Processes 39 (1987): 84–97. 52. The packet included “a copy of the MLS summary of residential real estate sales for both the entire city and the immediate neighborhood of the property for the last 6 months; and information (including listing price, square footage, characteristics of the property, etc.) about other property located in the same neighborhood as the property being evaluated (this information was divided into four categories: property currently for sale, property recently sold, property sold but the sale not yet completed, and property previously listed which did not sell); [and] standard MLS listing information for other property in the immediate neighborhood currently for sale.”


pages: 898 words: 266,274

The Irrational Bundle by Dan Ariely

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, hedonic treadmill, IKEA effect, 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 Thaler, Saturday Night Live, Schrödinger's Cat, second-price auction, Shai Danziger, 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

James Heyman, Yesim Orhun, and Dan Ariely, “Auction Fever: The Effect of Opponents and Quasi-Endowment on Product Valuations,” Journal of Interactive Marketing (2004). RELATED READINGS Richard Thaler, “Toward a Positive Theory of Consumer Choice,” Journal of Economic Behavior and Organization (1980). Jack Knetsch, “The Endowment Effect and Evidence of Nonreversible Indifference Curves,” American Economic Review, Vol. 79 (1989), 1277–1284. Daniel Kahneman, Jack Knetsch, and Richard Thaler, “Experimental Tests of the Endowment Effect and the Coase Theorem,” Journal of Political Economy (1990). Daniel Kahneman, Jack Knetsch, and Richard H. Thaler, “Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias,” Journal of Economic Perspectives, Vol. 5 (1991), 193–206. Chapter 9: Keeping Doors Open BASED ON Jiwoong Shin and Dan Ariely, “Keeping Doors Open: The Effect of Unavailability on Incentives to Keep Options Viable,” Management Science (2004).

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. Justin Kruger, Derrick Wirtz, Leaf Van Boven, and T.

It’s Unconscious Bias,” Harvard Business Review (2002). Maurice Schweitzer and Chris Hsee, “Stretching the Truth: Elastic Justification and Motivated Communication of Uncertain Information,” Journal of Risk and Uncertainty (2002). Chapter 15: Beer and Free Lunches BASED ON Dan Ariely and Jonathan Levav, “Sequential Choice in Group Settings: Taking the Road Less Traveled and Less Enjoyed,” Journal of Consumer Research (2000). Richard Thaler and Shlomo Benartzi, “Save More Tomorrow: Using Behavioral Economics to Increase Employee Savings,” Journal of Political Economy (2004). RELATED READINGS Eric J. Johnson and Daniel Goldstein, “Do Defaults Save Lives?” Science, (2003). Praise for Predictably Irrational “This is a wonderful, eye-opening book. Deep, readable, and providing refreshing evidence that there are domains and situations in which material incentives work in unexpected ways.


Investment: A History by Norton Reamer, Jesse Downing

activist fund / activist shareholder / activist investor, Albert Einstein, algorithmic trading, asset allocation, backtesting, banking crisis, Berlin Wall, Bernie Madoff, break the buck, Brownian motion, business cycle, buttonwood tree, buy and hold, 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, dogs of the Dow, 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

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. Thaler, “Myopic Loss Aversion and the Equity Premium Puzzle,” Quarterly Journal of Economics 110, no. 1 (February 1995): 73–92. 50. Burton G. Malkiel, “The Efficient Market Hypothesis and Its Critics,” Journal of Economic Perspectives 17, no. 1 (Winter 2003): 61–62. 8. MORE NEW INVESTMENT FORMS 1. Towers Watson and Financial Times, “Global Alternatives Survey 2012,” last modified July 2012, http://www.towerswatson.com/en-US /Insights/IC-Types/Sur vey-Research-Results/2012/07/Global -Alternatives-Survey-2012, 7–8. 2.

Accessed 2014. http://www.barclayhedge.com/research/indices/ghs/mum/Hedge_Fund.html. Barth, Chris. “Warren Buffett: Clairvoyant or Crazy?” Forbes, June 12, 2012. http://www.forbes.com/sites/chrisbarth/2012/06/12/warren-buffett -clairvoyant-or-crazy. Bartlett, Bruce. “How Deficit Hawks Could Derail the Recovery.” Forbes, January 8, 2010. http://www.forbes.com/2010/01/07/deficit-greatdepression-recovery-opinions-columnists-bruce-bartlett.html. Benartzi, Shlomo, and Richard H. Thaler. “Myopic Loss Aversion and the Equity Premium Puzzle.” Quarterly Journal of Economics 110, no. 1 (February 1995): 73–92. Benedict XIV (Pope). Vix Pervenit. [1745]. EWTN Global Catholic Network. http://www.ewtn.com/library/ENCYC/B14VIXPE.htm. Benhamou, Michael. “Betting Against the Street.” MarketWatch, June 9, 2005. http://www.marketwatch.com/story/taking-advantage-of-convertible-arbs. Berger, Adolf, Barry Nicholas, and Susan M.

There were some who suggested that it was merely survivorship bias that explained this phenomenon; that is, there were stocks that went bankrupt or otherwise delisted and so this high premium was not real after all.48 Others suggested that there were frictions unaccounted for, such as transaction costs. The behavioral economists mounted a different set of explanations. One of the most cited and well-regarded explanations, put forth by Shlomo Benartzi and Richard Thaler in 1995, is “myopic loss aversion,” a notion that borrows heavily from the concepts developed in prospect theory, including the fact that individuals tend to exhibit loss aversion and that they care about changes in wealth more keenly than about absolute levels of wealth. Investors who frequently look at the value of their equity portfolio—say, on a daily or weekly basis when the market behaves randomly over these short time frames, moving up and down—will thus experience more disutility on average, given that they derive greater pain from losses than pleasure from the same magnitude of gains.


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Economic Dignity by Gene Sperling

active measures, Affordable Care Act / Obamacare, autonomous vehicles, basic income, Bernie Sanders, Cass Sunstein, collective bargaining, corporate governance, David Brooks, desegregation, Detroit bankruptcy, Donald Trump, Double Irish / Dutch Sandwich, Elon Musk, employer provided health coverage, Erik Brynjolfsson, Ferguson, Missouri, full employment, gender pay gap, ghettoisation, gig economy, Gini coefficient, guest worker program, Gunnar Myrdal, housing crisis, income inequality, invisible hand, job automation, job satisfaction, labor-force participation, late fees, liberal world order, longitudinal study, low skilled workers, Lyft, Mark Zuckerberg, market fundamentalism, mass incarceration, mental accounting, meta analysis, meta-analysis, minimum wage unemployment, obamacare, offshore financial centre, payday loans, price discrimination, profit motive, race to the bottom, RAND corporation, randomized controlled trial, Richard Thaler, ride hailing / ride sharing, Ronald Reagan, Rosa Parks, Second Machine Age, secular stagnation, shareholder value, Silicon Valley, single-payer health, speech recognition, The Chicago School, The Future of Employment, The Wealth of Nations by Adam Smith, Toyota Production System, traffic fines, Triangle Shirtwaist Factory, Uber and Lyft, uber lyft, union organizing, universal basic income, War on Poverty, working poor, young professional, zero-sum game

Kathryn Schulz, “The Many Lives of Pauli Murray,” New Yorker, April 10, 2017, https://www.newyorker.com/magazine/2017/04/17/the-many-lives-of-pauli-murray. 2. Pauli Murray, “An American Credo,” Common Ground 5, no. 2 (December 1945): 22–24. CHAPTER ONE: ECONOMIC METRICS AND INVISIBILITY 1. See Richard H. Thaler, “Mental Accounting Matters,” Journal of Behavioral Decision Making 12, no. 3 (1999): 183–206, https://doi.org/10.1002/(sici)1099-0771(199909)12:3<183::aid-bdm318>3.0.co;2-f) [inactive]; and Richard H. Thaler, “Behavioral Economics: Past, Present and Future,” SSRN Electronic Journal, May 27, 2016, https://doi.org/10.2139/ssrn.2790606. 2. “Robert F. Kennedy, Remarks at the University of Kansas, March 18, 1968,” JFK Library, accessed November 4, 2019, https://www.jfklibrary.org/learn/about-jfk/the-kennedy-family/robert-f-kennedy/robert-f-kennedy-speeches/remarks-at-the-university-of-kansas-march-18-1968. 3.

Indeed, any economic metric that cannot tell us whether the great majority of people are seeing their lives enhanced cannot be a rational or humane end goal for economic policy. The only logical end goal for economic policy in a democracy is that which lifts up what matters most in the lives of the people that policy is supposed to serve. Economics, by the people, of the people, and for the people. Nobel Prize–winning economist Richard Thaler has said that a mistake in many human activities is to focus more on what can be measured than on what is most important.1 Consider your own life. For many of us, finding a loving, supportive life partner and the happiness of our children are the highest values—even if those values are incalculable and can never be measured with precision. Yet economics in practice is unusually focused on what can be counted, measured, added, or subtracted.


pages: 351 words: 100,791

The World Beyond Your Head: On Becoming an Individual in an Age of Distraction by Matthew B. Crawford

airport security, Cass Sunstein, choice architecture, collateralized debt obligation, creative destruction, David Brooks, delayed gratification, dematerialisation, deskilling, digital Maoism, Google Glasses, hive mind, index card, informal economy, Jaron Lanier, large denomination, new economy, new new economy, Norman Mailer, online collectivism, plutocrats, Plutocrats, Richard Thaler, Rodney Brooks, self-driving car, Silicon Valley, Silicon Valley ideology, Stanford marshmallow experiment, the built environment, the scientific method, The Wisdom of Crowds, theory of mind, Walter Mischel, winner-take-all economy

There are, then, three time scales that matter for the question of how we come to be what we are: Darwinian evolution, the history of a civilization, and the life course of an individual. This is perhaps obvious, once stated. But it puts limits, which would seem to be fatal, on the explanatory power of evolutionary psychology—that is, on the attempt to explain human behavior as the product of adaptive pressures we faced on the savannahs in the Pleistocene epoch. 5. Richard H. Thaler and Cass R. Sunstein, Nudge: Improving Decisions About Health, Wealth, and Happiness (New Haven: Yale University Press, 2008). 6. And, who knows, maybe this is to be preferred. The Protestant is a somewhat cramped human type. One might prefer to spend the evening with someone nudged into saving money (enough so he can pay for the meal), but who doesn’t have the deeply internalized ethic of thrift, which easily shades into miserliness. 7.

We give undue weight to the most recent events when trying to grasp a larger pattern and predict the future. In general, we are terrible at estimating probabilities. We are not so much rational optimizers as creatures who rely on biases and crude heuristics for making important decisions. In Nudge, Cass Sunstein, the former head of the Office of Information and Regulatory Affairs under President Obama, and the economist Richard Thaler argue for a mode of social engineering that takes account of these psychological facts.5 For starters, we’re a lot lazier than the rational optimizer view would have it. That is, to make everything a matter for reflection and explicit evaluation goes against the grain of how human beings normally operate. So, for example, if one wants to increase the savings rate, it makes a great deal of difference whether employers set the default so that employees have to opt in to a 401(k) plan if they want it, or instead they have to opt out if they don’t.


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The Economists' Hour: How the False Prophets of Free Markets Fractured Our Society by Binyamin Appelbaum

"Robert Solow", airline deregulation, Alvin Roth, Andrei Shleifer, anti-communist, battle of ideas, Benoit Mandelbrot, Big bang: deregulation of the City of London, Bretton Woods, British Empire, business cycle, capital controls, Carmen Reinhart, Cass Sunstein, Celtic Tiger, central bank independence, clean water, collective bargaining, Corn Laws, correlation does not imply causation, Credit Default Swap, currency manipulation / currency intervention, David Ricardo: comparative advantage, deindustrialization, Deng Xiaoping, desegregation, Diane Coyle, Donald Trump, ending welfare as we know it, financial deregulation, financial innovation, fixed income, floating exchange rates, full employment, George Akerlof, George Gilder, Gini coefficient, greed is good, Growth in a Time of Debt, income inequality, income per capita, index fund, inflation targeting, invisible hand, Isaac Newton, Jean Tirole, John Markoff, Kenneth Arrow, Kenneth Rogoff, land reform, Long Term Capital Management, low cost airline, manufacturing employment, means of production, Menlo Park, minimum wage unemployment, Mohammed Bouazizi, money market fund, Mont Pelerin Society, Network effects, new economy, oil shock, Paul Samuelson, Philip Mirowski, plutocrats, Plutocrats, price stability, profit motive, Ralph Nader, RAND corporation, rent control, rent-seeking, Richard Thaler, road to serfdom, Robert Bork, Robert Gordon, Ronald Coase, Ronald Reagan, Sam Peltzman, Silicon Valley, Simon Kuznets, starchitect, Steve Jobs, supply-chain management, The Chicago School, The Great Moderation, The Myth of the Rational Market, The Wealth of Nations by Adam Smith, Thomas Kuhn: the structure of scientific revolutions, transaction costs, trickle-down economics, ultimatum game, Unsafe at Any Speed, urban renewal, War on Poverty, Washington Consensus

: World Bank Group, 2015). 38. Amartya Sen, Development as Freedom (New York: Knopf, 1999), 14. 39. Frank H. Knight, Selected Essays by Frank H. Knight, vol. 2, Laissez Faire: Pro and Con, ed. Ross B. Emmett (Chicago: University of Chicago Press, 1999), 14. 40. Samuel Brittan, “The Economic Contradictions of Democracy,” British Journal of Political Science 5, no. 2 (1975): 129–59. 41. Richard H. Thaler, “Anomalies: The Ultimatum Game,” Journal of Economic Perspectives 2, no. 4 (1988): 195–206. 42. Milton Friedman, Capitalism and Freedom (Chicago: University of Chicago Press, 1962), 24. Index Abe, Shinzō, ref1 African Americans, ref1, ref2, ref3 airline industry: competition of, ref1, ref2, ref3, ref4, ref5, ref6, ref7; deregulation of, ref1, ref2, ref3, ref4, ref5, ref6, ref7, ref8, ref9, ref10; economic regulation of, ref1, ref2, ref3, ref4, ref5, ref6 Alchian, Armen, ref1, ref2, ref3 Alesina, Alberto, ref1, ref2 Alessandri, Jorge, ref1, ref2 Alexis, Marcus, ref1 Allende, Salvador, ref1, ref2, ref3, ref4 American Economic Association, ref1, ref2, ref3, ref4, ref5, ref6 American Enterprise Institute, ref1, ref2, ref3, ref4, ref5 Anderson, John, ref1, ref2 Anderson, Martin: and Arthur Burns, ref1; and Milton Friedman, ref1, ref2; and Richard Nixon, ref1, ref2, ref3; and Ronald Reagan, ref1, ref2, ref3, ref4 Angermueller, Hans H., ref1 antitrust regulation: Robert Bork on, ref1, ref2, ref3, ref4; and Jimmy Carter, ref1, ref2; and corporations, ref1, ref2, ref3, ref4, ref5, ref6, ref7, ref8, ref9, ref10; and efficiency, ref1, ref2, ref3, ref4, ref5; and Barack Obama, ref1; George Stigler on, ref1, ref2, ref3, ref4, ref5, ref6; and U.S.

The British government obtained similar results in a 1970s survey. It offered the following choice: (A) Everyone gets £4 per week. (B) You get £5 per week, but some people get £6 per week. Eighty percent of respondents picked the first option, forgoing £1 per week because other people would get more.40 “Homo economicus is usually assumed to care about wealth more than such issues as fairness and justice,” says the behavioral economist Richard Thaler. “The research on ultimatum games belies such easy characterizations.”41 Sometimes, the right answer is to do without a market. Congressional committees reserve at least a few seats at every hearing for the general public. The first people in line, however, generally have no interest in attending the hearing. They are paid to stand in line by companies that save seats, at a hefty price, for lobbyists or other members of the Washington elite.

The official responsible for that decision, Robert Carter, later testified it was the first time the Transportation Department had used cost-benefit analysis as its primary basis for evaluating a regulation: see “Federal Regulation and Regulatory Reform,” House Committee on Interstate and Foreign Commerce, 1976, fn. 73. 41. Thomas Schelling, “The Life You Save May Be Your Own,” in Problems in Public Expenditure Analysis, ed. Samuel B. Chase Jr. (Washington, D.C.: Brookings Institution, 1966). 42. The early estimators included Robert Smith, an economist at Cornell; W. Kip Viscusi, a graduate student at Harvard; and Richard Thaler, a graduate student at the University of Rochester. Thaler’s father, an actuary, provided him with data on occupational mortality rates, which Thaler combined with wage data to analyze what workers were paid to take larger risks. His conclusion, published in his 1974 doctoral thesis, was that workers valued their own lives at about $200,000. But Thaler was skeptical of his own results. He started surveying people to see whether their risk assessments were consistent with the values implied by their job choices.


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Poor Economics: A Radical Rethinking of the Way to Fight Global Poverty by Abhijit Banerjee, Esther Duflo

Albert Einstein, Andrei Shleifer, business process, business process outsourcing, call centre, Cass Sunstein, charter city, clean water, collapse of Lehman Brothers, congestion charging, demographic transition, diversified portfolio, experimental subject, hiring and firing, Kickstarter, land tenure, low skilled workers, M-Pesa, microcredit, moral hazard, purchasing power parity, randomized controlled trial, Richard Thaler, school vouchers, Silicon Valley, The Fortune at the Bottom of the Pyramid, Thomas Malthus, urban planning

Clemens, “Herd Immunity Conferred by Killed Oral Cholera Vaccines in Bangladesh: A Reanalysis,” Lancet 366 (2005): 44–49. 37 The psychological research has found its way in economics thanks to researchers such as Dick Thaler from the University of Chicago, George Lowenstein from Carnegie-Mellon, Matthew Rabin from Berkeley, David Laibson from Harvard, and others, whose work we cite here. 38 Richard H. Thaler and Cass R. Sunstein, Nudge: Improving Decisions About Health, Wealth, and Happiness (New York: Penguin, 2008). 39 See a comparative cost-effectiveness analysis on the Web site of the Abdul Latif Jameel Poverty Action Lab, available at http://www.povertyactionlab.org/policy-lessons/health/child-diarrhea. 40 Abhijit Banerjee, Esther Duflo, and Rachel Glennerster, “Is Decentralized Iron Fortification a Feasible Option to Fight Anemia Among the Poorest?”

Fines or incentives can push individuals to take some action that they themselves consider desirable but perpetually postpone taking. More generally, time inconsistency is a strong argument for making it as easy as possible for people to do the “right” thing, while, perhaps, leaving them the freedom to opt out. In their best-selling book Nudge: Improving Decisions About Health, Wealth, and Happiness, Richard Thaler and Cass Sunstein, an economist and a law scholar from the University of Chicago, recommend a number of interventions to do just this.38 An important idea is that of default option: The government (or a well-meaning NGO) should make the option that it thinks is the best for most people the default choice, so that people will need to actively move away from it if they want to. So people have the right to choose what they want, but there is a small cost of doing so, and as a result, most people end up choosing the default option.


pages: 387 words: 120,155

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

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, different worldview, endowment effect, happiness index / gross national happiness, hedonic treadmill, hindsight bias, IKEA effect, illegal immigration, job satisfaction, Kickstarter, libertarian paternalism, light touch regulation, longitudinal study, 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 Thaler, Right to Buy, Ronald Reagan, Rory Sutherland, Simon Kuznets, skunkworks, the built environment, theory of mind, traffic fines, twin studies, World Values Survey

Still, in spite of these difficulties, much has been learned about specific policy ideas and, just as importantly, how to create an organisation that can investigate the use of behavioural insights to solve real world problems. This first-hand account should be of interest to anyone curious about finding new ways to solve problems in any domain, from the public sector to the private sector to our own lives. As you read the pages that follow, my only request is the one that I write every time someone asks me to sign a copy of Nudge. ‘Nudge for good.’ Please. Richard Thaler, July 2015 PREFACE IT IS TWENTY months into the new government, elected in 2010. The Cabinet Secretary, Britain’s most senior civil servant, has gathered together the heads of the government departments. Between them, they are responsible for the collection and spending of more than half a trillion pounds and employ more than five million public sector workers. There are too many to fit comfortably around the table of the Cabinet Secretary’s wood-panelled room.

Similarly, it is not difficult to conclude that our brains weren’t made for the day-to-day financial judgements that are the foundation of modern economies: from mortgages, to pensions, to the best buy in a supermarket. Yet classic economic and regulatory models are themselves based on mental shortcuts, or naive models of humanity that do not ring true. They’re like ill-fitting suits, because the model on which they are based is a simplistic mental mannequin. In their book Nudge, Richard Thaler and Cass Sunstein describe these simplified creatures as ‘econs’. These econs consider and weigh up all the options, coolly and accurately, like the Vulcan Mr Spock from Star Trek, or the legendary Deep Blue that finally defeated the great chess champion Garry Kasparov (or at least how people think it ‘thought’). In contrast, ‘humans’ can’t consider 200 million options a second, and our thinking and decisions are fused with emotion.

A ‘nudge’ is essentially a means of encouraging or guiding behaviour, but without mandating or instructing, and ideally without the need for heavy financial incentives or sanctions. We know what it means in everyday life: it’s a gentle hint; a suggestion; a conspicuous glance at a heap of clothes that we’re hoping our kids or our partner might clear away. It stands in marked contrast to an obligation; a strict requirement; or the use of force. For Cass Sunstein and Richard Thaler, originators of the term ‘nudge’, a key element is that it avoids shutting down choices, unlike a law or formal requirement. But, as we shall see, a ‘nudge’ is a subset of a wider, more empirical and behaviourally focused approach to policymaking. Consider how a law actually works. A parliament or executive passes a resolution that says that henceforth there will be a new requirement on people or businesses to do something in a particular way (or not to do something).


pages: 545 words: 137,789

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

"Robert Solow", 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, Blythe Masters, Bretton Woods, British Empire, business cycle, 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, different worldview, 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, Kickstarter, 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

.”: Tversky and Kahneman, “Judgement under Uncertainty,” 1126. 197 Likelihood of getting killed in a terrorist attack: See N. Wilson and G. Thomson, “Deaths from International Terrorism Compared with Road Crash Deaths in OECD Countries,” Injury Prevention 11 (2005): 332–33. 197 “Payoffs for accuracy . . .”: Tversky and Kahneman, “Judgment under Uncertainty,” 1128. 198 Thaler’s mental shortcuts: See Richard H. Thaler, Winner’s Curse: Paradoxes and Anomalies of Economic Life (Princeton, N.J.: Princeton University Press, 1992). 198 “inspired a new generation . . .”: Nobel Prize press release, October 9, 2002, available at http://nobelprize.org/nobel_prizes/economics/laureates/2002/press.html. 199 “[T]he average individual bidder/manager . . .”: Richard Roll, “The Hubris Hypothesis of Corporate Takeovers,” part 1, Journal of Business 59, no. 2 (1986): 199–200. 199 “Disaster Myopia in International Banking”: Described in James M.

Experiments suggest that once a person gets “anchored” on a certain number, or argument, he may well try to cling to it by mistakenly interpreting any evidence that is presented to him as supportive, even if it is actually contradictory. (In the literature, this is known as the “confirmation bias.”) In the aftermath of the latest Columbine-style mass shooting, supporters of gun control invariably say, “I told you so,” but so do supporters of maintaining an armed citizenry. In 1977–1978, Kahneman and Tversky spent the academic year at Stanford, where they became friends and collaborators with Richard Thaler, a young economist who had done his Ph.D. at Rochester, a bastion of mathematical orthodoxy. During his graduate training, Thaler had developed a list of anecdotes that seemed to contradict the theory he’d been taught, such as people’s reluctance to part with minor possessions—mugs, pens, those sorts of things—and their tendency to divide their expenditures into separate mental accounts (one for leisure, another for rent, and so on).


Science Fictions: How Fraud, Bias, Negligence, and Hype Undermine the Search for Truth by Stuart Ritchie

Albert Einstein, anesthesia awareness, Bayesian statistics, Carmen Reinhart, Cass Sunstein, citation needed, Climatic Research Unit, cognitive dissonance, complexity theory, coronavirus, correlation does not imply causation, COVID-19, Covid-19, crowdsourcing, deindustrialization, Donald Trump, double helix, en.wikipedia.org, epigenetics, Estimating the Reproducibility of Psychological Science, Growth in a Time of Debt, Kenneth Rogoff, l'esprit de l'escalier, meta analysis, meta-analysis, microbiome, Milgram experiment, mouse model, New Journalism, p-value, phenotype, placebo effect, profit motive, publication bias, publish or perish, race to the bottom, randomized controlled trial, recommendation engine, rent-seeking, replication crisis, Richard Thaler, risk tolerance, Ronald Reagan, Scientific racism, selection bias, Silicon Valley, Silicon Valley startup, Stanford prison experiment, statistical model, stem cell, Steven Pinker, Thomas Bayes, twin studies, University of East Anglia

‘The 2007 Ig Nobel Prize Winners’, 4 Oct. 2007; https://www.improbable.com/ig/winners/#ig2007. The soup bowl paper is: Brian Wansink and Matthew M. Cheney, ‘Super Bowls: Serving Bowl Size and Food Consumption’, JAMA 293, no. 14 (13 April 2005): pp. 1727–28; https://doi.org/10.1001/jama.293.14.1727. It was featured and described as ‘another Wansink … masterpiece’ in Richard Thaler and Cass Sunstein’s influential 2008 book Nudge. Sunstein has since won a real Nobel Prize for economics. Richard H. Thaler & Cass R. Sunstein, Nudge: Improving Decisions about Health, Wealth and Happiness (New Haven: Yale University Press, 2008): p. 43. 45.  Portion-size research: Wansink & Cheney, ‘Super Bowls’. Shopping when hungry: Aner Tal & Brian Wansink, ‘Fattening Fasting: Hungry Grocery Shoppers Buy More Calories, Not More Food’, JAMA Internal Medicine 173, no. 12 (June 24, 2013): 1146–48; https://doi.org/10.1001/jamainternmed.2013.650.


pages: 249 words: 77,342

The Behavioral Investor by Daniel Crosby

affirmative action, Asian financial crisis, asset allocation, availability heuristic, backtesting, bank run, Black Swan, buy and hold, cognitive dissonance, colonial rule, compound rate of return, correlation coefficient, correlation does not imply causation, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, Donald Trump, endowment effect, feminist movement, Flash crash, haute cuisine, hedonic treadmill, housing crisis, IKEA effect, impulse control, index fund, Isaac Newton, job automation, longitudinal study, loss aversion, market bubble, market fundamentalism, mental accounting, meta analysis, meta-analysis, Milgram experiment, moral panic, Murray Gell-Mann, Nate Silver, neurotypical, passive investing, pattern recognition, Ponzi scheme, prediction markets, random walk, Richard Feynman, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, science of happiness, Shai Danziger, short selling, South Sea Bubble, Stanford prison experiment, Stephen Hawking, Steve Jobs, stocks for the long run, Thales of Miletus, The Signal and the Noise by Nate Silver, tulip mania, Vanguard fund

Being a behavioral investor is less about adhering to some textbook notion of rationality and more about understanding and bending the idiosyncrasies of human nature to our advantage. Consider the work of Nobel Prize winner Richard Thaler who first discovered and named what we now refer to as “mental accounting,” the tendency to separate money into different buckets and spend or save it differently depending on how it is labeled. Studies have shown that people are apt to save money labeled as a rebate but to spend money labeled as a bonus. Barack Obama and his advisors, Richard Thaler among them, used framing to position the stimulus given out after the Great Recession as a bonus to incent recipients to buy big screen TVs rather than hoard it. This simple notion is the basis for goals-based investing or personal benchmarking, the process of intentionally dividing money into safety, income and growth buckets and investing it accordingly.

What your textbook will likely omit altogether is a third type of risk – behavioral risk – and this is the most important risk of all. Codifying a universe of behavioral risk is a prerequisite to successfully managing it. After all, how can you fight a monster that you can’t see? In many cases, our universe of behavioral risk is generated from studies of investor misbehavior. As Daniel Kahneman says in The Undoing Project, “How do you understand memory? You don’t study memory. You study forgetting.” Misbehaving, Richard Thaler’s incredible origin story of the field of behavioral economics, recounts the simple but effective way that he set the discipline on its current course. Incredulous about what he was learning about efficient markets, Thaler set out to brainstorm all of the real-life ways in which the people he knew differed from the “Econs” (i.e., fictional individuals who optimize utility and always make rational financial decisions) he was learning about in his theory courses.

Military personnel often reenlist simply because they are unaware of what other options might be at their disposal.77 Sales professionals, who work so hard to position their product or service above that of the competition, are actually up against a far more formidable foe: inertia. According the Sales Benchmark Index, 60% of qualified leads culminate in a “no action,” meaning that the potential customer just didn’t make a choice. Retirement savers, tasked with the all-important mission of preparing a financial future, tend to just opt for whatever the company’s default choice is, a tendency deftly turned to investor advantage by Richard Thaler and colleagues.78 Yes, conservatism is everywhere. Psychological and neurological processes help account for its ubiquity. A study conducted at University College London examined neural pathways involved in status quo bias and found that the more difficult the decision we face, the more likely we are not to act. Participants in the study, which was published in the Proceedings of the National Academy of Sciences, were involved in a tennis “line judgment game” while their brains were scanned using functional magnetic resonance imaging (fMRI).


pages: 295 words: 66,824

A Mathematician Plays the Stock Market by John Allen Paulos

Benoit Mandelbrot, Black-Scholes formula, Brownian motion, business climate, business cycle, butter production in bangladesh, butterfly effect, capital asset pricing model, correlation coefficient, correlation does not imply causation, Daniel Kahneman / Amos Tversky, diversified portfolio, dogs of the Dow, 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, stocks for the long run, survivorship bias, transaction costs, ultimatum game, Vanguard fund, Yogi Berra

“Uncertainty,” he would say, “is the only certainty there is, and knowing how to live with insecurity is the only security.” 1 Anticipating Others’ Anticipations It was early 2000, the market was booming, and my investments in various index funds were doing well but not generating much excitement. Why investments should generate excitement is another issue, but it seemed that many people were genuinely enjoying the active management of their portfolios. So when I received a small and totally unexpected chunk of money, I placed it into what Richard Thaler, a behavioral economist I’ll return to later, calls a separate mental account. I considered it, in effect, “mad money.” Nothing distinguished the money from other assets of mine except this private designation, but being so classified made my modest windfall more vulnerable to whim. In this case it entrained a series of ill-fated investment decisions that, even now, are excruciating to recall.

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. L. Knetschin, and Baruch Fischhoff. Economist Richard Thaler (mentioned in the first chapter) is one of the leaders in applying these emerging insights to economics and finance, and his book The Winner’s Curse, as well as Gilovich’s How We Know What Isn’t So, are very useful compendiums of recent results. What makes these results particularly intriguing is the way they illuminate the tactics used, whether consciously or not, by people in everyday life.

Outside of business, loss aversion plays a role as well. It’s something of a truism that the attempt to cover up a scandal often leads to a much worse scandal. Although most people know this, attempts to cover up are still common, presumably because, here too, people are much more willing to take risks to avoid losses than they are to obtain gains. Another chink in our cognitive apparatus is Richard Thaler’s notion of “mental accounts,” mentioned in the last chapter. “The Legend of the Man in the Green Bathrobe” illustrates this notion compellingly. It is a rather long shaggy dog story, but the gist is that a newlywed on his honeymoon in Las Vegas wakes up in bed and sees a $5 chip left on the dresser. Unable to sleep, he goes down to the casino (in his green bathrobe, of course), bets on a particular number on the roulette wheel, and wins.


pages: 470 words: 148,730

Good Economics for Hard Times: Better Answers to Our Biggest Problems by Abhijit V. Banerjee, Esther Duflo

"Robert Solow", 3D printing, affirmative action, Affordable Care Act / Obamacare, Airbnb, basic income, Bernie Sanders, business cycle, call centre, Capital in the Twenty-First Century by Thomas Piketty, Cass Sunstein, charter city, correlation does not imply causation, creative destruction, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, decarbonisation, Deng Xiaoping, Donald Trump, Edward Glaeser, en.wikipedia.org, endowment effect, energy transition, Erik Brynjolfsson, experimental economics, experimental subject, facts on the ground, fear of failure, financial innovation, George Akerlof, high net worth, immigration reform, income inequality, Indoor air pollution, industrial cluster, industrial robot, information asymmetry, Intergovernmental Panel on Climate Change (IPCC), Jane Jacobs, Jean Tirole, Jeff Bezos, job automation, Joseph Schumpeter, labor-force participation, land reform, loss aversion, low skilled workers, manufacturing employment, Mark Zuckerberg, mass immigration, Network effects, new economy, New Urbanism, non-tariff barriers, obamacare, offshore financial centre, open economy, Paul Samuelson, place-making, price stability, profit maximization, purchasing power parity, race to the bottom, RAND corporation, randomized controlled trial, Richard Thaler, ride hailing / ride sharing, Robert Gordon, Ronald Reagan, school choice, Second Machine Age, secular stagnation, self-driving car, shareholder value, short selling, Silicon Valley, smart meter, social graph, spinning jenny, Steve Jobs, technology bubble, The Chicago School, The Future of Employment, The Market for Lemons, The Rise and Fall of American Growth, The Wealth of Nations by Adam Smith, total factor productivity, trade liberalization, transaction costs, trickle-down economics, universal basic income, urban sprawl, very high income, War on Poverty, women in the workforce, working-age population, Y2K

,” Quarterly Journal of Economics 130, no. 3 (2015): 1329–67. 45 Ernst Fehr, “Degustibus Est Disputandum,” Emerging Science of Preference Formation, inaugural talk, Universitat Pompeu Fabra, Barcelona, Spain, October 7, 2015. 46 Alain Cohn, Ernst Fehr, and Michel Andre Marechal, “Business Culture and Dishonesty in the Banking Industry,” Nature 516 (2014): 86–89. 47 For an overview of their work, see Roland Bénabou and Jean Tirole, “Mindful Economics: The Production, Consumption, and Value of Beliefs,” Journal of Economic Perspectives 30, no. 3 (2016): 141–64. 48 William Julius Wilson, When Work Disappears: The World of the New Urban Poor (New York: Knopf Doubleday, 1997). 49 J. D. Vance, Hillbilly Elegy: A Memoir of a Family and Culture in Crisis (New York: Harper, 2016). 50 Dan Ariely, George Loewenstein, and Drazen Prelec, “’Coherent Arbitrariness’: Stable Demand Curves without Stable Preferences,”Quarterly Journal of Economics 118, no. 1 (2003): 73–106. 51 Daniel Kahneman, Jack L. Knetsch, and Richard H. Thaler, “Experimental Tests of the Endowment Effect and the Coase Theorem,” Journal of Political Economy 98, no. 6 (1990): 1325–48. 52 Dan Ariely, George Loewenstein, and Drazen Prelec, “’Coherent Arbitrariness’: Stable Demand Curves without Stable Preferences,” Quarterly Journal of Economics 118, no. 1 (2003): 73–106. 53 Muzafer Sherif, The Robber’s Cave Experiment: Intergroup Conflict and Cooperation, (Middletown, CT: Wesleyan University Press, 1998). 54 Gerard Prunier, The Rwanda Crisis: History of a Genocide (New York: Columbia University Press, 1997). 55 Paul Lazarsfeld and Robert Merton, “Friendship as a Social Process: A Substantive and Methodological Analysis,” in Freedom and Control in Modern Society, eds.

COHERENT ARBITRARINESS50 We know that people will go to great lengths to avoid evidence that would force them to revise their opinions on what they consider to be their core value system (including their opinion about other races or immigrants), because it is so related to their views of themselves. Unfortunately, it does not follow that people are particularly thoughtful about forming those initial opinions. In one of the most famous experiments in the field of behavioral economics, Daniel Kahneman and Richard Thaler chose college students randomly to receive a mug or a pen. Immediately following the gifts, they offered to buy them back from the newly endowed mug and pen owners. At the same time, they also offered those who did not get a mug or a pen the opportunity to buy what they did not get. Strikingly, the price at which the newly endowed sellers were willing to part with their mugs or pens was often two to three times greater than what those who did not have the pen or mug wanted to pay for them.51 Since who ended up with a mug or a pen was entirely random, there was absolutely no reason why the arbitrary act of being chosen to get one of them would create such a divergence in valuations.


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The Acquirer's Multiple: How the Billionaire Contrarians of Deep Value Beat the Market by Tobias E. Carlisle

activist fund / activist shareholder / activist investor, business cycle, cognitive dissonance, corporate governance, corporate raider, Jeff Bezos, Paul Graham, Peter Thiel, Richard Thaler, shareholder value, Tim Cook: Apple

Overreaction: Profit Trend before Buying (1966–1983) Data Source: Werner F. M. De Bondt and Richard Thaler. “Further Evidence on Investor Overreaction and Stock Market Seasonality,” The Journal of Finance 42, no. 3 (1987), 557–581, doi:10.2307/2328371. It’s easy to see why the undervalued stocks were undervalued. Profits fell 30 percent in three years before they were picked. Investors expected those profits to keep falling. Expensive stocks were expensive because profits had risen 43 percent in the same three years. Investors expected the earnings to keep rising. Let’s see what happened next. Mean Reversion: Profit Trend after Buying (1966–1983) Data Source: Werner F. M. De Bondt and Richard Thaler. “Further Evidence on Investor Overreaction and Stock Market Seasonality,” The Journal of Finance 42, no. 3 (1987), 557–581, doi:10.2307/2328371.

Straight-Line Errors “Our statistical screens are merely exploiting a group of undervalued stocks that are easily identified and are further protected by strong balance sheets and large asset values. Additionally, because of the depressed nature and liquid make-up of the companies that meet our test criteria, they are often the object of takeover initiatives.” —Joel Greenblatt, “How The Small Investor Beats The Market” (1981) Werner De Bondt and Richard Thaler are economists who study investor behavior and stock prices. They are known as behavioral economists. In 1987, De Bondt and Thaler had an idea. Stocks get undervalued or expensive because we overreact. Mean reversion is likely. But we “extrapolate” the profit trend too far. We draw a straight line through the recent profits and assume the trend keeps going. Overreaction: The Profit Trend Extrapolated Too Far Investors expect stocks with profits that have gone up for a few years to keep going up.


Capital Ideas Evolving by Peter L. Bernstein

Albert Einstein, algorithmic trading, Andrei Shleifer, asset allocation, business cycle, buy and hold, buy low sell high, capital asset pricing model, commodity trading advisor, computerized trading, creative destruction, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, diversification, diversified portfolio, endowment effect, equity premium, Eugene Fama: efficient market hypothesis, financial innovation, fixed income, high net worth, hiring and firing, index fund, invisible hand, Isaac Newton, John Meriwether, John von Neumann, Joseph Schumpeter, Kenneth Arrow, London Interbank Offered Rate, Long Term Capital Management, loss aversion, Louis Bachelier, market bubble, mental accounting, money market fund, Myron Scholes, paper trading, passive investing, Paul Samuelson, price anchoring, price stability, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, Sharpe ratio, short selling, Silicon Valley, South Sea Bubble, statistical model, survivorship bias, systematic trading, technology bubble, The Wealth of Nations by Adam Smith, transaction costs, yield curve, Yogi Berra, zero-sum game

In the example of the outbreak of the dreaded disease, the audience in the first case framed their responses around how many people would live, while the second audience framed their responses around how many people might die. Kahneman’s Nobel address defines framing as “the passive * See, in particular, Thaler (1991), which describes many examples of the failure of invariance and framing. bern_c01.qxd 8 3/23/07 8:44 AM THE Page 8 B E H AV I O R A L AT TAC K acceptance of the formulation given.” And then he adds, “Invariance cannot be achieved by a finite mind.”4 Richard Thaler of the University of Chicago, one of Kahneman’s and Tversky’s earliest and most articulate disciples, describes an amusing example of the failure of invariance involving money. Thaler proposed to students in one of his classes that they had just won $30. Now they could choose between two outcomes: a coin f lip where the individual would win $9 on heads or lose $9 on tails, or no f lip of the coin at all.

Or, to put it more bluntly, how much money can we make as investors by studying the many interesting stories Behavioral Finance has to tell us? These questions motivate the rest of this chapter. Kahneman’s and Tversky’s work naturally attracted academics working in finance who were seeking new insights into how the capital markets work and how investors make decisions.* Among the earliest of their acolytes was a young graduate student named Richard Thaler, whose work on the house money effect we have already noted. Thaler is now among the leaders in the field of Behavioral Finance. Indeed, after teaching at Cornell and MIT, Thaler was appointed Robert P. Gwinn Professor of Behavioral Science and Economics at the Graduate School of Business of the University of Chicago in 1995, where Eugene Fama and his colleagues have had to put up with—and ultimately learn from—this energetic and iconoclastic man.

“A Great Company Can Be a Great Investment,” Financial Analysts Journal, July/August, pp. 86–94. Anson, Mark, 2005. “Institutional Portfolio Management,” The Journal of Portfolio Management, Summer, pp. 33–43. Barber, Brad M., Yi-Tsung Lee, Yu-Jane Liu, and Terrance Odean, 2006. “Just How Much Do Individual Investors Lose by Trading?” American Finance Association Annual Meetings. Benartzi, Shlomo, and Richard Thaler, 2001. “Naive Diversif ication Strategies in Retirement Savings Plans,” American Economic Review, Vol. 91, No. 57, pp. 1593–1616. Bernstein, Peter, 1992. Capital Ideas: The Remarkable Origins of Modern Wall Street, New York: Free Press. Bernstein, Peter, 1996. Against the Gods: The Remarkable Story of Risk, New York: John Wiley & Sons. Black, Fischer, 1986. “Noise,” Journal of Finance, Vol. 41 ( July), pp. 529–545.


pages: 354 words: 118,970

Transaction Man: The Rise of the Deal and the Decline of the American Dream by Nicholas Lemann

Affordable Care Act / Obamacare, Airbnb, airline deregulation, Albert Einstein, augmented reality, basic income, Bernie Sanders, Black-Scholes formula, buy and hold, capital controls, computerized trading, corporate governance, cryptocurrency, Daniel Kahneman / Amos Tversky, dematerialisation, diversified portfolio, Donald Trump, Elon Musk, Eugene Fama: efficient market hypothesis, financial deregulation, financial innovation, fixed income, future of work, George Akerlof, gig economy, Henry Ford's grandson gave labor union leader Walter Reuther a tour of the company’s new, automated factory…, index fund, information asymmetry, invisible hand, Irwin Jacobs, Joi Ito, Joseph Schumpeter, Kenneth Arrow, Kickstarter, life extension, Long Term Capital Management, Mark Zuckerberg, mass immigration, means of production, Metcalfe’s law, money market fund, Mont Pelerin Society, moral hazard, Myron Scholes, new economy, Norman Mailer, obamacare, Paul Samuelson, Peter Thiel, price mechanism, principal–agent problem, profit maximization, quantitative trading / quantitative finance, Ralph Nader, Richard Thaler, road to serfdom, Robert Bork, Robert Metcalfe, rolodex, Ronald Coase, Ronald Reagan, Sand Hill Road, shareholder value, short selling, Silicon Valley, Silicon Valley ideology, Silicon Valley startup, Social Responsibility of Business Is to Increase Its Profits, Steve Jobs, TaskRabbit, The Nature of the Firm, the payments system, Thomas Kuhn: the structure of scientific revolutions, Thorstein Veblen, too big to fail, transaction costs, universal basic income, War on Poverty, white flight, working poor

“the large costs associated with the obsolescence”: Michael C. Jensen, “The Modern Industrial Revolution, Exit, and the Failure of Internal Control Systems,” Journal of Finance, Volume 48, Number 3 (July 1993), 2. “a social invention of vast historical importance”: Jensen, “Eclipse of the Public Corporation,” 5. “In the course of conversation”: Richard Thaler, Misbehaving: The Making of Behavioral Economics, W. W. Norton, 2015, 51. “Keynes: Professor Jensen”: This is a passage from the original manuscript of Richard Thaler, Misbehaving, which Thaler gave to the author. It does not appear in the book. “I consent to the wishes of my wife”: Michael C. Jensen, “Toward a Theory of the Press,” in Karl Brunner, editor, Economics and Social Institutions, Martinus Nijhoff Publishing Company, 1979, 11. One former aide to Hubbard: Author’s interview with Nancy Many.

The other was behavioral economics, which focused on the many ways the human mind was naturally prone to misperceive reality and how that would affect people’s interactions with economic markets. Both ideas, by positing that markets behaved imperfectly, were opening the door to a role for government in improving the way markets functioned, and this was a highly offensive idea to Jensen. The fathers of behavioral economics were two psychologists, Daniel Kahneman and Amos Tversky; their main link to economics was Richard Thaler, whose first job was as a junior faculty member at Rochester’s business school. Naturally, Jensen and Thaler quarreled constantly. Thaler eventually left for the University of Chicago’s business school, where he began to quarrel constantly with Eugene Fama. Once, Jensen invited Tversky to a conference at Rochester, out of a combination of curiosity and eagerness to argue with him. The two of them, along with Thaler, went out to dinner one evening.

But if he hadn’t felt the need to demonstrate that he had superior knowledge and had given precedence to being an empathetic son, they might not have become permanently estranged. In just about any social encounter, such as the receptions and dinners after lectures he gave, Jensen wound up, as he liked to put it, acting like an asshole and leaving people feeling insulted. A persistent rumor among economists is that Jensen, unlike his closest colleagues (and his younger combatant, Richard Thaler), never won a Nobel Prize because the selection committee had invited him to participate in a panel discussion, as a kind of audition for his suitability for his profession’s highest honor, and he had put on his usual arrogant performance. By the end of the 1990s Jensen had been divorced twice. You can guess what it would have been like to be married to him from what Thaler quotes him saying to Tversky, or from this passage from an essay he wrote in the late 1970s: I consent to the wishes of my wife on occasion (for instance, by accompanying her to a movie or concert she wishes to attend) to make her happy and to maintain good relations—goodwill that I can draw upon the next time I unexpectedly bring home a colleague for dinner (or, worse yet, forget to come home for dinner).


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Skin in the Game: Hidden Asymmetries in Daily Life by Nassim Nicholas Taleb

availability heuristic, Benoit Mandelbrot, Bernie Madoff, Black Swan, Brownian motion, Capital in the Twenty-First Century by Thomas Piketty, Cass Sunstein, cellular automata, Claude Shannon: information theory, cognitive dissonance, complexity theory, David Graeber, disintermediation, Donald Trump, Edward Thorp, equity premium, financial independence, information asymmetry, invisible hand, knowledge economy, loss aversion, mandelbrot fractal, mental accounting, microbiome, moral hazard, Murray Gell-Mann, offshore financial centre, p-value, Paul Samuelson, Ponzi scheme, price mechanism, principal–agent problem, Ralph Nader, random walk, rent-seeking, Richard Feynman, Richard Thaler, Ronald Coase, Ronald Reagan, Rory Sutherland, Silicon Valley, Steven Pinker, stochastic process, survivorship bias, The Nature of the Firm, transaction costs, urban planning, Yogi Berra

With psychology studies replicating less than 40 percent of the time, dietary advice reversing after thirty years of dietary fat phobia, macroeconomics and financial economics (while trapped in an intricate Gargantuan patch of words) scientifically worse than astrology (this is what the reader of the Incerto has known since Fooled by Randomness), the reappointment of Bernanke (in 2010) who was less than clueless about financial risk as the Federal Reserve boss, and pharmaceutical trials replicating at best only a third of the time, people are perfectly entitled to rely on their own ancestral instincts and to listen to their grandmothers (or to Montaigne and such filtered classical knowledge), who have a better track record than these policymaking goons. SCIENCE AND SCIENTISM Indeed, one can see that these academico-bureaucrats who feel entitled to run our lives aren’t even rigorous, whether in medical statistics or policymaking. They can’t tell science from scientism—in fact in their eyes scientism looks more scientific than real science. For instance, it is trivial to show the following: much of what the Cass Sunstein and Richard Thaler types—those who want to “nudge” us into some behavior—much of what they would classify as “rational” or “irrational” (or some such categories indicating deviation from a desired or prescribed protocol) comes from their misunderstanding of probability theory and cosmetic use of first-order models. They are also prone to mistake the ensemble for the linear aggregation of its components—that is, they think that our understanding of single individuals allows us to understand crowds and markets, or that our understanding of ants allows us to understand ant colonies.

Whether it is superstition or something else, some deep scientific understanding of probability that is stopping you, it doesn’t matter, so long as you don’t sleep under dead trees. And if you dream of making people use probability in order to make decisions, I have some news: more than ninety percent of psychologists dealing with decision making (which includes such regulators and researchers as Cass Sunstein and Richard Thaler) have no clue about probability, and try to disrupt our efficient organic paranoias. FIGURE 4. The classical “large world vs small world” problem. Science is currently too incomplete to provide all answers—and says it itself. We have been so much under assault by vendors using “science” to sell products that many people, in their mind, confuse science and scientism. Science is mainly rigor in the process.

In practice, it is done by threshold, for ease of execution, not complicated rules: you start betting aggressively whenever you have a profit, never when you have a deficit, as if a switch was turned on or off. This method is practiced by probably every single trader who has survived. Now it happens that this dynamic strategy is deemed out of line by behavioral finance econophasters such as the scarily interventionist Richard Thaler, who, very ignorant of probability, calls this “mental accounting”fn2 a mistake (and, of course, invites government to “nudge” us away from it, and prevent strategies from being ergodic).fn3 I believe that risk aversion does not exist: what we observe is, simply, a residual of ergodicity. People are, simply, trying to avoid financial suicide and take a certain attitude to tail risks. But we do not need to be overly paranoid about ourselves; we need to shift some of our worries to bigger things.


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Hooked: How to Build Habit-Forming Products by Nir Eyal

Airbnb, AltaVista, Cass Sunstein, choice architecture, cognitive bias, cognitive dissonance, en.wikipedia.org, framing effect, game design, Google Glasses, IKEA effect, Inbox Zero, invention of the telephone, iterative process, Jeff Bezos, Lean Startup, Mahatma Gandhi, Mark Zuckerberg, meta analysis, meta-analysis, Oculus Rift, Paul Buchheit, Paul Graham, Peter Thiel, QWERTY keyboard, Richard Thaler, Silicon Valley, Silicon Valley startup, Snapchat, TaskRabbit, telemarketer, the new new thing, Toyota Production System, Y Combinator

Damien Brevers and Xavier Noël, “Pathological Gambling and the Loss of Willpower: A Neurocognitive Perspective,” Socioaffective Neuroscience & Psychology 3, no. 2 (Sept. 2013), doi:10.3402/snp.v3i0.21592. 13. Paul Graham, “The Acceleration of Addictiveness,” (accessed Nov. 12, 2013), http://www.paulgraham.com/addiction.html. 14. Night of the Living Dead, IMDb, (accessed June 25, 2014), http://www.imdb.com/title/tt0063350. 15. Richard H. Thaler, Cass R. Sunstein, and John P. Balz, “Choice Architecture” (SSRN Scholarly Paper, Rochester, NY), Social Science Research Network (April 2, 2010), http://papers.ssrn.com/abstract=1583509. Chapter 1: The Habit Zone 1. Wendy Wood, Jeffrey M. Quinn, and Deborah A. Kashy, “Habits in Everyday Life: Thought, Emotion, and Action,” Journal of Personality and Social Psychology 83, no. 6 (Dec. 2002): 1281–97. 2.

Kara Swisher and Liz Gannes, “Pinterest Does Another Massive Funding—$225 Million at $3.8 Billion Valuation (Confirmed),” All Things Digital (accessed Nov. 13, 2013), http://allthingsd.com/20131023/pinterest-does-another-massive-funding-225-million-at-3-8-billion-valuation/. Chapter 6: What Are You Going to Do with This? 1. For further thoughts on the morality of designing behavior, see: Richard H. Thaler, Cass R. Sunstein, and John P. Balz, “Choice Architecture” (SSRN Scholarly Paper, Rochester, New York), Social Science Research Network, (April 2, 2010), http://papers.ssrn.com/abstract=1583509. 2. Charlie White, “Survey: Cellphones vs. Sex—Which Wins?,” Mashable (accessed), http://mashable.com/2011/08/03/telenav-cellphone-infographic. 3. Ian Bogost, “The Cigarette of This Century,” Atlantic (June 6, 2012), http://www.theatlantic.com/technology/archive/2012/06/the-cigarette-of-this-century/258092/. 4.


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

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, longitudinal study, 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

more lopsided Daniel Kahneman, John L. Knetsch, and Richard H. Thaler (1986), “Fairness and the Assumptions of Economics,” Journal of Business, 59:S285–S300. Christoph Engel (2011), “Dictator Games: A Meta Study,” Experimental Economics, 14:584–610. Trust game Joyce Berg, John Dickhaut, and Kevin McCabe (1995), “Trust, Reciprocity, and Social History,” Games & Economic Behavior, 10:122–42. not what happens Colin Cramer (2003), Behavioral Game Theory: Experiments in Strategic Interaction, Russell Sage Foundation. Public Goods game John O. Ledyard (1995), “Public Goods: A Survey of Experimental Research,” in Alvin E. Roth and John H. Kagel, eds., Handbook of Experimental Economics, Princeton University Press. fear of rejection Daniel Kahneman, John L. Knetsch, and Richard H Thaler (1986), “Fairness and the Assumptions of Economics,” Journal of Business, 59:S285–S300.

Richerson, and Robert Boyd (1995), “Can Group Functional Behaviors Evolve by Cultural Group Selection?” Current Anthropology, 36:473–94. Chapter 4 Robert Sapolsky Robert Sapolsky (2003), “A Bozo of a Baboon: A Talk with Robert Sapolsky,” Edge. Matt Ridley Matt Ridley (1993), The Red Queen: Sex and the Evolution of Human Nature, HarperCollins Publishers, 9–10. hyperbolic discounting Richard H. Thaler (1981), “Some Empirical Evidence on Dynamic Inconsistency,” Economics Letters, 8:201–7. Shane Frederick, George Loewenstein, and Ted O'Donoghue (2002), “Time Discounting and Time Preference: A Critical Review,” Journal of Economic Literature, 40:351–401. Francis Fukuyama Francis Fukuyama (1995), Trust: The Social Virtues and the Creation of Prosperity, Simon & Schuster, 27–8. James Madison James Madison (1788), The Federalist, 51.

game is about taking Nicholas Bardsley (2008), “Dictator Game Giving: Altruism or Artifact?” Experimental Economics, 11:122–33. Distrust game Iris Bohnet and Stephan Meier (2005), “Deciding to Distrust,” Federal Reserve Bank of Boston Public Policy Discussion Paper 05–4. half of the money Ernst Fehr and Klaus M. Schmidt (1999), “A Theory of Fairness, Competition, and Cooperation,” The Quarterly Journal of Economics, 114:817–68. Daniel Kahneman, John L. Knetsch, and Richard H Thaler (1986), “Fairness and the Assumptions of Economics,” Journal of Business, 59:S285–S300. who are skeptical Ilan Dinstein, Cibu Thomas, Marlene Behrmann, and David J. Heeger (2008), “A Mirror Up to Nature,” Current Biology, 18:R13–8. Kaspar Meyer and Antonio Damasio (2008), “Mirror Neurons: Behind the Looking Glass,” Nature, 454:167–8. Gregory Hickok (2009), “Eight Problems for the Mirror Neuron Theory of Action Understanding in Monkeys and Humans,” Cognitive Neurosciences, 21:1229–43.


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

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, 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

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? Self Evaluation Maintenance and the Subjective Side of the ‘Friendship Paradox,’ ” Social Psychology Quarterly 64.3 (2001): 207–23. 5. College Board, Student Descriptive Questionnaire, Princeton, NJ: Educational Testing Service, 1976–77. 6.

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

accounting loophole / creative accounting, Albert Einstein, asset allocation, asset-backed security, backtesting, beat the dealer, Bernie Madoff, BRICs, butter production in bangladesh, buy and hold, capital asset pricing model, compound rate of return, correlation coefficient, Credit Default Swap, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, dogs of the Dow, 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, stocks for the long run, survivorship bias, The Myth of the Rational Market, the rule of 72, The Wisdom of Crowds, transaction costs, Vanguard fund, zero-coupon bond

But if the problem is framed differently, so that one must actively “opt out” of the savings plan, participation rates will be much greater. Corporations that frame their 401(k) savings plans with an automatic enrollment feature (where a conscious decision must be made to fill out an “opt out” declaration) have far higher participation rates than do plans where employees must actively “opt in” to the plan. Another brilliant enticement has been developed by the economists Richard Thaler and Shlomo Benartzi. Some employees will decline to save even with plans that have automatic enrollment because they can barely make ends meet with their current salary. The essence of the Thaler-Benartzi “Save More Tomorrow” plan is to have employees commit in advance to allocate a portion of any salary increases toward retirement savings. If employees join the plan, their contribution to their retirement savings plan is increased, beginning with the first paycheck after a raise.

The work of the behavioralists has been buttressed by a large number of statistical studies that confirmed several predictable patterns of stock prices. Indeed, the new mantra in the academic community is that the stock market is at least partially predictable. One of the brightest of the new wave of financial economists, Andrew Lo (with A. Craig MacKinlay) of the Massachusetts Institute of Technology, published a book in the late 1990s entitled A Non-Random Walk Down Wall Street. And behavioralists such as Richard Thaler have suggested that some predictable patterns can be used by savvy investors to implement successful investment strategies that can beat the market. That’s what this chapter is about: the attempts to show that the market, as demonstrated above, is not efficient and that there is no such thing as a profitable random walk through it. I will review all the recent research proclaiming the demise of the efficient-market theory and purporting to show that market prices are, in fact, predictable.

Indeed, the January Effect became undependable after it received considerable publicity. As one wag put it, “The January Effect sometimes occurs on the previous Thanksgiving week.” Similarly, suppose there is a general tendency for stock prices to underreact to certain new events, leading to abnormal returns to investors who exploit the lack of full immediate adjustment—a finding publicized by the behavioralists Werner De Bondt and Richard Thaler and the researchers John Campbell, Andrew M. Lo, and A. Craig MacKinlay. “Quantitative” investment managers will then develop strategies in an attempt to exploit the pattern. Indeed, the more potentially profitable a discoverable pattern is, the less likely it is to survive. Moreover, many of these predictable patterns may simply be the results of data mining. The ease of experimenting with financial data makes it quite likely that investigators will find some seemingly significant, but wholly spurious, correlation between financial variables or among financial and nonfinancial data sets.


pages: 384 words: 118,572

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

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

In the choice of food, effects like these may seem minor. But the order effect—what Russo was demonstrating—is but one of the many elements of decision architecture—how information is presented to us—that can get us to make decisions in a very precise way, and not necessarily in a way that corresponds to our stated preferences. There’s the positive side of decision architecture, the nudge, popularized by behavioral economist Richard Thaler and legal scholar Cass Sunstein in their 2008 book by the same name. The idea behind the nudge, in its positive guise, is a simple one. In many cases, our choices aren’t based on some innate preference. Instead, they are constructed at any given moment by a combination of situational factors. I may not have thought about drinking wine with dinner, for instance, but if the wine list is right in front of me, I may find myself ordering a glass all the same.

Eighty-five percent of students put themselves above the average in their ability to get along with others—a full quarter going so far as to place themselves in the top 1 percent. In 1977, a full 95 percent of the faculty of the University of Nebraska thought they were better than average at teaching; over two thirds placed themselves in the top quarter. In a survey that behavioral economist Richard Thaler performed on his own students, he found that less than 5 percent of the class expected to do below average, and over half thought they would be among the top fifth of performers. And, of course, almost all of us are better-than-average drivers, far more skillful and less risky than the next guy. In one study, researchers asked drivers who had been hospitalized after a car accident—which over two thirds of them had caused—to rate their driving skills.

Look at the geological reports, the warning letters. Construction should have been ended. Ann Freedman should have realized, if not immediately, then at least once the paintings just kept coming, that something wasn’t right. Because the flags. They are there. They are waving. And people aren’t blind, right? Except they absolutely are. And the more they have invested, the blinder they become. In the early 1980s, Paul Slovic and Richard Thaler were discussing the crazy things people do as they make decisions to buy and sell, invest and divest, in ways that seem completely illogical to an outside observer. Why, for instance, would a family drive sixty miles through a snowstorm to get to a basketball game they don’t even particularly want to see? Well, Teton Dam, Slovic offered. Teton Dam was the perfect case in point. The family had spent money on those tickets.


pages: 336 words: 113,519

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

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, Stanford marshmallow experiment, statistical model, the new new thing, Thomas Bayes, Walter Mischel, Yom Kippur War

The argument that Danny and Amos started would spill over into law and public policy. Psychology would use economics to enter these places and others. Richard Thaler—the first frustrated economist to stumble onto Danny and Amos’s work and pursue its consequences for economics single-mindedly—would help to create a new field, and give it the name “behavioral economics.” “Prospect Theory,” scarcely cited in the first decade after its publication, would become, by 2010, the second most cited paper in all of economics. “People tried to ignore it,” said Thaler. “Old economists never change their minds.” By 2016 every tenth paper published in economics would have a behavioral angle to it, which is to say it had at least a whisper of the work of Danny and Amos. And Richard Thaler would have just stepped down from his tenure as president of the American Economic Association.

But whatever it is in the human psyche that the Oakland A’s exploited for profit—this hunger for an expert who knows things with certainty, even when certainty is not possible—has a talent for hanging around. It’s like a movie monster that’s meant to have been killed but is somehow always alive for the final act. And so, once the dust had settled on the responses to my book, one of them remained more alive and relevant than the others: a review by a pair of academics, then both at the University of Chicago—an economist named Richard Thaler and a law professor named Cass Sunstein. Thaler and Sunstein’s piece, which appeared on August 31, 2003, in the New Republic, managed to be at once both generous and damning. The reviewers agreed that it was interesting that any market for professional athletes might be so screwed-up that a poor team like the Oakland A’s could beat most rich teams simply by exploiting the inefficiencies. But—they went on to say—the author of Moneyball did not seem to realize the deeper reason for the inefficiencies in the market for baseball players: They sprang directly from the inner workings of the human mind.

“Somehow, the economists felt that we are right and at the same time they wished we weren’t because the replacement of utility theory by the model we outlined would cause them no end of problems.” * * * There was at least one economist who didn’t feel that way, but he wasn’t, at least when he came upon Danny and Amos’s theory, anyone’s idea of a future Nobel Prize winner. His name was Richard Thaler. In 1975, Thaler was a thirty-year-old assistant professor in the School of Management at the University of Rochester with vague prospects. It was a wonder he was even there. He had two deeply pronounced traits that rendered him unsuited not just to economics but to academic life. The first was that he was easily bored, and highly imaginative in his attempts to escape boredom. As a child he routinely changed the rules of the games he was expected to play.


pages: 403 words: 119,206

Toward Rational Exuberance: The Evolution of the Modern Stock Market by B. Mark Smith

bank run, banking crisis, business climate, business cycle, buy and hold, capital asset pricing model, compound rate of return, computerized trading, credit crunch, cuban missile crisis, discounted cash flows, diversified portfolio, Donald Trump, Eugene Fama: efficient market hypothesis, financial independence, financial innovation, fixed income, full employment, income inequality, index arbitrage, index fund, joint-stock company, locking in a profit, Long Term Capital Management, Louis Bachelier, margin call, market clearing, merger arbitrage, money market fund, Myron Scholes, Paul Samuelson, price stability, random walk, Richard Thaler, risk tolerance, Robert Bork, Robert Shiller, Robert Shiller, Ronald Reagan, shareholder value, short selling, stocks for the long run, the market place, transaction costs

Another bias they have identified is what might be called a regret syndrome, where investors overemphasize past mistakes and make nonrational decisions in their attempts to avoid repeating them. Also included in the list of behavioral biases is the “money illusion,” which refers to investors’ inability to adequately take inflation into account when comparing real and nominal values.5 Research has uncovered empirical evidence that behavioral biases such as these may be influencing the stock market. One of the most important studies was performed in 1985, by Werner De Bondt and Richard Thaler, using stock price data going back to 1933.6 For each year, two portfolios of stocks were constructed—one for the best performers over the preceding three years, and one for the worst performers over that period. Then the returns for the portfolios over the subsequent five years were calculated and compared. The study concluded that the worst “losers”—the stocks that had performed the poorest over the preceding three years—outperformed the best “winners” by a wide margin in the subsequent five years.

Recognizing that allegedly “irrational” behavior by investors is often hard to predict and therefore difficult for savvy market participants to exploit, and that many of the mispricings resulting from irrational behavior are relatively minor, Shefrin admits that investors “would be better off acting as if … markets are efficient.” To be sure, other behavioralists do believe that exploitable opportunities are created by irrational investor behavior. Some have even set up investment management firms, soliciting investors who seek to take advantage of these opportunities. (Richard Thaler, who coauthored the 1985 winners-losers study, is one such entrepreneur.) If they are successful, however, these academics turned portfolio managers will ultimately confront the same problem Benjamin Graham faced when his style of “value” investing became popular. Realizing that the actions of like-minded investors had competed away the market mispricings he had earlier exploited, Graham said in a 1976 interview shortly before he died that “I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities.

Realizing that the actions of like-minded investors had competed away the market mispricings he had earlier exploited, Graham said in a 1976 interview shortly before he died that “I am no longer an advocate of elaborate techniques of security analysis in order to find superior value opportunities. This was a rewarding activity … but the situation has changed … I doubt whether such extensive efforts will [now] generate sufficient superior selections to justify their cost … I’m on the side of the efficient market school of thought.”1 To the extent that behavior-related mispricings can be shown to exist, behavioralist arbitrageurs like Richard Thaler will quickly compete them away. If the behavioralist critique of the efficient market theory is of little practical significance, then the notion that the stock market is subject to large, irrational bubbles is also suspect. In fact, over the course of the twentieth century, there is no real evidence of any speculative bubbles affecting the large-capitalization stocks that dominate the market.


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The Wisdom of Crowds by James Surowiecki

AltaVista, Andrei Shleifer, asset allocation, Cass Sunstein, coronavirus, 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, Monkeys Reject Unequal Pay, moral hazard, Myron Scholes, new economy, offshore financial centre, Picturephone, prediction markets, profit maximization, 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

It turns out that if people have to take action to opt out of a retirement plan rather than having to take action to opt in, they are significantly more likely to stay in the plan and therefore significantly more likely to save. Inertia is a powerful tool. Similarly, if people are offered the chance to set aside part of their future income, they’re far more likely to do so than they are to set aside current income. So, the economists Richard H. Thaler and Shlomo Benartzi set up a retirement plan at a company where workers could adopt different savings rates for present and future income. Not surprisingly, the workers adopted much higher rates for income that was months in the future, and within a short time, they had doubled their average savings rate. What makes these solutions so powerful is that instead of imposing top-down requirements or mandates, they try to harness people’s preferences in a productive way by offering them more options and by shifting the frames through which people see their own financial lives.

Sauer, “Fundamentals or Noise? Evidence from the Professional Basketball Betting Market,” Journal of Finance 48 (1993): 1193–209. Evidence for the NFL market’s late-season inefficiency can be found in Richard Borghesi, “Price Predictability: Insight from the NFL Point-Spread Market” (2003), www.cba.ufl.edu/fire/phdstudents/papers/borghesi%20price%20predictability.pdf. The long-shot bias is documented in Richard H. Thaler and William T. Ziemba, “Parimutuel Betting Markets: Racetracks and Lotteries,” Journal of Economic Perspectives 2 (1988): 161–74. Lawrence Page, Sergey Brin, Rajeev Motwani, and Terry Winograd, “The PageRank Citation Ranking: Bringing Order to the Web” (1998), http://dbpubs.stanford.edu/pub/1999-66. See also Brin and Page, “The Anatomy of a Large-Scale Hypertextual Web Search Engine” (1998), http://www-db.stanford.edu/~backrub/google.html.

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.


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

Albert Einstein, 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

Sec’y of Health and Human Services, 39–42, 252–53. 196 “I looked out at an audience”: Jane Johnson, interview with author, May 4, 2009. 196 “This is the federal government giving every kid”: Jane Johnson, interview with author, April 22, 2010. 196 “You wouldn’t be saying and doing”: Vicky Debold, interview with author, July 28, 2009. 196 a concept that was first articulated in a 1999 paper: Timur Kuran and Cass R. Sunstein, “Availability Cascades and Risk Regulation,” Stanford Law Review 1999;51(4): 683–768. 196 “self-reinforcing process of collective belief formation”: Kuran and Sunstein, “Availability Cascades and Risk Regulation,” 683. 197 In the 2008 book Nudge: Cass Sunstein and Richard Thaler, Nudge (New Haven: Yale University Press, 2008). 197 “As all women”: Cass Sunstein and Richard Thaler, “Easy Does It: How to Make Lazy People Do the Right Thing,” The New Republic, April 9, 2008; available as “The Amsterdam Urinals” on Nudge, http://nudges.wordpress.com/the-amsterdam-urinals/. See also: Sunstein and Thaler, Nudge, 3–4. 197 how nonscientists viewed scientific claims: Ralph M. Barnes, Audrey L. Alberstadt, and Lesleh E. Keilholtz, “How to Think About Scientific Claims: A Study of How Non-Scientists Evaluate Science Claims,” Skeptic, January 1, 2009;14(4): 48–55. 197 “poor source credibility”: B.

One e-mail, which The New York Times obtained through an open-records request, read, “I’d like to know how you people sleep straight in bed at night knowing all the lies you tell & the lives you know full well you destroy with the poisons you push & protect with your lies.” Several weeks later, the agency received an e-mail with an even more overt threat. “Forgiveness is between [the committee’s members] and God,” it read. “It is my job to arrange a meeting.” 46 Not all of Sunstein’s writing on behavioral law and economics is so academic. In the 2008 book Nudge, Sunstein and Richard Thaler write about external changes—nudges—that can influence human behavior. One of their examples stems from efforts to get men to stop peeing on the floor: “As all women who have ever shared a toilet with a man can attest, men can be especially spacey when it comes to their, er, aim. In the privacy of a home, that may be a mere annoyance. But, in a busy airport restroom used by throngs of travelers each day, the unpleasant effects of bad aim can add up rather quickly.

Smith, Rebecca. “Dishonest, Callous and Irresponsible: Verdict on Doctor in MMR Row; Wakefield Didn’t Care About Children’s Pain and Distress, Says GMC.” The Daily Telegraph (London), January 29, 2010, 7. Solovitch, Sara. “The Citizen Scientists.” Wired, September 2001. Stevens, William. “Despite Vaccine, Perilous Measles Won’t Go Away.” The New York Times, March 14, 1989, C1. Sunstein, Cass, and Richard Thaler. “Easy Does It: How to Make Lazy People Do the Right Thing.” The New Republic, April 9, 2008. Szabo, Liz. “Missed Vaccines Weaken ‘Herd Immunity’ in Children.” USA Today, January 6, 2010. Thompson, Tanya. “Doctor at Centre of MMR Controversy ‘Paid Children at Son’s Party GBP 5 for Blood Samples’: Supporters Gather Outside Hearing to Accuse GMC of ‘Witch Hunt.’ ” The Scotsman (Edinburgh), July 17, 2007, 6.


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

activist fund / activist shareholder / activist investor, affirmative action, Albert Einstein, Andrei Shleifer, barriers to entry, Berlin Wall, business cycle, 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

Kalyanaraman, “Mixing Virtue and Vice: Combining the Immediacy Effect and the Diversification Heuristic,” Journal of Behavioral Decision Making 12 (1999): 257–73, personal.lse.ac.uk/readd/ mixing%20virtue%20and%20vice.pdf. One of the researchers: e-mail correspondence with Daniel Read, June 2007. “one of those ladies”: Interview with Thomas Schelling, November 2005. That public commitment: Dodge, The Strategist, p. 91. A more sophisticated example: Richard Thaler and Shlomo Benartzi, “Save More Tomorrow: Using Behavioral Economics to Increase Employee Saving,” Journal of Political Economy 112, no. 1(February 2004): 164–87, part 2, gsbwww.uchicago.edu/fac/richard.thaler/research/ SMarTJPE.pdf. (Whom did the director): Interview with Thomas Schelling, November 2005. Also Dodge, The Strategist, p. 83. Paul Klemperer: Paul Klemperer, “What Really Matters in Auction Design,” Journal of Economic Perspectives 16 (2002): 169–89, www.nuff.ox.ac.uk/users/klemperer/wrm6.pdf.

Why else do people try to quit smoking on January 1 rather than on February 24? An addict, like a negotiator, may be able to gain an advantage by making binding decisions in advance. An everyday example is the dieter who shops for food over the Internet, and only after a good meal, so that he is not tempted by the sight of cakes and chips. A more sophisticated example, designed by economists Richard Thaler and Shlomo Benartzi, is a financial scheme called “Save More Tomorrow,” in which corporate employees boost their pensions by earmarking a proportion of future pay raises to go into their retirement accounts. The idea has nearly quadrupled retirement savings. In both cases, the forward-thinking person outwits the impatient or weak-willed person who inhabits the same body. Schelling wryly observed that it is not always easy to tell whose side you should be on.


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

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, business cycle, 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, lateral thinking, 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, Sam Peltzman, 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

So this is a fair bet; a risk-neutral individual should be just as happy with $500 in an envelope as a chance to flip a coin and earn $1,000 if it comes up heads. But in fact most people wouldn’t take that bet; they’ll take the envelope over the coin flip. So how much do we have to make the coin flip worth before they take it over the envelope? We have to offer $2,000 for flipping heads, so that the expected value is $2,000 × 50 percent = $1,000, which is twice the expected value of the envelope. 11 The economist Richard Thaler: Richard Thaler, “Toward a Positive Theory of Consumer Choice,” Journal of Economic Behavior and Organization l (1980): 3960. 12 George Loewenstein, an economist: Loewenstein described his work to me in several interviews. This experiment appears in the article by Leaf Van Boven, George Loewenstein, Edward Welch, and David Dunning, “The Illusion of Courage in Self-Predictions: Mispredicting One’s Own Behavior in Embarrassing Situations,” Journal of Behavioral Decision Making 25 (2012): 1–12. 13 Gorton took a circuitous route: Gary Gorton’s story is based on a series of interviews I conducted with him, on his extensive articles, and his book Misunderstanding Financial Crises: Why We Don’t See Them Coming (New York: Oxford University Press, 2012), a powerful and persuasive account of what causes financial panics. 14 When Gorton and two: Gary B.

The economist’s answer is the theory of diminishing utility, a fancy way of saying that each dollar of income provides less pleasure than the last. Going from middle class to rich is nice but going from middle class to destitute is horrible, and most of us would give up the first rather than risk the second. But even when our family’s welfare isn’t at stake, there’s an emotional cost associated with the unknown that affects our behavior. The economist Richard Thaler ran a series of experiments like the following. Coffee mugs were randomly distributed to half the students in a class, then all students were invited to trade so that those who value the mugs the most could buy them from those who valued them the least. On average, students demanded twice as much to sell what they already had as they would pay for something they did not yet have. Thaler dubbed this “the endowment effect”: people put greater value on something when they own it than when they don’t.


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

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, hedonic treadmill, IKEA effect, 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

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. Justin Kruger, Derrick Wirtz, Leaf Van Boven, and T.

Chapter 11: Lessons from Our Irrationalities: Why We Need to Test Everything Additional readings Colin Camerer and Robin Hogarth, “The Effects of Financial Incentives in Experiments: A Review and Capital-Labor-Production Framework,” Journal of Risk and Uncertainty 19, no. 1 (1999): 7–42. Robert Slonim and Alvin Roth, “Learning in High Stakes Ultimatum Games: An Experiment in the Slovak Republic,” Econometrica 66, no. 3 (1998): 569–596. Richard Thaler, “Toward a Positive Theory of Consumer Choice,” Journal of Economic Behavior and Organization 1, no. 1 (1980): 39–60. Index The pagination of this electronic edition does not match the edition from which it was created. To locate a specific passage, please use the search feature of your e-book reader. A Accessory Transit Company, 154 acknowledging workers, 74–76, 80 acronyms, 120 adaptation, 157–90 assortative mating and, 191–212; see also assortative mating focusing attention on changes and, 159–60 hedonic, 160–84; see also hedonic adaptation nineteenth-century experiments on, 157–58 to pain, 160–67 physical, 157–60, 161n sensory perception and, 158–60 Aesop, 198–99 agriculture, obesity and technological developments in, 8 AIDS, 250, 251 airlines, customer service problems of, 142–43 alienation of labor, 79–80 American Cancer Society (ACS), 241–42, 249–50, 254 Andrade, Eduardo, 262, 265, 267–68, 299 anger, acting on, 257 author��s anecdote of, 258–61 driving and, 261 ultimatum game and, 268, 269–70, 273, 274, 276 animals: empathy for suffering of, 249 generalizing about human behavior from studies on, 63 working for food preferred by, 59–63 annoying experiences: breaking up, 177–79, 180 decisions far into future affected by, 262–64 annuities, 234 anterior insula, 266–67 anticipatory anxiety, 45 Anzio, Italy, battle of (1944), 167 apathy toward large tragedies, 238–39 drop-in-the-bucket effect and, 244–45, 252, 254–55 statistical condition and, 238–41, 242, 246, 247–49, 252–53 apologies, 149–51 for medical errors, 152 Apple, 120n battery replacement issue and, 141–42 art, homemade, 89–90 Asian tsunami, 250, 251 assembly line, 78–79 assortative mating, 191–212 altering aesthetic perception and (sour grapes theory), 198–99, 200, 201, 203 author’s injuries and, 191–96, 210–11 dinner party game and, 198 failure to adapt and, 200–201, 203–5 gender differences and, 209, 211 HOT or NOT study and, 201–5, 208, 211 reconsidering rank of attributes and, 199–200, 201, 205–10 speed-dating experiment and, 205–10 Atchison, Shane, 140–41, 146 attachment: to one’s own ideas, see Not-Invented-Here (NIH) bias to self-made goods, see IKEA effect attractiveness, assortative mating and, 191–212 see also assortative mating auctions, first-price vs. second-price, 98–99 Audi customer service, author’s experience with, 131–36, 137, 149, 153–54 experimental situation analogous to, 135–39 fictional case study for Harvard Business Review based on, 147–49 B bailout, public outrage felt in response to, 128–31 baking mixes, instant, 85–87 bankers: author’s presentation of research findings to, 107–9, 121 bonus experiments and, 38–41, 51 Frank’s address to, 41 public outrage in response to bailout and, 128–31 bankruptcy, 129, 130 Barkan, Racheli, 39, 109–10, 299 basketball, clutch players in, 39–41 beauty: assortative mating and, 196–212; see also assortative mating general agreement on standard of, 203 Becker-DeGroot-Marschak procedure, 91 Beecher, Henry, 167 behavioral economics: goal of, 9–10 human rationality not assumed in, 6–7 revenge as metaphor for, 124n Betty Crocker, 87 Bible, Gideon’s conversation with God in, 288–89 blindness, adaptation to, 172–74 blogging, 65 Blunder (Shore), 117 boiling-frog experiment, 157–58 bonuses, 17–52 bank executives’ responses to research on, 37–39 clutch abilities and, 39–41 for cognitive vs. mechanical tasks, 33–36, 40–41 creativity improvements and, 47–48 experiments testing effectiveness of, 21–36, 44–46 Frank’s remarks on, 41 intuitions about, 36–37 inverse-U relationship between performance and, 20–21, 47 loss aversion and, 32–33 optimizing efficacy of, 51–52 public rage over, 21 rational economists’ view of, 36–37 social pressure and, 44–46 surgery situation and, 48–49 viewed as standard part of compensation, 33 in wake of financial meltdown of 2008, 131 brain: judgments about experiences and, 228–29 punishment and, 126 breaks, in pleasant vs. painful experiences, 177–81 Brickman, Philip, 170 business, experimental approach to, 292–93 C cake mixes, instant, 85–87 California, moving to, 176 Call, Josep, 127 cancer, American Cancer Society fundraising and, 241–42, 249–50, 254 canoeing, romantic relationships and, 278–79 cars, 215–16 designing one’s own, 88, 89 division of labor in manufacture of, 78–79 in early days of automotive industry, 94 hedonic treadmill and, 175 see also driving cell phones, 7 in experiments on customer revenge, 135–39, 145–46, 150–51 see also texting CEOs, very high salaries and bonuses paid to, 21 Chance, Zoë, 220, 300 changes: ability to focus attention on, 159–60 decisions about life’s path and, 287 in future, foreseeing adaptation to, 160, 171–74 status quo bias and, 285, 286 in workers’ pay, job satisfaction and, 169–70 charities: American Cancer Society (ACS), 241–42, 249–50, 254 calculating vs. emotional priming and, 246–48 emotional appeals and, 240–42, 248–50, 253–54, 256 identifiable victim effect and, 239–42, 248, 256 charities (cont.)


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Strategy: A History by Lawrence Freedman

Albert Einstein, anti-communist, Anton Chekhov, Ayatollah Khomeini, barriers to entry, battle of ideas, Black Swan, British Empire, business process, butterfly effect, centre right, Charles Lindbergh, circulation of elites, cognitive dissonance, coherent worldview, collective bargaining, complexity theory, conceptual framework, corporate raider, correlation does not imply causation, creative destruction, cuban missile crisis, Daniel Kahneman / Amos Tversky, defense in depth, desegregation, Edward Lorenz: Chaos theory, en.wikipedia.org, endogenous growth, endowment effect, Ford paid five dollars a day, framing effect, Frederick Winslow Taylor, Gordon Gekko, greed is good, information retrieval, interchangeable parts, invisible hand, John Nash: game theory, John von Neumann, Kenneth Arrow, lateral thinking, linear programming, loose coupling, loss aversion, Mahatma Gandhi, means of production, mental accounting, Murray Gell-Mann, mutually assured destruction, Nash equilibrium, Nelson Mandela, Norbert Wiener, Norman Mailer, oil shock, Pareto efficiency, performance metric, Philip Mirowski, prisoner's dilemma, profit maximization, race to the bottom, Ralph Nader, RAND corporation, Richard Thaler, road to serfdom, Ronald Reagan, Rosa Parks, shareholder value, social intelligence, Steven Pinker, strikebreaker, The Chicago School, The Myth of the Rational Market, the scientific method, theory of mind, Thomas Davenport, Thomas Kuhn: the structure of scientific revolutions, Torches of Freedom, Toyota Production System, transaction costs, ultimatum game, unemployed young men, Upton Sinclair, urban sprawl, Vilfredo Pareto, War on Poverty, women in the workforce, Yogi Berra, zero-sum game

Amos Tversky and Daniel Kahneman, “The Framing of Decisions and the Psychology of Choice,” Science 211, no. 4481 (1981): 453–458; “Rational Choice and the Framing of Decisions,” Journal of Business 59, no. 4, Part 2 (October 1986): S251–S278. 15. Richard H. Thaler, “Toward a Positive Theory of Consumer Choice,” Journal of Economic Behavior and Organization 1, no. 1 (March 1980): 36–90; “Mental Accounting and Consumer Choice,” Marketing Science 4, no. 3 (Summer 1985): 199–214. 16. Joseph Henrich, Steven J. Heine, and Ara Norenzayan, “The Weirdest People in the World?” Behavioral and Brain Sciences, 2010, 1–75. 17. Chris D. Frith and Tania Singer, “The Role of Social Cognition in Decision Making,” Philosophical Transactions of the Royal Society 363, no. 1511 (December 2008): 3875–3886; Colin Camerer and Richard H. Thaler, “Ultimatums, Dictators and Manners,” Journal of Economic Perspectives 9, no. 2: 209–219; A. G. Sanfey, J. K.

Framing helped explain how choices came to be viewed differently by altering the relative salience of certain features. Individuals compared alternative courses of action by focusing on one aspect, often randomly chosen, rather than keep in the frame all key aspects.14 Another important finding concerned loss aversion. The value of a good to an individual appeared to be higher when viewed as something that could be lost or given up than when evaluated as a potential gain. Richard Thaler, one of the first to incorporate the insights from behavioral economics into mainstream economics, described the “endowment effect,” whereby the selling price for consumption goods was much higher than the buying price.15 Experiments Another challenge to the rational choice model came from experiments that tested propositions derived from game theory. These were not the same as experiments in the natural sciences which should not be context dependent.


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Intertwingled: Information Changes Everything by Peter Morville

A Pattern Language, Airbnb, Albert Einstein, Arthur Eddington, augmented reality, Bernie Madoff, Black Swan, business process, Cass Sunstein, cognitive dissonance, collective bargaining, disruptive innovation, index card, information retrieval, Internet of things, Isaac Newton, iterative process, Jane Jacobs, John Markoff, Lean Startup, Lyft, minimum viable product, Mother of all demos, Nelson Mandela, Paul Graham, peer-to-peer, RFID, Richard Thaler, ride hailing / ride sharing, Schrödinger's Cat, self-driving car, semantic web, sharing economy, Silicon Valley, Silicon Valley startup, source of truth, Steve Jobs, Stewart Brand, Ted Nelson, The Death and Life of Great American Cities, the scientific method, The Wisdom of Crowds, theory of mind, uber lyft, urban planning, urban sprawl, Vannevar Bush, zero-sum game

People need to care about the outcome. Relative to information, architecture is a less direct but more persuasive path to change. Of course, the two tactics usually work best when paired. For instance, asking designers and engineers to collaborate may have a limited effect, unless we also co-locate their desks. As Winston Churchill famously remarked “We shape our buildings; thereafter they shape us.” In Nudge, Richard Thaler and Cass Sunstein define a “choice architect” as a person responsible for “organizing the context in which people make decisions.”cxvii They note that by rearranging a school cafeteria, it’s possible to increase or decrease the consumption of many food items by as much as 25 percent.cxviii Of course the context need not be physical. In one study, forty thousand people were asked “Do you intend to buy a new car in the next six months?”

cviii Spradley (1979), adapted from Figure 5.1, p.102. cix Spradley (1979), adapted from Figure 10.1, p.176. cx The Fifth Discipline by Peter Senge (1990), p.57. cxi Senge (1990), p.88. cxii Senge (1990), p.63. cxiii Schein (1999), p.34. cxiv Schein (1999), p.223. cxv Schein (1999), p.86. cxvi Leading from the Emerging Future by Otto Scharmer and Katrim Kaufer (2013), p.16. cxvii Nudge by Richard Thaler and Cass Sunstein (2008), p.3. cxviii Thaler and Sunstein (2008), p.1. cxix Thaler and Sunstein (2008), p.71. cxx Thaler and Sunstein (2008), p.111. cxxi Culture Mapping by Dave Gray. cxxii The Power of Habit by Charles Duhigg (2012), p.139. cxxiii The Fastest Way to Make Change (2012). cxxiv Meetup’s Dead Simple User Testing (2008). cxxv Duhigg (2012), p.98. cxxvi Duhigg (2012), p.116.


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The Googlization of Everything: by Siva Vaidhyanathan

1960s counterculture, activist fund / activist shareholder / activist investor, AltaVista, barriers to entry, Berlin Wall, borderless world, Burning Man, Cass Sunstein, choice architecture, cloud computing, computer age, corporate social responsibility, correlation does not imply causation, creative destruction, data acquisition, death of newspapers, don't be evil, Firefox, Francis Fukuyama: the end of history, full text search, global pandemic, global village, Google Earth, Howard Rheingold, informal economy, information retrieval, John Markoff, Joseph Schumpeter, Kevin Kelly, knowledge worker, libertarian paternalism, market fundamentalism, Marshall McLuhan, means of production, Mikhail Gorbachev, moral panic, Naomi Klein, Network effects, new economy, Nicholas Carr, PageRank, Panopticon Jeremy Bentham, pirate software, Ray Kurzweil, Richard Thaler, Ronald Reagan, side project, Silicon Valley, Silicon Valley ideology, single-payer health, Skype, Social Responsibility of Business Is to Increase Its Profits, social web, Steven Levy, Stewart Brand, technoutopianism, The Nature of the Firm, The Structural Transformation of the Public Sphere, Thorstein Veblen, urban decay, web application, zero-sum game

There is no formula for assessing it: I can’t give Google three of my privacy points in exchange 88 TH E G OOGL IZATION OF US for 10 percent better service. More seriously, Mayer and Google fail to acknowledge the power of default settings in a regime ostensibly based on choice. T H E IRR EL EVANC E O F C H O I C E In their 2007 book Nudge: Improving Decisions about Health, Wealth, and Happiness, the economist Richard Thaler and law professor Cass Sunstein describe a concept they call “choice architecture.” Plainly put, the structure and order of the choices offered to us profoundly influence the decisions we make. So, for instance, the arrangement of foods in a school cafeteria can influence children to eat better. The positions of restrooms and break rooms can influence the creativity and communality of office staff.

Barry Schwartz, “First Google Image Result for Michelle Obama Pure Racist,” Search Engine Round Table, November 13, 2009, www.seroundtable.com/ archives/021162.html; David Colker, “Google Won’t Exclude Distorted Michelle Obama Image from Its Site,” Los Angeles Times, November 25, 2009; Judit BarIlan, “Web Links and Search Engine Ranking: The Case of Google and the Query ‘Jew’,” Journal of the American Society for Information Science and Technology 57, no. 12 (2006): 1581. 8. Richard Thaler and Cass Sunstein, Nudge: Improving Decisions about Health, Wealth, and Happiness (New Haven: Yale University Press, 2008). 9. Levy, “Secret of Googlenomics.” 10. Randall E. Stross, Planet Google: One Company’s Audacious Plan to Organize Everything We Know (New York: Free Press, 2008), 109–28. 11. Cecillia Kang, “AT&T Accuses Google of Violating Telecom Laws; Google Rejects Claims,” Post I.T., blog, September 25, 2009; Amy Schatz, “AT&T Asks for Curbs on Google,” WSJ.com, September 26, 2009; John Markoff and Matt Richtel, “F.C.C.

“Privacy Policy: Google Privacy Center,” Google.com, www.google.com/ privacypolicy.html, accessed March 11, 2009. 5. Paul Ohm, “Broken Promises of Privacy: Responding to the Surprising Failure of Anonymization,” SSRN eLibrary, August 13, 2009, http://papers.ssrn .com. 6. “Privacy Policy,” Google.com. March 11, 2009. 7. Arshad Mohammed, “Google Refuses Demand for Search Information,” Washington Post, January 20, 2006. 8. Charlie Rose Show, 2009, available at http://video.google.com. 9. Richard Thaler and Cass Sunstein, Nudge: Improving Decisions about Health, Wealth, and Happiness (New Haven, CT: Yale University Press, 2008), 109. 10. Ibid., 3. 11. Google Search Privacy: Plain and Simple, 2007, www.youtube.com. 12. Louise Story and Brad Stone, “Facebook Retreats on On-Line Tracking,” New York Times, November 30, 2007. 13. Warren St. John, “When Information Becomes T.M.I.,” New York Times, September 10, 2006. 236 NOTES TO PAGES 92– 97 14.


pages: 670 words: 194,502

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

3Com Palm IPO, accounting loophole / creative accounting, air freight, Andrei Shleifer, asset allocation, business cycle, buy and hold, buy low sell high, capital asset pricing model, corporate governance, corporate raider, Daniel Kahneman / Amos Tversky, diversified portfolio, dogs of the Dow, Eugene Fama: efficient market hypothesis, Everybody Ought to Be Rich, 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, stocks for the long run, survivorship bias, the market place, the rule of 72, transaction costs, tulip mania, VA Linux, Vanguard fund, Y2K, Yogi Berra

The company changed its name officially to Yum! Brands, Inc. in May 2002. 7 See “CEO Speaks” and “The Bottom Line,” Money, May 2000, pp. 42–44. 8 In early 2003, Capital One’s chief financial officer resigned after securities regulators revealed that they might charge him with violations of laws against insider trading. 9 For a more advanced look at this bizarre event, see Owen A. Lamont and Richard H. Thaler, “Can the Market Add and Subtract?” National Bureau of Economic Research working paper no. 8302, at www.nber.org/papers/w8302. 10 CMGI began corporate life as College Marketing Group, which sold information about college professors and courses to academic publishers—a business that bore a faint but disturbing similarity to National Student Marketing, discussed by Graham on p. 235. 11 All stock prices for Red Hat are adjusted for its two-for-one stock split in January 2000. 12 Ironically, 65 years earlier Graham had singled out Brown Shoe as one of the most stable companies on the New York Stock Exchange.

Higher Dividends = Higher Earnings Growth,” Financial Analysts Journal, January/February, 2003, pp. 70–87. 14 Doron Nissim and Amir Ziv, “Dividend Changes and Future Profitability,” The Journal of Finance, vol. 56, no. 6, December, 2001, pp. 2111–2133. Even researchers who disagree with the Arnott-Asness and Nissim-Ziv findings on future earnings agree that dividend increases lead to higher future stock returns; see Shlomo Benartzi, Roni Michaely, and Richard Thaler, “Do Changes in Dividends Signal the Future or the Past?” The Journal of Finance, vol. 52, no. 3, July, 1997, pp. 1007–1034. 15 The tax reforms proposed by President George W. Bush in early 2003 would change the taxability of dividends, but the fate of this legislation was not yet clear by press time. 16 Historically, companies took a common-sense approach toward share repurchases, reducing them when stock prices were high and stepping them up when prices were low.


pages: 267 words: 72,552

Reinventing Capitalism in the Age of Big Data by Viktor Mayer-Schönberger, Thomas Ramge

accounting loophole / creative accounting, Air France Flight 447, Airbnb, Alvin Roth, Atul Gawande, augmented reality, banking crisis, basic income, Bayesian statistics, bitcoin, blockchain, Capital in the Twenty-First Century by Thomas Piketty, carbon footprint, Cass Sunstein, centralized clearinghouse, Checklist Manifesto, cloud computing, cognitive bias, conceptual framework, creative destruction, Daniel Kahneman / Amos Tversky, disruptive innovation, Donald Trump, double entry bookkeeping, Elon Musk, en.wikipedia.org, Erik Brynjolfsson, Ford paid five dollars a day, Frederick Winslow Taylor, fundamental attribution error, George Akerlof, gig economy, Google Glasses, information asymmetry, interchangeable parts, invention of the telegraph, inventory management, invisible hand, James Watt: steam engine, Jeff Bezos, job automation, job satisfaction, joint-stock company, Joseph Schumpeter, Kickstarter, knowledge worker, labor-force participation, land reform, lone genius, low cost airline, low cost carrier, Marc Andreessen, market bubble, market design, market fundamentalism, means of production, meta analysis, meta-analysis, Moneyball by Michael Lewis explains big data, multi-sided market, natural language processing, Network effects, Norbert Wiener, offshore financial centre, Parag Khanna, payday loans, peer-to-peer lending, Peter Thiel, Ponzi scheme, prediction markets, price anchoring, price mechanism, purchasing power parity, random walk, recommendation engine, Richard Thaler, ride hailing / ride sharing, Sam Altman, Second Machine Age, self-driving car, Silicon Valley, Silicon Valley startup, six sigma, smart grid, smart meter, Snapchat, statistical model, Steve Jobs, technoutopianism, The Future of Employment, The Market for Lemons, The Nature of the Firm, transaction costs, universal basic income, William Langewiesche, Y Combinator

eBay’s recent troubles: Nicole Perlroth, “EBay Urges New Passwords After Breach,” New York Times, May 21, 2014, https://www.nytimes.com/2014/05/22/technology/ebay-reports-attack-on-its-computer-network.html?_r=0. sellers of Yahoo’s shares: Matt Levine, “How Can Yahoo Be Worth Less Than Zero?” Bloomberg, April 17, 2014, http://www.bloomberg.com/view/articles/2014-04-17/how-can-yahoo-be-worth-less-than-zero; see generally, Richard H. Thaler, Misbehaving: The Making of Behavioural Economics (London: Allen Lane, 2015), 244–253. “electronic markets”: Thomas W. Malone, Joanne Yates, and Robert I. Benjamin, “Electronic Markets and Electronic Hierarchies,” Communications of the ACM, June 1987, https://www.researchgate.net/publication/220425850. a staggering 500 percent upturn: “The Zettabyte Era: Trends and Analysis,” Cisco White Paper No. 1465272001812119, June 7, 2017, http://www.cisco.com/c/en/us/solutions/collateral/service-provider/visual-networking-index-vni/vni-hyperconnectivity-wp.html.

computer system that would assist the Chilean government: The evolution of Cybersyn and its implications are eloquently captured in Eden Medina, Cybernetics Revolutionaries: Technology and Politics in Allende’s Chile (Cambridge: MIT Press, 2011); see also Evgeny Morozov, “The Planning Machine,” New Yorker, October 13, 2014, http://www.newyorker.com/magazine/2014/10/13/planning-machine. The development of Cybersyn also underlies the plot of a work of fiction: see Sascha Reh, Gegen die Zeit (Frankfurt, Germany: Schöffling, 2015). Great Famine of 1932–1933: See Anne Applebaum, Red Famine: Stalin’s War on Ukraine (New York: Doubleday, 2017). to coax us to transact appropriately: See, e.g., Richard H. Thaler and Cass R. Sunstein, Nudge: Improving Decisions About Health, Wealth, and Happiness (New Haven: Yale University Press, 2008). CHAPTER 9: UNBUNDLING WORK “The drive was as mundane”: Alex Davies, “Uber’s Self-Driving Truck Makes Its First Delivery: 50,000 Beers,” Wired, October 25, 2016, https://www.wired.com/2016/10/ubers-self-driving-truck-makes-first-delivery-50000-beers. the system won’t take away their jobs: Eric Newcomer and Alex Webb, “Uber Self-Driving Truck Packed with Budweiser Makes First Delivery in Colorado,” Bloomberg, October 25, 2016, https://www.bloomberg.com/news/articles/2016-10-25/uber-self-driving-truck-packed-with-budweiser-makes-first-delivery-in-colorado.


pages: 267 words: 71,941

How to Predict the Unpredictable by William Poundstone

accounting loophole / creative accounting, Albert Einstein, Bernie Madoff, Brownian motion, business cycle, butter production in bangladesh, buy and hold, buy low sell high, call centre, centre right, Claude Shannon: information theory, computer age, crowdsourcing, Daniel Kahneman / Amos Tversky, Edward Thorp, Firefox, fixed income, forensic accounting, high net worth, index card, index fund, John von Neumann, market bubble, money market fund, pattern recognition, Paul Samuelson, Ponzi scheme, prediction markets, random walk, Richard Thaler, risk-adjusted returns, Robert Shiller, Robert Shiller, Rubik’s Cube, statistical model, Steven Pinker, transaction costs

American Economic Review 92, 1138–1151. Clifford, Stephanie (2012). “Shopper Alert: Price May Drop for You Alone.” New York Times, Aug. 9, 2012. Cones, Harold, John H. Bryant, and Martin Blankinship (2003). Zenith Radio, the Glory Years, 1936– 1945: History and Products. Altgen, Penna.: Schiffer Publishing. Coupling, J. J. (1950). “Science for Art’s Sake.” Astounding Science Fiction, Nov. 1950, 83–92. De Bondt, Werner, and Richard H. Thaler (1985). “Does the Stock Market Overreact?” Journal of Finance 40, 793–805. Deckert, Joseph, Mikhail Myagkov, and Peter C. Ordeschook (n.d.). “The Irrelevance of Benford’s Law for Detecting Fraud in Elections.” www.vote.caltech.edu/sites/default/files/benford_pdf_4b97cc5b5b.pdf. DeStefano, Joseph, Peter Doyle, and J. Laurie Snell (2003). “The Evil Twin strategy for a football pool.” www.math.dartmouth.edu/~doyle/docs/twin/twin.pdf.

Lux, Hal (2000). “The Secret World of Jim Simons.” Institutional Investor, Nov. 1, 2000. faculty.fuqua.duke.edu/~charvey/Teaching/BA453_2006/II_On_Jim_.pdf. MacLean, Leonard, William T. Ziemba, and George Blazenko (1987). “Growth versus Security in Dynamic Investment Analysis.” University of British Columbia, Faculty of Commerce and Business Administration, mimeograph. Massey, Cade, and Richard H. Thaler (2010). “The Loser’s Curse: Overconfidence vs. Market Efficiency in the National Football League Draft.” Working paper, ssrn.com/abstract=697121. Mather, Victor (2011). “2011 N.C.A.A. Tournament: How to Win a Pool That Rewards Upsets.” New York Times, Mar. 14, 2011. Matson, John (2012). “The Not So Hot Hand.” Scientific American, Feb. 2012, 16. Maue, Rick (2000). The Book of Haunted Magick.


Not Working by Blanchflower, David G.

active measures, affirmative action, Affordable Care Act / Obamacare, Albert Einstein, bank run, banking crisis, basic income, Berlin Wall, Bernie Madoff, Bernie Sanders, Black Swan, Boris Johnson, business cycle, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, Clapham omnibus, collective bargaining, correlation does not imply causation, credit crunch, declining real wages, deindustrialization, Donald Trump, estate planning, Fall of the Berlin Wall, full employment, George Akerlof, gig economy, Gini coefficient, Growth in a Time of Debt, illegal immigration, income inequality, indoor plumbing, inflation targeting, job satisfaction, John Bercow, Kenneth Rogoff, labor-force participation, liquidationism / Banker’s doctrine / the Treasury view, longitudinal study, low skilled workers, manufacturing employment, Mark Zuckerberg, market clearing, Martin Wolf, mass incarceration, meta analysis, meta-analysis, moral hazard, Nate Silver, negative equity, new economy, Northern Rock, obamacare, oil shock, open borders, Own Your Own Home, p-value, Panamax, pension reform, plutocrats, Plutocrats, post-materialism, price stability, prisoner's dilemma, quantitative easing, rent control, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Coase, selection bias, selective serotonin reuptake inhibitor (SSRI), Silicon Valley, South Sea Bubble, Thorstein Veblen, trade liberalization, universal basic income, University of East Anglia, urban planning, working poor, working-age population, yield curve

Noah Smith, “Anti-empiricism Is Not Humility,” http://noahpinionblog.blogspot.com, March 10, 2017. 39. John Cochrane, “Russ Roberts on Economic Humility,” Grumpy Economist, March 3, 2017, http://johnhcochrane.blogspot.com/2017/03/russ-roberts-on-economic-humility.html. 40. Robert Shiller, “Richard Thaler Is a Controversial Nobel Prize Winner—but a Deserving One,” Guardian, October 11, 2017. Six percent of all Nobels have been awarded, says Shiller, to people who can be classified as behavioral economists including Richard Thaler (2017), Bob Shiller (2013), George Akerlof (2001), Robert Fogel (1993), Daniel Kahneman (2002), and Elinor Ostrom (2009). 41. Stephen Nickell, “Household Debt, House Prices and Consumption Growth” (Speech given at Bloomberg in London, September 14, 2004). 42. Charles Bean, speech given at the Colchester Town Partnership Annual Dinner, Moot Hall, Colchester, November 25, 2004, https://www.bankofengland.co.uk/-/media/boe/files/speech/2004/colechester-town-partnership-annual-dinner. 43.

And until we figure out what happened, and how to look at the labor market, social cohesion will continue to break down. The Economics of Walking About I will document in some detail what I call the “economics of walking about.” There was a long tradition in labor economics to try to understand how the world worked and to reveal, what the great Harvard economist John Dunlop once told me, rules of thumb on how people make decisions. It involves listening to what people say and taking it seriously. Richard Thaler (2018) in his 2017 Nobel Prize lecture noted that “what economists often call estimates or forecasts, and heuristics is a fancy word for rules-of-thumb . . . faced with a complex prediction problem (‘What is the chance this applicant will do well in graduate school?’) people often rely on simple rules-of-thumb (‘heuristics’) to help them.” Heuristics sounds better. The economics of walking about involves looking at qualitative data from the representatives of firms on how the firm is doing and from individuals on their well-being.

Famously, Ronald Coase in his Nobel Prize lecture argued that “inspiration is most likely to come through the stimulus provided by the patterns, puzzles, and anomalies revealed by the systematic gathering of data, particularly when the prime need is to break our existing habits of thought” (1992, 718). In a recent column celebrating the award of the 2017 Sveriges Riksbank Nobel Economics prize to Richard Thaler, Robert Shiller, who won the prize in 2013, noted that there had been antagonism within the profession to the research agenda of the behavioral economists, which includes him. Shiller notes that “many in economics and finance still believe that the best way to describe human behavior is to eschew psychology and instead model human behavior as mathematical optimization by separate and relentlessly selfish individuals, subject to budget constraints.”


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Fault Lines: How Hidden Fractures Still Threaten the World Economy by Raghuram Rajan

accounting loophole / creative accounting, Andrei Shleifer, Asian financial crisis, asset-backed security, assortative mating, bank run, barriers to entry, Bernie Madoff, Bretton Woods, business climate, business cycle, Clayton Christensen, clean water, collapse of Lehman Brothers, collateralized debt obligation, colonial rule, corporate governance, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, currency manipulation / currency intervention, diversification, Edward Glaeser, financial innovation, fixed income, floating exchange rates, full employment, global supply chain, Goldman Sachs: Vampire Squid, illegal immigration, implied volatility, income inequality, index fund, interest rate swap, Joseph Schumpeter, Kenneth Rogoff, knowledge worker, labor-force participation, Long Term Capital Management, longitudinal study, market bubble, Martin Wolf, medical malpractice, microcredit, money market fund, moral hazard, new economy, Northern Rock, offshore financial centre, open economy, price stability, profit motive, Real Time Gross Settlement, Richard Florida, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, Ronald Reagan, school vouchers, short selling, sovereign wealth fund, The Great Moderation, the payments system, The Wealth of Nations by Adam Smith, too big to fail, upwardly mobile, Vanguard fund, women in the workforce, World Values Survey

Rather than falling short for sure, they preferred to move into longer-term riskier bonds, such as mortgage-backed securities, that paid higher interest rates. In addition, as long-term interest rates fell and the value of stocks, bonds, and housing rose, households felt wealthier and may have felt the confidence to take more risks. Some of these choices may have been irrational. As my colleague Richard Thaler has argued, when gamblers win money, they take more risks, because they treat their earlier winnings as “house” money—not their own—and therefore less important if lost. Whatever the reason, with investors more willing to take risks, the risk premium on all manner of assets came down. One effect of the search for yield was that money moved out of the United States into other countries, especially into the high-yielding bonds, stocks, and government securities in developing countries.

It was an illusion even before the current crisis—after all, you have to live somewhere, so if the value of the home you live in is rising, you really do not have extra disposable wealth—and it became even more illusory as house prices collapsed and borrowers were left staring at a mountain of debt. Americans need to save more, and the government should be far less eager to encourage them to spend. Savings rates are increasing as households dig themselves out of this crisis. A number of interesting ideas have been proposed to encourage savings and are worth exploring. For instance, my colleague Richard Thaler at the University of Chicago has suggested innovative ways by which households can be nudged into saving more. In his “Save More Tomorrow” plan, devised with Shlomo Benartzi, workers sign an agreement with their employer and their financial services provider that they will place some portion of future salary raises into savings plans. The idea is that when they commit to doing so, the extra amount saved does not shrink their budget and requires no sacrifice of current consumption.

However, some reasonable portion of their savings should be independent of the health of their firms. 33 See, for instance, Robert Shiller, The New Financial Order (Princeton, NJ: Princeton University Press, 2003), 118–19. 34 The next few paragraphs draw on my previous book with Luigi Zingales, Saving Capitalism from the Capitalists (Princeton, NJ: Princeton University Press, 2004). 35 Shlomo Benartzi and Richard Thaler, “Save More Tomorrow: Using Behavioral Economics to Increase Employee Savings,” unpublished manuscript, University of Chicago. Chapter Ten. The Fable of the Bees Replayed 1 Bernard Mandeville, The Fable of the Bees (1714) (Oxford: Clarendon Press, 1957). 2 Ibid. 3 Yashwant Sinha, speech at World Economic Forum, Davos, Switzerland, January 2001. 4 Jeffry Frieden, “Global Imbalances, National Rebalancing, and the Political Economy of Recovery,” working paper, Council on Foreign Relations, New York, 2009. 5 Ibid. 6 “Leaders’ Statement: The Pittsburgh Summit,” Pittsburgh Summit, www.pittsburgh summit.gov/mediacenter/129639.htm, September 25, 2009. 7 M.


pages: 453 words: 111,010

Licence to be Bad by Jonathan Aldred

"Robert Solow", Affordable Care Act / Obamacare, Albert Einstein, availability heuristic, Ayatollah Khomeini, Benoit Mandelbrot, Berlin Wall, Black Swan, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, Cass Sunstein, clean water, cognitive dissonance, corporate governance, correlation does not imply causation, cuban missile crisis, Daniel Kahneman / Amos Tversky, Donald Trump, Douglas Engelbart, Douglas Engelbart, Edward Snowden, Fall of the Berlin Wall, falling living standards, feminist movement, framing effect, Frederick Winslow Taylor, From Mathematics to the Technologies of Life and Death, full employment, George Akerlof, glass ceiling, Intergovernmental Panel on Climate Change (IPCC), invisible hand, Isaac Newton, Jeff Bezos, John Nash: game theory, John von Neumann, Long Term Capital Management, Louis Bachelier, mandelbrot fractal, meta analysis, meta-analysis, Mont Pelerin Society, mutually assured destruction, Myron Scholes, Nash equilibrium, Norbert Wiener, nudge unit, obamacare, offshore financial centre, Pareto efficiency, Paul Samuelson, plutocrats, Plutocrats, positional goods, profit maximization, profit motive, race to the bottom, RAND corporation, rent-seeking, Richard Thaler, ride hailing / ride sharing, risk tolerance, road to serfdom, Robert Shiller, Robert Shiller, Ronald Coase, Ronald Reagan, Skype, Social Responsibility of Business Is to Increase Its Profits, spectrum auction, The Nature of the Firm, The Wealth of Nations by Adam Smith, transaction costs, trickle-down economics, Vilfredo Pareto, wealth creators, zero-sum game

Some markets, notably in the financial world, couldn’t even exist without an economic theory to explain them and give them rules: the financial products being traded are so complex that without a theory (or its manifestation as a computer model) to consult, traders cannot tell whether prices are cheap or expensive. When economists see the chasm between economic theory and real-world behaviour their solution is often to change the world, not the theory.fn3 Economist Richard Thaler recently won the Nobel Prize for his work leading to the Nudge idea. Nudge economists seek to change the environment in which we make choices, to steer us to choose as homo economicus would do – to make us behave in accordance with economic theory, even though we don’t think like that. This approach, making our choice environment human-proof, assumes human decisions are generally inferior, and never superior, to those of machine-like homo economicus.

But as the new behavioural economics began to filter through to policy-making circles, something strange happened. The central lesson of behavioural economics is that people make poor decisions – yet the policy innovation it provoked seeks to rely on precisely those poor decisions to bring about desirable outcomes. Welcome to the weird world of Nudge. Nudge began with a 2008 book of that name by economist Richard Thaler and lawyer Cass Sunstein. Both of them had worked with Kahneman and Tversky, who had shown that real people do not act like homo economicus. Rather than weighing up all relevant considerations and carefully calculating the ‘optimal’ choice, people are guided by rules of thumb, intuition, impulse and inertia. The core idea behind Nudge is that rather than fighting these forces, we should use them, to steer or nudge people to make the choices they would want to make – the choices homo economicus would make, or at least something close.

objection, 107, 119–20 Friedman, Milton, 4–5, 56, 69, 84, 88, 126, 189 awarded Nobel Prize, 132 and business responsibility, 2, 152 debate with Coase at Director’s house, 50, 132 as dominant Chicago thinker, 50, 132 on fairness and justice, 60 flawed arguments of, 132–3 influence on modern economics, 131–2 and monetarism, 87, 132, 232 at Mont Pèlerin, 5, 132 rejects need for realistic assumptions, 132–3 Sheraton Hall address (December 1967), 132 ‘The Methodology of Positive Economics’ (essay, 1953), 132–3 ‘The Social Responsibility of Business is to Increase Its Profits’ (article, 1970), 2, 152 Frost, Gerald, Antony Fisher: Champion of Liberty (2002), 7* Galbraith, John Kenneth, 242–3 game theory assumptions of ‘rational behaviour’, 18, 28, 29–32, 35–8, 41–3, 70, 124 Axelrod’s law of the instrument, 41 backward induction procedure, 36–7, 38 and Cold War nuclear strategy, 18, 20, 21–2, 24, 27, 33–4, 35, 70, 73, 198 focus on consequences alone, 43 as form of zombie science, 41 and human awareness, 21–3, 24–32 and interdependence, 23 limitations of, 32, 33–4, 37–40, 41–3 minimax solution, 22 multiplicity problem, 33–4, 35–7, 38 Nash equilibrium, 22–3, 24, 25, 27–8, 33–4, 41–2 the Nash program, 25 and nature of trust, 28–31, 41 the Prisoner’s Dilemma, 26–8, 29–32, 42–3 real world as problem for, 21–2, 24–5, 29, 31–2, 37–8, 39–40, 41–3 rise of in economics, 40–41 and Russell’s Chicken, 33–4 and Schelling, 138–9 and spectrum auctions, 39–40 theory of repeated games, 29–30, 35 tit-for-tat, 30–31 and trust, 29, 30–31, 32, 41 uses of, 23–4, 34, 38–9 view of humanity as non-cooperative/distrustful, 18, 21–2, 25–32, 36–8, 41–3 Von Neumann as father of, 18, 19, 20–22, 25, 26, 28, 30, 34, 41 zero-sum games, 21–2 Gates, Bill, 221–2 Geithner, Tim, 105 gender, 127–8, 130–31, 133, 156 General Electric, 159 General Motors (GM), 215–16 George, Prince of Cambridge, 98 Glass–Steagall Act, repeal of, 194 globalization, 215, 220 Goldman Sachs, 182, 184, 192 Google, 105 Gore, Al, 39 Great Reform Act (1832), 120 greed, 1–2, 196, 197, 204, 229, 238 Greenspan, Alan, 57, 203 Gruber, Jonathan, 245 Haifa, Israel, 158, 161 Harper, ‘Baldy’, 7 Harsanyi, John, 34–5, 40 Harvard Business Review, 153 Hayek, Friedrich and Arrow’s framework, 78–9 economics as all of life, 8 and Antony Fisher, 6–7 influence on Thatcher, 6, 7 and Keynesian economics, 5–6 and legal frameworks, 7* at LSE, 4 at Mont Pèlerin, 4, 5, 6, 15 and Olson’s analysis, 104 and public choice theory, 89 rejection of incentive schemes, 156 ‘spontaneous order’ idea, 30 The Road to Serfdom (1944), 4, 5, 6, 78–9, 94 healthcare, 91–2, 93, 178, 230, 236 hedge funds, 201, 219, 243–4 Heilbroner, Robert, The Worldly Philosophers, 252 Heller, Joseph, Catch-22, 98, 107, 243–4 Helmsley, Leona, 105 hero myths, 221–3, 224 Hewlett-Packard, 159 hippie countercultural, 100 Hoffman, Abbie, Steal This Book, 100 Holmström, Bengt, 229–30 homo economicus, 9, 10, 12, 140, 156–7 and Gary Becker, 126, 129, 133, 136 and behaviour of real people, 15, 136, 144–5, 171, 172, 173, 250–51 and behavioural economics, 170, 171, 172, 255 long shadow cast by, 248 and Nudge economists, 13, 172, 173, 174–5, 177 Hooke, Robert, 223 housing market, 128–9, 196, 240–41 separate doors for poor people, 243 Hume, David, 111 Huxley, Thomas, 114 IBM, 181, 222 identity, 32, 165–6, 168, 180 Illinois, state of, 46–7 immigration, 125, 146 Impossibility Theorem, 72, 73–4, 75, 89, 97 Arrow’s assumptions, 80, 81, 82 and Duncan Black, 77–8 and free marketeers, 78–9, 82 as misunderstood and misrepresented, 76–7, 79–82 ‘paradox of voting’, 75–7 as readily solved, 76–7, 79–80 Sen’s mathematical framework, 80–81 incentives adverse effect on autonomy, 164, 165–6, 168, 169–70, 180 authority figure–autonomy contradiction, 180 and behavioural economics, 171, 175, 176–7 cash and non-cash gifts, 161–2 context and culture, 175–6 contrast with rewards and punishments, 176–7 ‘crowding in’, 176 crowding out of prior motives, 160–61, 162–3, 164, 165–6, 171, 176 impact of economists’ ideas, 156–7, 178–80 and intrinsic motivations, 158–60, 161–3, 164, 165–6, 176 and moral disengagement, 162, 163, 164, 166 morally wrong/corrupting, 168–9 origins in behaviourism, 154 and orthodox theory of motivation, 157–8, 164, 166–7, 168–70, 178–9 payments to blood donors, 162–3, 164, 169, 176 as pervasive in modern era, 155–6 respectful use of, 175, 177–8 successful, 159–60 as tools of control/power, 155–7, 158–60, 161, 164, 167, 178 Indecent Proposal (film, 1993), 168 India, 123, 175 individualism, 82, 117 and Becker, 134, 135–8 see also freedom, individual Industrial Revolution, 223 inequality and access to lifeboats, 150–51 and climate change, 207–9 correlation with low social mobility, 227–8, 243 and demand for positional goods, 239–41 and economic imperialism, 145–7, 148, 151, 207 and efficiency wages, 237–8 entrenched self-deluding justifications for, 242–3 and executive pay, 215–16, 219, 224, 228–30, 234, 238 as falling in 1940–80 period, 215, 216 Great Gatsby Curve, 227–8, 243 hero myths, 221–3, 224 increases in as self-perpetuating, 227–8, 230–31, 243 as increasing since 1970s, 2–3, 215–16, 220–21 and lower growth levels, 239 mainstream political consensus on, 216, 217, 218, 219–21 marginal productivity theory, 223–4, 228 new doctrine on taxation since 1970s, 232–5 and Pareto, 217, 218–19, 220 poverty as waste of productive capacity, 238–9 public attitudes to, 221, 226–8 rises in as not inevitable, 220, 221, 242 role of luck downplayed, 222, 224–6, 243 scale-invariant nature of, 219, 220 ‘socialism for the rich’, 230 Thatcher’s praise of, 216 and top-rate tax cuts, 231, 233–5, 239 trickle-down economics, 232–3 US and European attitudes to, 226–7 ‘you deserve what you get’ belief, 223–6, 227–8, 236, 243 innovation, 222–3, 242 Inside Job (documentary, 2010), 88 Institute of Economic Affairs, 7–8, 15, 162–3 intellectual property law, 57, 68, 236 Ishiguro, Kazuo, Never Let Me Go, 148 Jensen, Michael, 229 Journal of Law and Economics, 49 justice, 1, 55, 57–62, 125, 137 Kahn, Herman, 18, 33 Kahneman, Daniel, 170–72, 173, 179, 202–3, 212, 226 Kennedy, President John, 139–40 Keynes, John Maynard, 11, 21, 162, 186, 204 and Buchanan’s ideology, 87 dentistry comparison, 258–9, 261 on economics as moral science, 252–3 Friedman’s challenge to orthodoxy of, 132 Hayek’s view of, 5–6 massive influence of, 3–4, 5–6 on power of economic ideas, 15 and probability, 185, 186–7, 188–9, 190, 210 vision of the ideal economist, 20 General Theory (1936), 15, 188–9 Khomeini, Ayatollah, 128 Khrushchev, Nikita, 139–40, 181 Kilburn Grammar School, 48 Kildall, Gary, 222 Kissinger, Henry, 184 Knight, Frank, 185–6, 212 Krugman, Paul, 248 Kubrick, Stanley, 35*, 139 labour child labour, 124, 146 and efficiency wages, 237–8 labour-intensive services, 90, 92–3 lumpenproletariat, 237 Olson’s hostility to unions, 104 Adam Smith’s ‘division of labour’ concept, 128 Laffer, Arthur, 232–3, 234 Lancet (medical journal), 257 Larkin, Philip, 67 law and economics movement, 40, 55, 56–63, 64–7 Lazear, Edward, ‘Economic Imperialism’, 246 legal system, 7* and blame for accidents, 55, 60–61 and Chicago School, 49, 50–52, 55 and Coase Theorem, 47, 49, 50–55, 63–6 criminal responsibility, 111, 137, 152 economic imperialist view of, 137 law and economics movement, 40, 55, 56–63, 64–7 ‘mimic the market’ approach, 61–3, 65 Posner’s wealth-maximization principle, 57–63, 64–7, 137 precautionary principle, 211–12, 214 transaction costs, 51–3, 54–5, 61, 62, 63–4, 68 Lehmann Brothers, 194 Lexecon, 58, 68 Linda Problem, 202–3 LineStanding.com, 123 Little Zheng, 123, 124 Lloyd Webber, Andrew, 234–5, 236 lobbying, 7, 8, 88, 115, 123, 125, 146, 230, 231, 238 loft-insulation schemes, 172–3 logic, mathematical, 74–5 The Logic of Life (Tim Harford, 2008), 130 London School of Economics (LSE), 4, 48 Long-Term Capital Management (LTCM), 201, 257 Machiavelli, Niccoló, 89, 94 Mafia, 30 malaria treatments, 125, 149 management science, 153–4, 155 Mandelbrot, Benoît, 195, 196, 201 Mankiw, Greg, 11 marginal productivity theory, 223–4 Markowitz, Harry, 196–7, 201, 213 Marx, Karl, 11, 101, 102, 104, 111, 223 lumpenproletariat, 237 mathematics, 9–10, 17–18, 19, 21–4, 26, 247, 248, 255, 259 of 2007 financial crash, 194, 195–6 and Ken Arrow, 71, 72, 73–5, 76–7, 82–3, 97 axioms (abstract assumptions), 198 fractals (scale-invariance), 194, 195–6, 201, 219 and orthodox decision theory, 190–91, 214 Ramsey Rule on discounting, 208–9, 212 and Savage, 189–90, 193, 197, 198, 199, 205 and Schelling, 139 Sen’s framework on voting systems, 80–81 standard deviation, 182, 192, 194 and stock market statistics, 190–91, 195–6 use of for military ends, 71–2 maximizing behaviour and Becker, 129–31, 133–4, 147 and catastrophe, 211 and Coase, 47, 55, 59, 61, 63–9 economic imperialism, 124–5, 129–31, 133–4, 147, 148–9 Posner’s wealth-maximization principle, 57–63, 64–7, 137 profit-maximizing firms, 228 see also wealth-maximization principle; welfare maximization McCluskey, Kirsty, 194 McNamara, Robert, 138 median voter theorem, 77, 95–6 Merton, Robert, 201 Meucci, Antonio, 222 microeconomics, 9, 232, 259 Microsoft, 222 Miles, David, 258 Mill, John Stuart, 102, 111, 243 minimum wage, national, 96 mobility, economic and social correlation with inequality, 226–8, 243 as low in UK, 227 as low in USA, 226–7 US–Europe comparisons, 226–7 Modern Times (Chaplin film, 1936), 154 modernism, 67 Moivre, Abraham de, 193 monetarism, 87, 89, 132, 232 monopolies and cartels, 101, 102, 103–4 public sector, 48–9, 50–51, 93–4 Mont Pèlerin Society, 3–9, 13, 15, 132 Morgenstern, Oskar, 20–22, 24–5, 28, 35, 124, 129, 189, 190 Mozart, Wolfgang Amadeus, 91, 92–3 Murphy, Kevin, 229 Mussolini, Benito, 216, 219 Nash equilibrium, 22–3, 24, 25, 27–8, 33–4, 41–2 Nash, John, 17–18, 22–3, 24, 25–6, 27–8, 33–4, 41–2 awarded Nobel Prize, 34–5, 38, 39, 40 mental health problems, 25, 26, 34 National Health Service, 106, 162 ‘neoliberalism’, avoidance of term, 3* Neumann, John von ambition to make economics a science, 20–21, 24–5, 26, 35, 125, 151, 189 as Cold War warrior, 20, 26, 138 and expansion of scope of economics, 124–5 as father of game theory, 18, 19, 20–22, 25, 26, 28, 30, 34, 41 final illness and death of, 19, 34, 35, 43–4 genius of, 19–20 as inspiration for Dr Strangelove, 19 and Nash’s equilibrium, 22–3, 25, 38* simplistic view of humanity, 28 theory of decision-making, 189, 190, 203 neuroscience, 14 New Deal, US, 4, 194, 231 Newton, Isaac, 223 Newtonian mechanics, 21, 24–5 Nixon, Richard, 56, 184, 200 NORAD, Colorado Springs, 181 nuclear weapons, 18–19, 20, 22, 27, 181 and Ellsberg, 200 and game theory, 18, 20, 21–2, 24, 27, 33–4, 35, 70, 73, 198 MAD (Mutually Assured Destruction), 35, 138 and Russell’s Chicken, 33–4 and Schelling, 138, 139 Nudge economists, 13, 171–5, 177–8, 179, 180, 251 Oaten, Mark, 121 Obama, Barack, 110, 121, 157, 172, 180 Olson, Mancur, 103, 108, 109, 119–20, 122 The Logic of Collective Action (1965), 103–4 On the Waterfront (Kazan film, 1954), 165 online invisibility, 100* organs, human, trade in, 65, 123, 124, 145, 147–8 Orwell, George, Nineteen Eighty-Four, 42–3 Osborne, George, 233–4 Packard, David, 159 Paine, Tom, 243 Pareto, Vilfredo 80/20 rule’ 218 and inequality, 217, 218–19, 220 life and background of, 216–17 Pareto efficiency, 217–18, 256* Paul the octopus (World Cup predictor, 2010), 133 pensions, workplace, 172, 174 physics envy, 9, 20–21, 41, 116, 175–6, 212, 247 Piketty, Thomas, 234, 235 plastic shopping bag tax, 159–60 Plato’s Republic, 100–101, 122 political scientists and Duncan Black, 78, 95–6 Black’s median voter theorem, 95–6 Buchanan’s ideology, 84–5 crises of the 1970s, 85–6 influence of Arrow, 72, 81–2, 83 see also public choice theory; social choice theory Posner, Richard, 54, 56–63, 137 ‘mimic the market’ approach, 61–3, 65 ‘The Economics of the Baby Shortage’ (1978), 61 precautionary principle, 211–12, 214 price-fixing, 101, 102, 103–4 Princeton University, 17, 19–20 Prisoner’s Dilemma, 26–8, 29–32, 42–3 prisons, cell upgrades in, 123 privatization, 50, 54, 88, 93–4 probability, 182–4 and Keynes, 185, 186–7, 188–9, 210 Linda Problem, 202–3 modern ideas of, 184–5 Ramsey’s personal probabilities (beliefs as probabilities), 187–8, 190, 197, 198, 199, 204–5 and Savage, 190, 193, 197, 198, 199, 203, 205 ‘Truth and Probability’ (Ramsey paper), 186–8, 189, 190 see also risk and uncertainty Proceedings of the National Academy of Sciences, 22 productivity Baumol’s cost disease, 90–92, 93, 94 and efficiency wages, 237–8 improvement in labour-intensive services, 92–3 labour input, 92 protectionism, 246, 255 psychology availability heuristic, 226 behaviourism, 154–8, 237 and behavioural economics, 12, 170–71 cognitive dissonance, 113–14 and financial incentives, 156–7, 158–60, 163–4, 171 framing effects, 170–71, 259 of free-riding, 113–14, 115 intrinsic motivations, 158–60, 161–3, 164, 165–6, 176 irrational behaviour, 12, 15, 171 learning of social behaviour, 163–4 moral disengagement, 162, 163, 164, 166 motivated beliefs, 227 ‘self-command’ strategies, 140 view of in game theory, 26–31 view of in public choice theory, 85–6 and welfare maximization, 149 ‘you deserve what you get’ belief, 223–6, 227–8, 236, 243 public choice theory as consensus view, 84–5 and crises of the 1970s, 85–6 foolish voter assumption, 86–8 ‘paradox of voter turnout’, 88–9, 95–6, 115–16 partial/self-contradictory application of, 86, 87–9 ‘political overload’ argument, 85, 86–7 ‘public bad, private good’ mantra, 93–4, 97 and resistance to tax rises, 94, 241 self-fulfilling prophecies, 95–7 and selfishness, 85–6, 87–8, 89, 94, 95–7 as time-bomb waiting to explode, 85 public expenditure in 1970s and ’80s, 89 Baumol’s cost disease, 90–92, 93, 94 and Keynesian economics, 4 and public choice theory, 85–8, 89, 241 and tax rises, 241–2 public-sector monopolies, 48–9, 50–51, 93–4 Puzzle of the Harmless Torturers, 118–19 queue-jumping, 123, 124 QWERTY layout, 42 racial discrimination, 126–7, 133, 136, 140 Ramsey, Frank, 186–8, 189, 190, 205, 208 Ramsey Rule, 208–9, 212 RAND Corporation, 17, 41, 103, 138, 139 and Ken Arrow, 70–71, 72–3, 74, 75–6, 77, 78 and behaviourism, 154 and Cold War military strategy, 18, 20, 21–2, 24, 27, 33–4, 70, 73, 75–6, 141, 200, 213 and Ellsberg, 182–4, 187, 197–8, 200 and Russell’s Chicken, 33 Santa Monica offices of, 18 self-image as defender of freedom, 78 rational behaviour assumptions in game theory, 18, 28, 29–32, 35–8, 41–3, 70, 124 axioms (abstract mathematical assumptions), 198 Becker’s version of, 128–9, 135, 140, 151 behavioural economics/Nudge view of, 173, 174–5 distinction between values and tastes, 136–8 economic imperialist view of, 135, 136–8, 140, 151 and free-riding theory, 100–101, 102, 103–4, 107–8, 109–10, 115–16 and orthodox decision theory, 198, 199 public choice theory relates selfishness to, 86 term as scientific-sounding cover, 12 see also homo economicus Reader’s Digest, 5, 6 Reagan, Ronald, 2, 87–8, 89, 104, 132 election of as turning point, 6, 216, 220–21 and top-rate tax cuts, 231, 233 regulators, 1–2 Chicago view of, 40 Reinhart, Carmen, 258 religion, decline of in modern societies, 15, 185 renewable energy, 116 rent-seeking, 230, 238 ‘right to recline’, 63–4 risk and uncertainty bell curve distribution, 191–4, 195, 196–7, 201, 203–4, 257 catastrophes, 181–2, 191, 192, 201, 203–4, 211–12 delusions of quantitative ‘risk management’, 196, 213 Ellsberg’s experiment (1961), 182–4, 187, 197, 198–200 errors in conventional thinking about, 191–2, 193–4, 195–7, 204–5, 213 financial orthodoxy on risk, 196–7, 201–2 and First World War, 185 and fractals (scale-invariance), 194, 195–6, 201 hasard and fortuit, 185* ‘making sense’ of through stories, 202–3 ‘measurable’ and ‘unmeasurable’ distinction, 185–6, 187–9, 190, 210–11, 212–13 measurement in numerical terms, 181–4, 187, 189, 190–94, 196–7, 201–2, 203–5, 212–13 orthodox decision theory, 183–4, 185–6, 189–91, 193–4, 201–2, 203–5, 211, 212–14 our contemporary orthodoxy, 189–91 personal probabilities (beliefs as probabilities), 187–8, 190, 197, 198, 199, 204–5 precautionary principle, 211–12, 214 pure uncertainty, 182–3, 185–6, 187–9, 190, 197, 198–9, 210, 211, 212, 214, 251 redefined as ‘volatility’, 197, 213 the Savage orthodoxy, 190–91, 197, 198–200, 203, 205 scenario planning as crucial, 251 Taleb’s black swans, 192, 194, 201, 203–4 ‘Truth and Probability’ (Ramsey paper), 186–8, 189, 190 urge to actuarial alchemy, 190–91, 197, 201 value of human life (‘statistical lives’), 141–5, 207 see also probability Robertson, Dennis, 13–14 Robinson, Joan, 260 Rodrik, Dani, 255, 260–61 Rogoff, Ken, 258 Rothko, Mark, 4–5 Rumsfeld, Donald, 232–3 Russell, Bertrand, 33–4, 74, 97, 186, 188 Ryanair, 106 Sachs, Jeffrey, 257 Santa Monica, California, 18 Sargent, Tom, 257–8 Savage, Leonard ‘Jimmie’, 189–90, 193, 203, 205scale-invariance, 194, 195–6, 201, 219 Scandinavian countries, 103, 149 Schelling, Thomas, 35* on access to lifeboats, 150–51 awarded Nobel Prize, 138–9 and Cold War nuclear strategy, 138, 139–40 and economic imperialism, 141–5 and game theory, 138–9 and Washington–Moscow hotline, 139–40 work on value of human life, 141–5, 207 ‘The Intimate Contest for Self-command’ (essay, 1980), 140, 145 ‘The Life You Save May be Your Own’ (essay, 1968), 142–5, 207 Schiphol Airport, Amsterdam, 172 Schmidt, Eric, 105 Scholes, Myron, 201 Schwarzman, Stephen, 235 Second World War, 3, 189, 210 selfishness, 41–3, 178–9 and Becker, 129–30 and defence of inequality, 242–3 as free marketeers’ starting point, 10–12, 13–14, 41, 86, 178–9 and game theory, 18 and public choice theory, 85–6, 87–8, 89, 94, 95–7 Selten, Reinhard, 34–5, 36, 38, 40 Sen, Amartya, 29, 80–81 service sector, 90–93, 94 Shakespeare, William, Measure for Measure, 169 Shaw, George Bernard, 101 Shiller, Robert, 247 Simon, Herbert, 223 Skinner, Burrhus, 154–5, 158 Smith, Adam, 101, 111, 122 The Wealth of Nations (1776), 10–11, 188–9 snowflakes, 195 social choice theory, 72 and Ken Arrow, 71–83, 89, 95, 97, 124–5, 129 and Duncan Black, 78, 95 and free marketeers, 79, 82 Sen’s mathematical framework, 80–81 social media, 100* solar panels, 116 Solow, Bob, 163, 223 Sorites paradox, 117–18, 119 sovereign fantasy, 116–17 Soviet Union, 20, 22, 70, 73, 82, 101, 104, 167, 237 spectrum auctions, 39–40, 47, 49 Stalin, Joseph, 70, 73, 101 the state anti-government attitudes in USA, 83–5 antitrust regulation, 56–8 dismissal of almost any role for, 94, 135, 235–6, 241 duty over full employment, 5 economic imperialist arguments for ‘small government’, 135 increased economic role from 1940s, 3–4, 5 interventions over ‘inefficient’ outcomes, 53 and monetarism, 87, 89 and Mont Pèlerin Society, 3, 4, 5 and privatization, 50, 54, 88, 93–4 public-sector monopolies, 48–50, 93–4 replacing of with markets, 79 vital role of, 236 statistical lives, 141–5, 207 Stern, Nick, 206, 209–10 Stigler, George, 50, 51, 56, 69, 88 De Gustibus Non Est Disputandum (with Becker, 1977), 135–6 Stiglitz, Joseph, 237 stock markets ‘Black Monday’ (1987), 192 and fractals (scale-invariance), 194, 195–6, 201 orthodox decision theory, 190–91, 193–4, 201 Strittmatter, Father, 43–4 Summers, Larry, 10, 14 Sunstein, Cass, 173 Nudge (with Richard Thaler, 2008), 171–2, 175 Taleb, Nassim, 192 Tarski, Alfred, 74–5 taxation and Baumol’s cost disease, 94 and demand for positional goods, 239–41 as good thing, 231, 241–2, 243 Laffer curve, 232–3, 234 new doctrine of since 1970s, 232–4 property rights as interdependent with, 235–6 public resistance to tax rises, 94, 239, 241–2 and public spending, 241–2 revenue-maximizing top tax rate, 233–4, 235 tax avoidance and evasion, 99, 105–6, 112–13, 175, 215 ‘tax revolt’ campaigns (1970s USA), 87 ‘tax as theft’ culture, 235–6 top-rate cuts and inequality, 231, 233–5, 239 whines from the super-rich, 234–5, 243 Taylor, Frederick Winslow, 153–4, 155, 167, 178, 237 Thaler, Richard, 13 Nudge (with Cass Sunstein, 2008), 171–2, 175 Thatcher, Margaret, 2, 88, 89, 104, 132 election of as turning point, 6, 216, 220–21 and Hayek, 6, 7 and inequality, 216, 227 privatization programme, 93–4 and top-rate tax cuts, 231 Theory of Games and Economic Behavior (Von Neumann and Morgenstern, 1944), 20, 21, 25, 189 Titanic, sinking of (1912), 150 Titmuss, Richard, The Gift Relationship, 162–3 tobacco-industry lobbyists, 8 totalitarian regimes, 4, 82, 167–8, 216, 219 see also Soviet Union trade union movement, 104 Tragedy of the Commons, 27 Truman, Harry, 20, 237 Trump, Donald, 233 Tucker, Albert, 26–7 Tversky, Amos, 170–72, 173, 202–3, 212, 226 Twitter, 100* Uber, 257 uncertainty see risk and uncertainty The Undercover Economist (Tim Harford, 2005), 130 unemployment and Coase Theorem, 45–7, 64 during Great Depression, 3–4 and Keynesian economics, 4, 5 United Nations, 96 universities auctioning of places, 124, 149–50 incentivization as pervasive, 156 Vietnam War, 56, 198, 200, 249 Villari, Pasquale, 30 Vinci, Leonardo da, 186 Viniar, David, 182, 192 Volkswagen scandal (2016), 2, 151–2 Vonnegut, Kurt, 243–4 voting systems, 72–4, 77, 80, 97 Arrow’s ‘Independence of Irrelevant Alternatives’, 81, 82 Arrow’s ‘Universal Domain’, 81, 82 and free marketeers, 79 ‘hanging chads’ in Florida (2000), 121 recount process in UK, 121 Sen’s mathematical framework, 80–81 Waldfogel, Joel, 161* Wanniski, Jude, 232 Watertown Arsenal, Massachusetts, 153–4 Watson Jr, Thomas J., 181 wealth-maximization principle, 57–63 and Coase, 47, 55, 59, 63–9 as core principle of current economics, 253 created markets, 65–7 extension of scope of, 124–5 and justice, 55, 57–62, 137 and knee space on planes, 63–4 practical problems with negotiations, 62–3 and values more important than efficiency, 64–5, 66–7 welfare maximization, 124–5, 129–31, 133–4, 148–9, 176 behavioural economics/Nudge view of, 173 and vulnerable/powerless people, 146–7, 150 welfare state, 4, 162 Wilson, Charlie, 215 Wittgenstein, Ludwig, 186, 188 Wolfenschiessen (Swiss village), 158, 166–7 Woolf, Virginia, 67 World Bank, 96 World Cup football tournament (2010), 133 World Health Organization, 207 Yale Saturday Evening Pest, 4–5 Yellen, Janet, 237 THE BEGINNING Let the conversation begin … Follow the Penguin twitter.com/penguinukbooks Keep up-to-date with all our stories youtube.com/penguinbooks Pin ‘Penguin Books’ to your pinterest.com/penguinukbooks Like ‘Penguin Books’ on facebook.com/penguinbooks Listen to Penguin at soundcloud.com/penguin-books Find out more about the author and discover more stories like this at penguin.co.uk ALLEN LANE UK | USA | Canada | Ireland | Australia India | New Zealand | South Africa Allen Lane is part of the Penguin Random House group of companies whose addresses can be found at global.penguinrandomhouse.com First published 2019 Copyright © Jonathan Aldred, 2019 The moral right of the author has been asserted Jacket photograph © Getty Images ISBN: 978-0-241-32544-5 This ebook is copyright material and must not be copied, reproduced, transferred, distributed, leased, licensed or publicly performed or used in any way except as specifically permitted in writing by the publishers, as allowed under the terms and conditions under which it was purchased or as strictly permitted by applicable copyright law.


pages: 190 words: 61,970

Life You Can Save: Acting Now to End World Poverty by Peter Singer

accounting loophole / creative accounting, Branko Milanovic, Cass Sunstein, clean water, end world poverty, experimental economics, illegal immigration, Martin Wolf, microcredit, Monkeys Reject Unequal Pay, Peter Singer: altruism, pre–internet, purchasing power parity, randomized controlled trial, Richard Thaler, Silicon Valley, Thomas Malthus, ultimatum game, union organizing

In seven countries with “opt out” systems, the lowest proportion of potential donors is 85.9 percent.8 Just as we tend to leave unchanged the factory settings on a computer, so other kinds of “defaults” can make a big difference to our behavior—and, in the case of organ donations, save thousands of lives. There is a new wave of interest in exploring how to frame choices so that people make better decisions. Richard Thaler and Cass Sunstein, professors of economics and law, respectively, teamed up to write Nudge: Improving Decisions About Health, Wealth, and Happiness, which advocates using defaults to nudge us to make better choices.9 Even when we are choosing in our own interests, we often choose unwisely. When employees have the option of participating in a retirement-savings scheme, many do not, despite the financial advantages of doing so.

Charles Isherwood, “The Graffiti of the Philanthropic Class,” The New York Times, December 2, 2007. 6. www.boldergiving.org. 7. Plan International, “Sponsor a Child: Frequently Asked Questions,” www.plan-international.org/sponsorshipform/sponsorfaq/, accessed January 16, 2008. 8. Eric Johnson and Daniel Goldstein, “Do Defaults Save Lives?” Science 302 (November 2003), pp. 1338-39. I owe this reference to Eldar Shafir, whose comments on this topic were very helpful. 9. Richard Thaler and Cass Sunstein, Nudge: Improving Decisions about Health, Wealth and Happiness (New Haven, CT: Yale University Press, 2008). 10. Brigitte Madrian and Dennis Shea, “The Power of Suggestion: Inertia in 401(k) Participation and Savings Behavior,” Quarterly Journal of Economics 116:4 (2001), pp. 1149-87. 11. Louise Story, “A Big Salary With a Big Stipulation: Share It,” The New York Times, November 12, 2007. 12.


pages: 407 words: 114,478

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

asset allocation, Bretton Woods, British Empire, business cycle, butter production in bangladesh, buy and hold, 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, stocks for the long run, stocks for the long term, 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

A well-known rule among scientists is that each successive mathematical formula cuts a book’s popular readership in half; I’ve done my best to keep the math simple and the graphs as spare as possible. Now, almost a decade later, this title is in its seventeenth printing; so I suppose I’ve succeeded. Special thanks go to those who have provided encouragement and help along the way, including Cliff Asness, John C. Bogle Sr., Scott Burns, Edward Chancellor, Mark Gochnour, Christian Oelke, John Rekenthaler, Bill Schultheis, Larry Swedroe, Robert Sidelsky, Richard Thaler, Mike Veseth, and Jason Zweig. I’ll never understand what motivated Catherine Dassopoulos and Jeffrey Krames of McGraw-Hill to take an interest in an obscure electronic file by an unknown scribbler floating around in cyberspace, but their editorial and publishing support has been a constant source of delight and satisfaction. Thanks are also given to Stephen Isaacs, who shepherded this work through each step of the production process.

Benjamin Graham Dick Thaler Misses a Basketball Game The major premise of economics is that investors are rational and will always behave in their own self-interest. There’s only one problem. It isn’t true. Investors, like everyone else, are most often the hapless captives of human nature. As Benjamin Graham said, we are our own worst enemies. But until very recently, financial economists ignored the financial havoc wreaked by human beings on themselves. Thirty years ago, a young finance academic by the name of Richard Thaler and a friend were contemplating driving across Rochester, New York, in a blinding snowstorm to see a basketball game. They wisely elected not to. His companion remarked, “But if we had bought the tickets already, we’d go.” To which Thaler replied, “True—and interesting.” Interesting because according to economic theory, whether or not the tickets have already been purchased should not influence the decision to brave a snowstorm to see a ball game.

In fact, many academicians refer to this as “The Equity Premium Puzzle”—why investors allowed stocks to remain so cheap that their returns so greatly and consistently exceeded that of other assets. The answer is that our primordial instincts, a relic of millions of years of evolution, cause us to feel more pain when we suddenly lose 30% of our liquid net worth than when we face the more damaging possibility of failing to meet our long-term financial goals. How bad is the problem? Richard Thaler, in an immensely clever bit of research, examined the interaction of the risk premium and investor preference. He estimated the risk horizon of the average investor to be about one year. Myopic indeed! Trees Don’t Grow to the Sky One of the most dangerous of all investment illusions is the great company/great stock fallacy. During the Nifty Fifty market of the early 1970s and the more recent mania over Internet and tech stocks, the importance of earnings growth was overemphasized.


pages: 252 words: 70,424

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

business cycle, 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

Setbacks such as those experienced by Mark Cuban, who had to rebuild his first major business, MicroSolutions, after a secretary defrauded the company of its entire cash flow. Setbacks at the level experienced by the oil-and-gas magnate T. Boone Pickens, who was ousted from the business he’d spent decades building, Mesa Petroleum, in a scenario similar to that faced by the now-iconic Steve Jobs when he was removed from Apple. The economists Richard Thaler and Eric Johnson have studied individuals who have suffered investment losses or business failures, and posit that the experience causes them to view future opportunities through a different, more pessimistic lens than they would otherwise. In the context of this chapter, past failure makes most people less able to take a relative view.7 There are few things more anxiety provoking than the prospect of making a bad call that will cost you your job or your business.

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. Osnos, “Wastepaper Queen.” 9. For more on Yan Cheung, see ibid. Will Hutton, “Thanks to Mao, Zhang Yin’s a Billionaire,” Observer, October 14, 2006; David Barboza, “Blazing a Paper Train in China,” New York Times, January 16, 2007; and an interview conducted by CNN’s Talk Asia on June 3, 2007, http://www.cnn.com/2007/WORLD/asiapcf/06/03/talkasia.cheungyan/index.html?


The Intelligent Asset Allocator: How to Build Your Portfolio to Maximize Returns and Minimize Risk by William J. Bernstein

asset allocation, backtesting, buy and hold, capital asset pricing model, commoditize, computer age, correlation coefficient, diversification, diversified portfolio, Eugene Fama: efficient market hypothesis, fixed income, index arbitrage, index fund, intangible asset, Long Term Capital Management, p-value, passive investing, prediction markets, random walk, Richard Thaler, risk tolerance, risk-adjusted returns, risk/return, South Sea Bubble, stocks for the long run, survivorship bias, the rule of 72, the scientific method, time value of money, transaction costs, Vanguard fund, Yogi Berra, zero-coupon bond

That a recent survey of over 66,000 accounts at a large West Coast discount brokerage showed an average annual portfolio turnover of 75%? That Odds and Ends 131 only 7% of mutual fund investments are indexed? That the historically modest market declines of 1987, 1990, and 1997, far from resulting in inflows from legions of long-termers buying cheap, produced dramatic mutual fund outflows? Most authoritatively of all, in an elegant study published in the Quarterly Journal of Economics in 1993 Shlomo Benzarti and Richard Thaler calculated that the risk horizon of the average investor was just one year. The easiest way of thinking about the interplay of short- and longterm risk is to imagine a new kind of 30-year Treasury bond, similar to the conventional bond, except that the government stands ready at all times to redeem it at par (face value). Clearly, the redeemable bond would carry a considerably higher price and lower yield because it is immunized against the shock of a short-term increase in rates.

In fact, many academicians refer to this as “the equity riskpremium puzzle”—why stocks have been allowed to remain so cheap that their returns so greatly and consistently exceed that of other assets. The answer is that our primordial instincts, a useless relic of millions of years of evolutionary history, cause us to feel more pain when we suddenly lose 30% of our liquid net worth than the more damaging possibility of failing to meet our long-term financial goals. How bad is the problem? I’ve already mentioned the immensely clever article by Shlomo Benzarti and Richard Thaler (one of behavioral finance’s brightest stars) which examined the interaction of the risk premium and investor preference. They estimated that the risk horizon of the average investor, was about one year. Myopic indeed. Socrates told us that the unexamined life is not worth living. For the modern investor, failure of self-examination can be as damaging to the pocketbook as to the soul. Summary 1.


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Networks, Crowds, and Markets: Reasoning About a Highly Connected World by David Easley, Jon Kleinberg

Albert Einstein, AltaVista, clean water, conceptual framework, Daniel Kahneman / Amos Tversky, Douglas Hofstadter, Erdős number, experimental subject, first-price auction, fudge factor, George Akerlof, Gerard Salton, Gerard Salton, Gödel, Escher, Bach, incomplete markets, information asymmetry, information retrieval, John Nash: game theory, Kenneth Arrow, longitudinal study, market clearing, market microstructure, moral hazard, Nash equilibrium, Network effects, Pareto efficiency, Paul Erdős, planetary scale, prediction markets, price anchoring, price mechanism, prisoner's dilemma, random walk, recommendation engine, Richard Thaler, Ronald Coase, sealed-bid auction, search engine result page, second-price auction, second-price sealed-bid, Simon Singh, slashdot, social web, Steve Jobs, stochastic process, Ted Nelson, The Market for Lemons, The Wisdom of Crowds, trade route, transaction costs, ultimatum game, Vannevar Bush, Vickrey auction, Vilfredo Pareto, Yogi Berra, zero-sum game

Would the Borda Count have avoid the Civil War? Journal of Theoretical Politics, 11(2):261–288, 1999. [379] Éva Tardos and Tom Wexler. Network formation games and the potential function method. In Noam Nisan, Tim Roughgarden, Éva Tardos, and Vijay Vazirani, editors, Algorithmic Game Theory, pages 487–516. Cambridge University Press, 2007. [380] Richard H. Thaler. Anomalies: The ultimatum game. Journal of Economic Perspectives, 2(4):195–206, 1988. [381] Richard H. Thaler. Anomalies: The winner’s curse. Journal of Economic Perspectives, 2(1):191–202, 1988. [382] Michael F. Thorpe and Philip M. Duxbury. Rigidity Theory and Applications. Springer, 1999. [383] Shane Thye, Michael Lovaglia, and Barry Markovsky. Responses to social exchange and social exclusion in networks. Social Forces, 75:1031–1049, 1997

So in particular, her estimate is more likely to be an over-estimate of the common value than an under-estimate. Moreover, with many bidders, the second-place bid — which is what she paid — is also likely 9.7. ADVANCED MATERIAL: BIDDING STRATEGIES IN FIRST-PRICE AND ALL-PAY AUCTIONS269 to be an over-estimate. As a result she will likely lose money on the resale relative to what she paid. This is known as the winner’s curse, and it is a phenomenon that has a rich history in the study of auctions. Richard Thaler’s review of this history [381] notes that the winner’s curse appears to have been first articulated by researchers in the petroleum industry [94]. In this domain, firms bid on oil-drilling rights for tracts of land that have a common value, equal to the value of the oil contained in the tract. The winner’s curse has also been studied in the context of competitive contract offers to baseball free agents [97] — with the unknown common value corresponding to the future performance of the baseball player being courted.1 Rational bidders should take the winner’s curse into account in deciding on their bids: a bidder should bid her best estimate of the value of the object conditional on both her private estimate vi and on winning the object at her bid.


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The Success Equation: Untangling Skill and Luck in Business, Sports, and Investing by Michael J. Mauboussin

Amazon Mechanical Turk, Atul Gawande, Benoit Mandelbrot, Black Swan, Checklist Manifesto, Clayton Christensen, cognitive bias, commoditize, Daniel Kahneman / Amos Tversky, David Brooks, deliberate practice, disruptive innovation, Emanuel Derman, fundamental attribution error, Gini coefficient, hindsight bias, hiring and firing, income inequality, Innovator's Dilemma, Long Term Capital Management, loss aversion, Menlo Park, mental accounting, moral hazard, Network effects, prisoner's dilemma, random walk, Richard Thaler, risk-adjusted returns, shareholder value, Simon Singh, six sigma, Steven Pinker, transaction costs, winner-take-all economy, zero-sum game, Zipf's Law

Benchmarking Sustained Superior Performance Without Being Fooled By Randomness,” Strategic Management Journal 33, no. 4 (April 2012): 387–406. 22. Charles MacKay, Extraordinary Delusions and the Madness of Crowds (New York: Three Rivers Press, 1995). 23. John C. Bogle, Common Sense on Mutual Funds: Fully Updated 10th Anniversary Issue (Hoboken, NJ: John Wiley & Sons, 2010). 24. Werner F. M. De Bondt and Richard H. Thaler, “Anomalies: A Mean-Reverting Walk Down Wall Street,” Journal of Economic Perspectives 3, no. 1 (Winter 1989): 189–202. 25. Mark Grinblatt and Sheridan Titman, “The Persistence of Mutual Fund Performance,” Journal of Finance 47, no. 5 (December 1992): 1977–1984; Darryll Hendricks, Jayendu Patel, and Richard Zeckhauser, “Hot Hands in Mutual Funds: Short-Run Persistence of Relative Performance, 1974–1988,” Journal of Finance 48, no. 1 (March 1993): 93–129; and Stephen J.

Business History Review 66, no. 1 (Spring 1992): 51–94. Cutler, David M., James M. Poterba, and Lawrence H. Summers. “What Moves Stock Prices?” Journal of Portfolio Management 15, no. 3 (Spring 1989): 4–12. Danto, Arthur. Analytical Philosophy of History. Cambridge: Cambridge University Press, 1965. Dawes, Robyn M. Everyday Irrationality. Boulder, CO: Westview Press, 2001. De Bondt, Werner F. M., and Richard H. Thaler. “Anomalies: A Mean-Reverting Walk Down Wall Street.” Journal of Economic Perspectives 3, no. 1 (Winter 1989): 189–202. Del Guercio, Diane, and Paula A. Tkac. “The Determinants of the Flow of Funds of Managed Portfolios: Mutual Funds Versus Pension Funds.” Journal of Financial and Quantitative Analysis 37, no. 4 (December 2002): 523–555. Del Guercio, Diane, and Paula A. Tkac. “Star Power: The Effect of Morningstar Ratings on Mutual Fund Flow.”


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

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, longitudinal study, 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 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, Thales of Miletus, transaction costs, Tunguska event, unbanked and underbanked, underbanked, Vanguard fund, web application

This experiment and others convinced the researchers that like humans, monkeys weigh losses more than gains. Monkeys have not yet evolved far enough to invent pensions, but if they did, the Save More Tomorrow program would help. Because take-home pay does not go down when contributions go up, there is no perceived loss of earnings and people are much happier to keep saving. The first application of the program, which was developed by two behavioralists named Shlomo Benartzi and Richard Thaler, prompted employees at a manufacturer to increase their contribution rates from 3.5 percent to 13.6 percent of salary in only three and a half years. The option is now offered by more than half of the large companies in the United States.19 With these encouraging examples to build from, a mini industry devoted to behavioral prompts and nudges is springing up. Academics and institutions are busily conducting experiments that tease out the effects of subliminal cues on savings.

., “The Impact of Employer Matching on Savings Plan Participation Under Automatic Enrolment” (NBER Working Paper 13352, August 2007). 17. Anne Tergesen, “401(k) Law Suppresses Saving for Retirement,” Wall Street Journal, July 7, 2011. 18. M. 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.


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Stuffocation by James Wallman

3D printing, Airbnb, back-to-the-land, Berlin Wall, big-box store, Black Swan, BRICs, carbon footprint, Cass Sunstein, clean water, collaborative consumption, commoditize, creative destruction, crowdsourcing, David Brooks, Fall of the Berlin Wall, happiness index / gross national happiness, hedonic treadmill, high net worth, income inequality, Intergovernmental Panel on Climate Change (IPCC), James Hargreaves, Joseph Schumpeter, Kitchen Debate, Martin Wolf, mass immigration, McMansion, means of production, Nate Silver, Occupy movement, Paul Samuelson, post-industrial society, post-materialism, Richard Florida, Richard Thaler, sharing economy, Silicon Valley, Simon Kuznets, Skype, spinning jenny, The Signal and the Noise by Nate Silver, Thorstein Veblen, Tyler Cowen: Great Stagnation, World Values Survey, Zipcar

Thank you for that, and also, among other things: for your suggestions of more avenues to explore, for challenging and inspiring me over lunch and email and phone and Skype, for responding to far more fact-checking emails than strictly necessary, for patiently explaining how you do what you do, and for pushing me to re-examine whether I believed in what I believe – and whether I really was reading the data right. So, thank you: Richard Thaler, Oliver James, Barry Schwartz, Stuart Ewen, Robert Fogel, Chris Goodall, Michael Schrage, Ron Inglehart, Ryan Howell, Jeanne Arnold, Darby Saxbe, Travis Carter, Leaf van Boven, Tom Gilovich, Brian Wansink, Geoffrey Miller, Danny Miller, Rupert Pennant-Rea, Garson O’Toole, Daniel Franklin, John Andrews, Rob Hyndman, Corinne Shefner-Rogers, Jim Dearing, Juliet Schor, Anna Coote, Benjamin Kline Hunnicutt, Pippa Norris, Trudi Toyne, Felipe Fernandez-Armesto, Avner Offer, Peter Stearns, Joe Pine, Jim Gilmore, Grant McCracken, Blake Mycoskie, Rob Symington, Alice Marwick, Harry Parr, Sam Bompas, Jules Evans, Bob Cummins, Bernice Steinhardt, Chris Hoenig, Mark Tungate, Ann Mack, Albert Cañigueral, Anna-Maren Ashford, James O’Shaughnessy, Joe Goodman, Alastair Humphreys, Richard Layard, Tim Kasser, Vicki Robin, Gabriel Rossman, Janice Rutherford, and Eve Fisher.

In summer, the temperatures are balmy too. They are not in winter. On average, 305 inches of snow falls.” Source: Taos Ski Valley Chamber of Commerce. “The way to make sense of this is, as behavioural psychologists have showed time and again, that people do not necessarily behave in a rational, logical way.” To understand this, read Daniel Kahneman, Thinking, Fast and Slow (New York: Penguin, 2011), and Richard Thaler and Cass Sunstein, Nudge (New York: Penguin, 2008). For the best visualization of how the two parts of the brain work together, read about the elephant and its rider in Jonathan Haidt, The Happiness Hypothesis: Putting Ancient Wisdom to the Test of Modern Science (London: Arrow, 2007). Not Simple, but Simpler Living To read a more complete account of how LeVally and Harris came down from the mountain, and struggled with that decision, read www.cagefreefamily.com.


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

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, global pandemic, 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, Sam Peltzman, security theater, Ted Kaczynski, the built environment, The Chicago School, the High Line, Thorstein Veblen, transaction costs, US Airways Flight 1549

(I once heard a very rich person say that he didn’t care about his absolute wealth, only what his ranking was on the Forbes list of richest people.) Third, you can’t really blame yourself for house prices falling, but you could second-guess your decision to carry around $18,000 in cash. Fourth, the fact that a thief has your money might make it worse than the money just evaporating into space, like it does when house prices fall. There are probably other reasons as well. More generally, the economist Richard Thaler coined the phrase mental accounts to describe the way in which people seem to treat different assets as non-fungible, even though in principle it seems like they should be. Although my economist friends make fun of me for it, I definitely use mental accounts myself. For me, a dollar made playing poker means much more than a dollar earned from the stock market going up. (And a dollar lost playing poker is likewise far more painful.)

Trilby and I then ate, fairly happily, though the taste of the rancid chicken remained with me; in fact, it remains with me still. Trilby had had a glass of wine before we ordered, and took another with her meal, sauvignon blanc. I drank water. When the waitress cleared our plates, she asked again if we wanted complimentary dessert. No, we said, just coffee. As Trilby and I talked, I mentioned that I had not long ago interviewed Richard Thaler, the godfather of behavioral economics, which seeks to marry psychology and economics. Thaler and I had considered some small experiments at lunch—offering the waiter a gigantic tip, perhaps, in exchange for special considerations—but we didn’t get around to it. Trilby was interested, so we kept talking about money. I mentioned the behavioralists’ concept of “anchoring” (which used-car salesmen in particular know so well): establish a price that may be 100 percent more than what you need in order to ensure that you’ll still walk away with, say, a 50 percent profit.


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Them And Us: Politics, Greed And Inequality - Why We Need A Fair Society by Will Hutton

Andrei Shleifer, asset-backed security, bank run, banking crisis, Benoit Mandelbrot, Berlin Wall, Bernie Madoff, Big bang: deregulation of the City of London, Blythe Masters, Boris Johnson, Bretton Woods, business cycle, capital controls, carbon footprint, Carmen Reinhart, Cass Sunstein, centre right, choice architecture, cloud computing, collective bargaining, conceptual framework, Corn Laws, corporate governance, creative destruction, credit crunch, Credit Default Swap, debt deflation, decarbonisation, Deng Xiaoping, discovery of DNA, discovery of the americas, discrete time, diversification, double helix, Edward Glaeser, financial deregulation, financial innovation, financial intermediation, first-past-the-post, floating exchange rates, Francis Fukuyama: the end of history, Frank Levy and Richard Murnane: The New Division of Labor, full employment, George Akerlof, Gini coefficient, global supply chain, Growth in a Time of Debt, Hyman Minsky, I think there is a world market for maybe five computers, income inequality, inflation targeting, interest rate swap, invisible hand, Isaac Newton, James Dyson, James Watt: steam engine, joint-stock company, Joseph Schumpeter, Kenneth Rogoff, knowledge economy, knowledge worker, labour market flexibility, liberal capitalism, light touch regulation, Long Term Capital Management, Louis Pasteur, low cost airline, low-wage service sector, mandelbrot fractal, margin call, market fundamentalism, Martin Wolf, mass immigration, means of production, Mikhail Gorbachev, millennium bug, money market fund, moral hazard, moral panic, mortgage debt, Myron Scholes, Neil Kinnock, new economy, Northern Rock, offshore financial centre, open economy, plutocrats, Plutocrats, price discrimination, private sector deleveraging, purchasing power parity, quantitative easing, race to the bottom, railway mania, random walk, rent-seeking, reserve currency, Richard Thaler, Right to Buy, rising living standards, Robert Shiller, Robert Shiller, Ronald Reagan, Rory Sutherland, Satyajit Das, shareholder value, short selling, Silicon Valley, Skype, South Sea Bubble, Steve Jobs, The Market for Lemons, the market place, The Myth of the Rational Market, the payments system, the scientific method, The Wealth of Nations by Adam Smith, too big to fail, unpaid internship, value at risk, Vilfredo Pareto, Washington Consensus, wealth creators, working poor, zero-sum game, éminence grise

This goes against orthodox economics, which suggests that CEO pay is determined by market forces, so if it is high, that must reflect the need to incentivise effort and reward the contribution that is being made. Fairness, trust and power relationships are disregarded. But economics is beginning to change as the weight of evidence about real-life behaviour challenges its woeful abstractions. Process and fairness do matter, and they need to be incorporated into economists’ thinking about market behaviour. For example, Nobel Prize-winning economist Daniel Kahneman, along with psychologists Richard Thaler and Jack Knetsch, has developed the thesis that people hold an idea about what they consider to be a fair price or wage.37 This is usually determined by prices and wages that have prevailed in the past – what the authors call ‘reference prices’ – and it governs their conduct in markets. People consider themselves to be entitled to reference prices, and firms to reference profits. A price that has stood the test of time is likely to be a fair price; it is familiar and has become part of our psychological landscape.

, Independent, 20 August 2009, at http://www.independent.co.uk/news/business/analysis-and-features/streets-ahead-does-john-lewis-offer-a-revolutionary-way-forward-for-big-business-1774510.html. 35 Both points come from Lehki and Blaug (2009) ‘Ownership and Good Work’. 36 Lucian Bebchuk, Martijn Cremers and Urs Peyer (2009) ‘The CEO Pay Slice’, mimeo, at http://www.law.harvard.edu/faculty/bebchuk/. 37 Daniel Kahneman, Jack Knetsch and Richard Thaler (1986) ‘Fairness as a Constraint on Profit Seeking Entitlements in the Market’, American Economic Review 76 (4): 728–41. 38 For a history, see Robert Dahl (1991) Democracy and Its Critics, Yale University Press; and David Held (2002) Models of Democracy, 2nd edn, Polity Press. Chapter Four: The Good, the Bad and the Ugly 1 Eric J. Hobsbawm (1969) Industry and Empire from 1750 to the Present Day, Penguin, p. 40. 2 William Baumol (1990) ‘Entrepreneurship: Productive, Unproductive, and Destructive’, Journal of Business Venturing ll: 3–22. 3 Thomas Schweich, ‘Is Afghanistan a Narco-State?’

Steinmueller and Juan Mateos-Garcia (2009) ‘Rebooting Britain’, Nesta Policy Briefing. 6 Rohit Talwar and Tim Hancock (2010) ‘The Shape of Jobs to Come: Possible New Careers Emerging from Advances in Science and Technology (2010–2030)’, report, Fast Future. 7 Ian Brinkley (2008) ‘The Knowledge Economy: How Knowledge is Reshaping the Economic Life of Nations’, report, Work Foundation. 8 Robert Nozick (1974) Anarchy, State, and Utopia, Basic Books, p. 169. 9 Liam Murphy and Thomas Nagel (2002) The Myth of Ownership: Taxes and Justice, Harvard University Press. 10 Will Hutton and Philippe Schneider (2008) ‘The Failure of Market Failure: Towards a 21st Century Keynesianism’, Nesta Provocation. 11 George Akerlof (1970) ‘The Market for Lemons: Quality Uncertainty and the Market Mechanism’, Quarterly Journal of Economics 84 (3): 488–500. 12 Nava Asraf, Colin Camerer and George Loewenstein (2005) ‘Adam Smith,Behavioral Economist’, Journal of Economic Perspectives 19 (3): 131–45. 13 John Coates and Joe Herbert (2008) ‘Endogenous Steroids and Financial Risk Taking on a London Trading Floor’, Proceedings of the National Academy of Sciences 105: 6167–72. 14 Technically, this can be understood as rational behaviour. 15 Studies have sought to limit attention to one potential bias at a time; but several biases might plausibly explain behaviour. There is a need to distinguish between biases insofar as the policy responses to the underlying explanations for behaviour point in very different directions. 16 John Sterman (2000) Business Dynamics: Systems Thinking and Modeling for a Complex World, Irwin McGraw-Hill. 17 Richard Thaler and Cass Sunstein (2008) Nudge: Improving Decisions about Health, Wealth and Happiness, Yale University Press, esp. Part V. See also Jack Fuller (2009) ‘Heads, You Die: Bad Decisions, Choice Architecture, and How to Mitigate Predictable Irrationality’, Per Capita, at http://www.percapita.org.au/01_cms/details.asp?ID=215. 18 Friedrich Hayek (1945) ‘The Use of Knowledge in Society’, American Economic Review 34 (4): 519–30, at http://www.econlib.org/library/Essays/ hykKnw1.html. 19 Herbert Hart (1997) The Concept of Law, Oxford University Press. 20 HM Treasury (2007) ‘The Race to the Top: A Review of Government’s Science and Innovation Policies’, HMSO. 21 Yannis Pierrakis and Stian Westlake (2009) ‘Reshaping the UK Economy: The Role of Public Investment in Financing Growth’, report, Nesta. 22 Ibid. 23 John R.


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Walk Away by Douglas E. French

business cycle, Elliott wave, forensic accounting, full employment, Home mortgage interest deduction, loss aversion, McMansion, mental accounting, mortgage debt, mortgage tax deduction, negative equity, New Journalism, Own Your Own Home, Richard Thaler, Robert Shiller, Robert Shiller, the market place, transaction costs, unbiased observer, wealth creators

The work of these behavioral economists helps shed light on why some homeowners who are underwater keep paying. They believe the benefits of staying and consuming (if you will) the house outweigh the amount of the payment. But when the hole becomes too deep the increasing numbers of borrowers begin to feel like they are paying for nothing. They don’t feel the benefit of increasing equity, but only the pain of making the monthly payment. Economist Richard Thaler has found that people are irrationally regret averse. In an experiment where respondents had the choice of being a person who wins $100 in one scenario or a person who wins $150, but was just short of winning $1,000 in another, most people said that they would rather win the $100 and not have to deal with the regret of just missing the $1,000 windfall. “People tend to experience losses even more acutely when they feel responsible for the decision that led to the loss; this sense of responsibility leads to regret,” explains Hersh Shefrin in Beyond Greed and Fear: Understanding Behavioral Finance and the Psychology of Investing.


pages: 313 words: 91,098

The Knowledge Illusion by Steven Sloman

Affordable Care Act / Obamacare, Air France Flight 447, attribution theory, bitcoin, Black Swan, Cass Sunstein, combinatorial explosion, computer age, crowdsourcing, Dmitri Mendeleev, Elon Musk, Ethereum, Flynn Effect, Hernando de Soto, hindsight bias, hive mind, indoor plumbing, Isaac Newton, John von Neumann, libertarian paternalism, Mahatma Gandhi, Mark Zuckerberg, meta analysis, meta-analysis, obamacare, prediction markets, randomized controlled trial, Ray Kurzweil, Richard Feynman, Richard Thaler, Rodney Brooks, Rosa Parks, single-payer health, speech recognition, stem cell, Stephen Hawking, Steve Jobs, technological singularity, The Coming Technological Singularity, The Wisdom of Crowds, Vernor Vinge, web application, Whole Earth Review, Y Combinator

“For me, the story is about how relying on others affects attention, which feeds into learning and knowledge, which feeds into decision-making and downstream outcomes . . . if you are bad at finances but are tasked with financial responsibility, you pay attention to financial stuff in the environment and that helps you get better. If you offload financial responsibility, you don’t even notice financial information.” We think it is inevitable that people will continue to make decisions—even very consequential decisions—without deep understanding. So how can we help people to make wiser choices? Nudging Better Decisions The University of Chicago economist Richard Thaler and the Harvard legal scholar Cass Sunstein have developed a philosophy that they call libertarian paternalism. Although the name is a mouthful, the idea is simple and compelling. The main observation is that people don’t always make the best possible decisions; they don’t always choose the option that makes it most likely that they will achieve their own goals. Examples abound: We choose the large pizza instead of the salad and regret it as we’re leaving the restaurant.

On Reddit you can find a discussion forum called “Explain Like I’m 5.” People post questions, often about difficult topics like particle physics or finance, and forum members try to provide a satisfying explanation that is easily understood. The popularity of this forum speaks to how enjoyable it is to read explanations that we can actually make sense of. It also highlights how rare these are in our day-to-day lives. Lesson 2: Simple Decision Rules Richard Thaler, one of the fathers of the libertarian paternalism approach, has thought a lot about financial decision-making. He agrees that attempting to give people a deep understanding of financial topics is unlikely to work. The financial world is just too complex and people’s abilities are too limited. He argues that rather than trying to educate people, we should give them simple rules that work pretty well and can be applied with little knowledge or effort, rules like “Invest as much as possible in your 401(k) plan,” “Save 15 percent of your income,” or “Get a fifteen-year mortgage if you are over fifty.”


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Can It Happen Here?: Authoritarianism in America by Cass R. Sunstein

active measures, affirmative action, Affordable Care Act / Obamacare, airline deregulation, anti-communist, anti-globalists, availability heuristic, business cycle, Cass Sunstein, David Brooks, Donald Trump, Edward Snowden, Estimating the Reproducibility of Psychological Science, failed state, Filter Bubble, Francis Fukuyama: the end of history, ghettoisation, illegal immigration, immigration reform, Isaac Newton, job automation, Joseph Schumpeter, Long Term Capital Management, Nate Silver, Network effects, New Journalism, night-watchman state, obamacare, Potemkin village, random walk, Richard Thaler, road to serfdom, Ronald Reagan, the scientific method, War on Poverty, WikiLeaks, World Values Survey

He worked as an attorney-advisor in the Office of the Legal Counsel of the US Department of Justice and was a faculty member at the University of Chicago Law School from 1981 to 2008. From 2009 to 2012, he served as Administrator of the White House Office of Information and Regulatory Affairs. From 2013 to 2014, he served on the President’s Review Group on Intelligence and Communications Technologies. Sunstein is the author of hundreds of articles and dozens of books, including Republic.com (2001), Nudge: Improving Decisions About Health, Wealth, and Happiness (with Richard H. Thaler 2008), and Simpler (2013). His latest books are The World According to Star Wars (2016) and The Ethics of Influence (2016). Sunstein received his bachelor of arts from Harvard College in 1975 and his doctorate in law from Harvard Law School in 1978. Duncan J. Watts is a principal researcher at Microsoft Research and a founding member of the MSR-NYC lab. He is also an AD White Professor at Large at Cornell University.

See also Japanese-American internment civil liberties during, 438–41 Yates, Sally, 9, 124 Yoo, John, 225 About the Author CASS R. SUNSTEIN is the Robert Walmsley University Professor at Harvard University, where he is founder and director of the Program on Behavioral Economics and Public Policy and a columnist for Bloomberg View. His many books include the New York Times bestsellers The World According to Star Wars and Nudge (with Richard H. Thaler). He lives in Concord, Massachusetts. Discover great authors, exclusive offers, and more at hc.com. Copyright “Lessons from the American Founding” contains content adapted from Introduction, The Federalist (Cambridge: Harvard University Press, 2009). CAN IT HAPPEN HERE? Copyright © 2018 by Cass R. Sunstein. All rights reserved under International and Pan-American Copyright Conventions.


Rockonomics: A Backstage Tour of What the Music Industry Can Teach Us About Economics and Life by Alan B. Krueger

accounting loophole / creative accounting, Affordable Care Act / Obamacare, Airbnb, autonomous vehicles, bank run, Berlin Wall, bitcoin, Bob Geldof, butterfly effect, buy and hold, creative destruction, crowdsourcing, disintermediation, diversified portfolio, Donald Trump, endogenous growth, George Akerlof, gig economy, income inequality, index fund, invisible hand, Jeff Bezos, John Maynard Keynes: Economic Possibilities for our Grandchildren, Kenneth Arrow, Kickstarter, Live Aid, Mark Zuckerberg, Moneyball by Michael Lewis explains big data, moral hazard, Network effects, obamacare, offshore financial centre, Paul Samuelson, personalized medicine, pre–internet, price discrimination, profit maximization, random walk, recommendation engine, rent-seeking, Richard Thaler, ride hailing / ride sharing, Saturday Night Live, Skype, Steve Jobs, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, ultimatum game, winner-take-all economy, women in the workforce, Y Combinator, zero-sum game

Yet, I would even play more if I could. I have separate buckets in my head for what I should be paid in music and what I should be paid in my day job. If we make $150 a night playing, that’s usually a good night. If we make $300 a night, that’s an amazingly good night. But that’s a fraction of what I get paid with my day job. So, they’re ridiculously incongruent. Perhaps behavioral economist Richard Thaler could explain it. Have you ever played with any members of the Grateful Dead? I’ve played with Bob Weir a couple of times. Stella Blue’s played the Capitol Theater in Westchester, and Phil Lesh came on and played a set with us. What was it like playing with Bob Weir and Phil Lesh? It’s such a sort of awestruck moment, and you’re trying so hard not to screw up, that you don’t even know the moment’s there.

If ticket prices are not set with an eye toward balancing supply and demand, the result will be an empty house (if prices are set too high) or a large secondary market where resale prices are much higher than the list value (if prices are set too low). Resistance to congestion pricing, a method for charging drivers a higher price when roads are congested, has left roads from Los Angeles to New York City gridlocked with traffic during rush hour. When asked about the tension in concert ticket pricing, Richard Thaler, the University of Chicago economist who won a Nobel Prize for his seminal contributions to behavioral economics, observed, “A good rule of thumb is we shouldn’t impose a set of rules that will create moral outrage, even if that moral outrage seems stupid to economists.”21 One indication of the distance that concerts have traveled in the direction of charging market-determined prices is the extent to which ticket prices vary within the venue, from the worst seat to the best seat.


pages: 481 words: 125,946

What to Think About Machines That Think: Today's Leading Thinkers on the Age of Machine Intelligence by John Brockman

agricultural Revolution, AI winter, Alan Turing: On Computable Numbers, with an Application to the Entscheidungsproblem, algorithmic trading, artificial general intelligence, augmented reality, autonomous vehicles, basic income, bitcoin, blockchain, clean water, cognitive dissonance, Colonization of Mars, complexity theory, computer age, computer vision, constrained optimization, corporate personhood, cosmological principle, cryptocurrency, cuban missile crisis, Danny Hillis, dark matter, discrete time, Douglas Engelbart, Elon Musk, Emanuel Derman, endowment effect, epigenetics, Ernest Rutherford, experimental economics, Flash crash, friendly AI, functional fixedness, global pandemic, Google Glasses, hive mind, income inequality, information trail, Internet of things, invention of writing, iterative process, Jaron Lanier, job automation, Johannes Kepler, John Markoff, John von Neumann, Kevin Kelly, knowledge worker, loose coupling, microbiome, Moneyball by Michael Lewis explains big data, natural language processing, Network effects, Norbert Wiener, pattern recognition, Peter Singer: altruism, phenotype, planetary scale, Ray Kurzweil, recommendation engine, Republic of Letters, RFID, Richard Thaler, Rory Sutherland, Satyajit Das, Search for Extraterrestrial Intelligence, self-driving car, sharing economy, Silicon Valley, Skype, smart contracts, social intelligence, speech recognition, statistical model, stem cell, Stephen Hawking, Steve Jobs, Steven Pinker, Stewart Brand, strong AI, Stuxnet, superintelligent machines, supervolcano, the scientific method, The Wisdom of Crowds, theory of mind, Thorstein Veblen, too big to fail, Turing machine, Turing test, Von Neumann architecture, Watson beat the top human players on Jeopardy!, Y2K

SMITH After the Plug Is Pulled GIULIO BOCCALETTI Monitoring and Managing the Planet IAN BOGOST Panexperientialism AUBREY DE GREY When Is a Minion Not a Minion? MICHAEL I. NORTON Not Buggy Enough THOMAS A. BASS More Funk, More Soul, More Poetry and Art HANS ULRICH OBRIST The Future Is Blocked to Us KOO JEONG-A An Immaterial Thinkable Machine RICHARD FOREMAN Baffled and Obsessed RICHARD H. THALER Who’s Afraid of Artificial Intelligence? SCOTT DRAVES I See a Symbiosis Developing MATTHEW RITCHIE Reimagining the Self in a Distributed World RAPHAEL BOUSSO It’s Easy to Predict the Future JAMES CROAK Fear of a God, Redux ANDRÉS ROEMER Tulips on My Robot’s Tomb LEE SMOLIN Toward a Naturalistic Account of Mind STUART A. KAUFFMAN Machines That Think? Nuts! MELANIE SWAN The Future Possibility-Space of Intelligence TOR NØRRETRANDERS Love KAI KRAUSE An Uncanny Three-Ring Test for Machina sapiens GEORG DIEZ Free from Us EDUARDO SALCEDO-ALBARÁN Flawless AI Seems Like Science Fiction MARIA SPIROPULU Emergent Hybrid Human/Machine Chimeras THOMAS METZINGER What If They Need to Suffer?

Everyone (me included) wants the many sweets they offer, while those very sweets do mold us in their image, thereby smothering the blankness of deep creativity inside each of us. And why did I have to go in circles to get here, where I’m offering an opinion—worth not nearly as much as the rhythm of my circling . . . a Hole. Yes, I am caught in a trap of my own making—just like everyone. But not like machines that think! The trap they’re in—well, they cannot “know.” WHO’S AFRAID OF ARTIFICIAL INTELLIGENCE? RICHARD H. THALER Father of behavioral economics; director, Center for Decision Research, University of Chicago Booth School of Business; author, Misbehaving: The Making of Behavior Economics My brief remarks on this question are framed by two one-liners that happen to have been uttered by brilliant Israelis. The first comes from my friend, colleague, and mentor Amos Tversky. When asked once what he thought about artificial intelligence, Amos quipped that he didn’t know much about it, his specialty was natural stupidity.


pages: 139 words: 33,246

Money Moments: Simple Steps to Financial Well-Being by Jason Butler

Albert Einstein, asset allocation, buy and hold, Cass Sunstein, diversified portfolio, estate planning, financial independence, fixed income, happiness index / gross national happiness, index fund, intangible asset, longitudinal study, loss aversion, Lyft, Mark Zuckerberg, mortgage debt, passive income, placebo effect, Richard Thaler, ride hailing / ride sharing, Steve Jobs, time value of money, traffic fines, Travis Kalanick, Uber and Lyft, uber lyft, Vanguard fund, Yogi Berra

I felt great about the purchase for a few weeks, until I received my credit card bill! So why did I succumb to an impulsive purchase of an expensive and unnecessary item instead of putting that money in my retirement plan? A key reason is because we have two modes of thinking, one instinctive and the other reflective. Think of these two modes as a bit like having different financial personalities. Richard Thaler and Cass Sunstein, two distinguished professors of behavioural economics describe these personalities as a far-sighted ‘Planner’ and a myopic ‘Doer’. The Planner represents the reflective thinking mode and the Doer represents the instinctive mode. ‘The Planner is trying to promote your long-term welfare but must cope with the feelings, mischief, and strong will of the Doer, who is exposed to the temptations that come with arousal.


pages: 123 words: 32,382

Grouped: How Small Groups of Friends Are the Key to Influence on the Social Web by Paul Adams

Airbnb, Cass Sunstein, cognitive dissonance, David Brooks, information retrieval, invention of the telegraph, planetary scale, race to the bottom, Richard Thaler, sentiment analysis, social web, statistical model, The Wisdom of Crowds, web application, white flight

People in our group, and people we perceive to be like us, disproportionately influence us. We often change our behavior to conform to the expectations, attitudes, and behavior of our group. We overrate the advice of experts. Random strangers can often outperform experts. Further reading 1. See the Wikipedia article titled Mirror Neuron for an introduction and further reading. 2. See Richard Thaler and Cass Sunstein’s book Nudge: Improving Decisions About Health, Wealth, and Happiness (Yale University Press, 2008). 3. In their book Connected (Little, Brown, 2009), Nicholas Christakis and James Fowler describe how people are influenced by social proof. 4. See the 2002 research paper “Evidence on learning and network externalities in the diffusion of home computers” by Austan Goolsbee and Peter Klenow. 5.


pages: 416 words: 106,582

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

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, Johannes Kepler, 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: Challenger O-ring, Richard Thaler, Satyajit Das, Schrödinger's Cat, security theater, selection bias, Silicon Valley, Stanford marshmallow experiment, stem cell, Steve Jobs, Steven Pinker, Stewart Brand, the scientific method, Thorstein Veblen, Turing complete, Turing machine, twin studies, Vilfredo Pareto, Walter Mischel, Whole Earth Catalog, WikiLeaks, zero-sum game

Timothy Taylor Technology Paved the Way for Humanity Thinking through things and with things, and manipulating virtual things in our minds, is an essential part of critical self-consciousness. Paul Saffo Time Span of Discretion We all have a natural time horizon we are comfortable with. Tania Lombrozo Defeasibility Between blind faith and radical skepticism is a vast but sparsely populated space where defeasibility finds its home. Richard Thaler Aether Aether variables are extremely common in my own field of economics. Mark Pagel Knowledge as a Hypothesis There will always be some element of doubt about anything we come to “know” from our observations of the world. Evgeny Morozov The Einstellung Effect Familiar solutions may not be optimal. Eduardo Salcedo-Albarán Homo sensus sapiens: The Animal That Feels and Reasons We are the tension of the sensus and the sapiens.

Recognizing the potential revisability of our beliefs is a prerequisite to rational discourse and progress, be it in science, politics, religion, or the mundane negotiations of daily life. Consider the world we could live in if all of our local and global leaders, if all of our personal and professional friends and foes, recognized the defeasibility of their beliefs and acted accordingly. That sure sounds like progress to me. But of course I could be wrong. Aether Richard Thaler Economist; director, Center for Decision Research, Booth School of Business, University of Chicago; coauthor (with Cass Sunstein), Nudge: Improving Decisions About Health, Wealth, and Happiness I recently posted a question on Edge asking people to name their favorite example of a wrong scientific belief. One of my prized answers came from Clay Shirky. Here is an excerpt: The existence of ether, the medium through which light (was thought to) travel.


No Slack: The Financial Lives of Low-Income Americans by Michael S. Barr

active measures, asset allocation, Bayesian statistics, business cycle, Cass Sunstein, conceptual framework, Daniel Kahneman / Amos Tversky, financial exclusion, financial innovation, Home mortgage interest deduction, income inequality, information asymmetry, labor-force participation, late fees, London Interbank Offered Rate, loss aversion, market friction, mental accounting, Milgram experiment, mobile money, money market fund, mortgage debt, mortgage tax deduction, New Urbanism, p-value, payday loans, race to the bottom, regulatory arbitrage, Richard Thaler, risk tolerance, Robert Shiller, Robert Shiller, the payments system, transaction costs, unbanked and underbanked, underbanked

“Electronic Filing, Tax Preparers, and Participation in the Earned Income Tax Credit.” Working Paper 11768. Cambridge, Mass.: National Bureau of Economic Research (www.nber.org/papers/w11768). Loewenstein, George, and Nachum Sicherman. 1991. “Do Workers Prefer Increasing Wage Profiles?” Journal of Labor Economics 9:67–84 (www.jstor.org/stable/2535114). 12864-09_CH09_2ndPgs.indd 216 3/23/12 11:57 AM expensive tax refunds 217 Loewenstein, George, and Richard H. Thaler. 1989. “Anomalies: Intertemporal Choice.” Journal of Economic Perspectives 3 (Autumn): 181–93 (www.jstor.org/stable/1942918). Neumark, David. 1995. “Are Rising Earnings Profiles a Forced-Saving Mechanism?” Economic Journal 105, no. 428: 95–106 (www.jstor.org/stable/2235321). President’s Advisory Panel on Federal Tax Reform. 2005. Simple, Fair, and Pro-Growth: Proposals to Fix America’s Tax System (http://govinfo.library.unt.edu/taxreformpanel/ final-report/index.html).

La Vida: A Puerto Rican Family in the Culture of Poverty; San Juan and New York. Random House. ———. 1968. “The Culture of Poverty.” In On Understanding Poverty: Perspectives from the Social Sciences, edited by Daniel P. Moynihan, 187–220. New York: Basic Books. Loewenstein, George, and Nachum Sicherman. 1991. “Do Workers Prefer Increasing Wage Profiles?” Journal of Labor Economics 9:67–84 (www.jstor.org/stable/2535114). Loewenstein, George, and Richard H. Thaler. 1989. “Anomalies: Intertemporal Choice.” Journal of Economic Perspectives 3 (Autumn): 181–93 (www.jstor.org/stable/1942918). 12864-10_CH10_3rdPgs.indd 244 3/23/12 11:57 AM paying to save 245 Mishkin, Frederick S. 1981. “The Real Interest Rate: An Empirical Investigation.” Carnegie-Rochester Conference Series on Public Policy 15:151–200 (doi:10.1016/01672231(81)90022-1). Neumark, David. 1995.


pages: 393 words: 115,217

Loonshots: How to Nurture the Crazy Ideas That Win Wars, Cure Diseases, and Transform Industries by Safi Bahcall

accounting loophole / creative accounting, Albert Einstein, Apple II, Apple's 1984 Super Bowl advert, Astronomia nova, British Empire, Cass Sunstein, Charles Lindbergh, Clayton Christensen, cognitive bias, creative destruction, disruptive innovation, diversified portfolio, double helix, Douglas Engelbart, Douglas Engelbart, Edmond Halley, Gary Taubes, hypertext link, invisible hand, Isaac Newton, Johannes Kepler, Jony Ive, knowledge economy, lone genius, Louis Pasteur, Mark Zuckerberg, Menlo Park, Mother of all demos, Murray Gell-Mann, PageRank, Peter Thiel, Philip Mirowski, Pierre-Simon Laplace, prediction markets, pre–internet, Ralph Waldo Emerson, RAND corporation, random walk, Richard Feynman, Richard Thaler, side project, Silicon Valley, six sigma, Solar eclipse in 1919, stem cell, Steve Jobs, Steve Wozniak, the scientific method, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Tim Cook: Apple, tulip mania, Wall-E, wikimedia commons, yield management

Requiring equal pay for both C-sections and vaginal births does not tell physicians and patients which treatment to choose, unlike, for example, a seat-belt law, which tells you to put on your seat belt. But it eliminates a perverse incentive. Simple changes that encourage, but don’t mandate, behaviors we would like to see have been called “nudges.” In their book with that title, Cass Sunstein and Richard Thaler offer a handful of policy examples, ranging from the serious (a plan that improves employee retirement-savings rates) to the less serious but equally effective (painting a fly on urinals has been shown to reduce urinal spillage by 80 percent). For his work in helping launch the field of behavioral economics, Thaler was awarded the 2017 Nobel Prize. For his work in bringing the psychology of individual decision-making—the study of cognitive biases—into economics, which inspired Thaler’s work, Daniel Kahneman was awarded the 2002 Nobel Prize.

leads to fewer failures: For an analysis of these two choices by economists, see Sah and Stiglitz; Csaszar. jail terms: For more on behavioral economics, see Thinking, Fast and Slow by Daniel Kahneman (from which the jail term example is drawn, pages 225–26); the Predictably Irrational series by Dan Ariely; or the Freakonomics collection and blog by Steven Levitt and Stephen Dubner. For a recent summary and entertaining history, see Misbehaving: The Making of Behavioral Economics by Richard Thaler. for both types of deliveries: See Allin for a recent economic analysis, and NPW for an assessment of likely reasons and common myths behind the steep rise in C-section rates. Although legal pressures have been frequently cited as contributing to the rise, recent studies have shown they have played little role (Sakala). the 2017 Nobel Prize: Thaler notes that although the field has been called behavioral economics, “It is not a different discipline: it is still economics, but it is economics done with strong injections of good psychology and other social sciences” (Thaler, 9).


pages: 450 words: 113,173

The Age of Entitlement: America Since the Sixties by Christopher Caldwell

1960s counterculture, affirmative action, Affordable Care Act / Obamacare, anti-communist, Bernie Sanders, big data - Walmart - Pop Tarts, blue-collar work, Cass Sunstein, choice architecture, computer age, crack epidemic, crony capitalism, Daniel Kahneman / Amos Tversky, David Attenborough, desegregation, disintermediation, disruptive innovation, Edward Snowden, Erik Brynjolfsson, Ferguson, Missouri, financial deregulation, financial innovation, Firefox, full employment, George Gilder, global value chain, Home mortgage interest deduction, illegal immigration, immigration reform, informal economy, Jeff Bezos, John Markoff, Kevin Kelly, libertarian paternalism, Mark Zuckerberg, Martin Wolf, mass immigration, mass incarceration, mortgage tax deduction, Nate Silver, new economy, Norman Mailer, post-industrial society, pre–internet, profit motive, reserve currency, Richard Thaler, Robert Bork, Robert Gordon, Robert Metcalfe, Ronald Reagan, Rosa Parks, Silicon Valley, Skype, South China Sea, Steve Jobs, Thomas Kuhn: the structure of scientific revolutions, Thomas L Friedman, too big to fail, transatlantic slave trade, transcontinental railway, War on Poverty, Whole Earth Catalog, zero-sum game

Now the word “bias,” which had once carried overtones of bigotry and evil, had come to mean something like “human nature.” During the presidential campaign of 2008, two of Barack Obama’s friends and advisors from the University of Chicago collaborated on a book called Nudge, which used behavioral economics to justify an activist state. The law professor Cass Sunstein would become the senior advisor on regulation to the Obama White House. The economist Richard Thaler, an early collaborator of Kahneman, would take up a similar role as head of the Behavioural Insights Team for Britain’s Conservative prime minister David Cameron. Thaler and Sunstein laid out the baleful consequences of poorly designed choosing systems and suggested ways to fix them. Schoolchildren carrying their trays through lunch lines don’t usually mull over which dessert they prefer; they often grab the first thing their eyes alight on.

Christopher Caldwell, “Coaxers and Coercers on Common Ground,” Financial Times, March 1, 2013. “largely an empirical question”: Cass Sunstein, “It’s for Your Own Good!,” review of Sarah Conly, Against Autonomy: Justifying Coercive Paternalism, New York Review of Books, March 7, 2013. “So I left him”: Plato, The Apology 21, in The Dialogues of Plato, Jowett translation (New York: Macmillan, 1892), 113–14. “We agree that”: Richard Thaler and Cass Sunstein, Nudge: Improving Decisions About Health, Wealth, and Happiness (New Haven, Connecticut: Yale University Press, 2008), 238. When New Republic editor Andrew Sullivan: Andrew Sullivan, “Here Comes the Groom,” New Republic, August 28, 1989: 20–22. The first male strippers started performing: Henry Weinstein, “Chippendale Club Owner Kills Himself,” Los Angeles Times, October 25, 1994.


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The Fifth Domain: Defending Our Country, Our Companies, and Ourselves in the Age of Cyber Threats by Richard A. Clarke, Robert K. Knake

A Declaration of the Independence of Cyberspace, Affordable Care Act / Obamacare, Airbnb, Albert Einstein, Amazon Web Services, autonomous vehicles, barriers to entry, bitcoin, Black Swan, blockchain, borderless world, business cycle, business intelligence, call centre, Cass Sunstein, cloud computing, cognitive bias, commoditize, computer vision, corporate governance, cryptocurrency, data acquisition, DevOps, don't be evil, Donald Trump, Edward Snowden, Exxon Valdez, global village, immigration reform, Infrastructure as a Service, Internet of things, Jeff Bezos, Julian Assange, Kubernetes, Mark Zuckerberg, Metcalfe’s law, MITM: man-in-the-middle, move fast and break things, move fast and break things, Network effects, open borders, platform as a service, Ponzi scheme, ransomware, Richard Thaler, Sand Hill Road, Schrödinger's Cat, self-driving car, shareholder value, Silicon Valley, Silicon Valley startup, Skype, smart cities, Snapchat, software as a service, Steven Levy, Stuxnet, technoutopianism, Tim Cook: Apple, undersea cable, WikiLeaks, Y2K, zero day

She pulled out a copy of a book called Nudge: Improving Decisions About Health, Wealth, and Happiness, and suggested they do some reading. The book was coauthored by her boss, Cass Sunstein. Sunstein, a Democrat, was not necessarily a fan of regulation. A former colleague of President Obama’s at the University of Chicago Law School, Sunstein had advocated for simple but not always popular ideas, such as subjecting regulation to cost-benefit analysis. With the economist Richard Thaler, Sunstein had written Nudge, arguing that government may be more effective when it shapes voluntary action rather than when it sets mandatory requirements. On his first date with his future wife and former UN ambassador Samantha Power, he told her his dream job was to run OIRA and implement these ideas. The nudge the NSC team came up with was the NIST Cybersecurity Framework, discussed in chapter 3.

Chapter 7: Nudges and Shoves the White House delivered to Congress: “Fact Sheet: Cybersecurity Legislative Proposal,” White House, May 12, 2011, obamawhitehouse.archives.gov/the-press-office/2011/05/12/fact-sheet-cybersecurity-legislative-proposal. The CSIS commission report: “Securing Cyberspace for the 44th Presidency,” Report of the CSIS Commission on Cybersecurity for the 44th Presidency, Center for Strategic and International Studies, December 2008, https://csis-prod.s3.amazonaws.com/s3fs-public/legacy_files/files/media/csis/pubs/081208_securingcyberspace_44.pdf. She pulled out a copy of a book: Richard Thaler and Cass Sunstein, Nudge: Improving Decisions About Health, Wealth, and Happiness (New York: Penguin, 2009). Twenty years ago, when President Clinton: “Defending America’s Cyberspace: National Plan for Information Systems Protection,” White House, 2000, https://fas.org/irp/offdocs/pdd/CIP-plan.pdf. Surprisingly, the Department: U.S. Department of Homeland Security Cybersecurity Strategy, May 15, 2018, www.dhs.gov/sites/default/files/publications/DHS-Cybersecurity-Strategy_1.pdf.


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The Age of Surveillance Capitalism by Shoshana Zuboff

Amazon Web Services, Andrew Keen, augmented reality, autonomous vehicles, barriers to entry, Bartolomé de las Casas, Berlin Wall, bitcoin, blockchain, blue-collar work, book scanning, Broken windows theory, California gold rush, call centre, Capital in the Twenty-First Century by Thomas Piketty, Cass Sunstein, choice architecture, citizen journalism, cloud computing, collective bargaining, Computer Numeric Control, computer vision, connected car, corporate governance, corporate personhood, creative destruction, cryptocurrency, dogs of the Dow, don't be evil, Donald Trump, Edward Snowden, en.wikipedia.org, Erik Brynjolfsson, facts on the ground, Ford paid five dollars a day, future of work, game design, Google Earth, Google Glasses, Google X / Alphabet X, hive mind, impulse control, income inequality, Internet of things, invention of the printing press, invisible hand, Jean Tirole, job automation, Johann Wolfgang von Goethe, John Markoff, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Maynard Keynes: technological unemployment, Joseph Schumpeter, Kevin Kelly, knowledge economy, linked data, longitudinal study, low skilled workers, Mark Zuckerberg, market bubble, means of production, multi-sided market, Naomi Klein, natural language processing, Network effects, new economy, Occupy movement, off grid, PageRank, Panopticon Jeremy Bentham, pattern recognition, Paul Buchheit, performance metric, Philip Mirowski, precision agriculture, price mechanism, profit maximization, profit motive, recommendation engine, refrigerator car, RFID, Richard Thaler, ride hailing / ride sharing, Robert Bork, Robert Mercer, Second Machine Age, self-driving car, sentiment analysis, shareholder value, Shoshana Zuboff, Silicon Valley, Silicon Valley ideology, Silicon Valley startup, slashdot, smart cities, Snapchat, social graph, social web, software as a service, speech recognition, statistical model, Steve Jobs, Steven Levy, structural adjustment programs, The Future of Employment, The Wealth of Nations by Adam Smith, Tim Cook: Apple, two-sided market, union organizing, Watson beat the top human players on Jeopardy!, winner-take-all economy, Wolfgang Streeck

Picard, Affective Computing, 119, 123, 244, 123–24, 136–37. See also Chapter 4. 121. Rosalind Picard, “Towards Machines That Deny Their Maker—Lecture with Rosalind Picard,” VBG, April 22, 2016, http://www.vbg.net/ueber-uns/agenda/termin/3075.html. 122. Joseph Weizenbaum, “Not Without Us,” SIGCAS Computers and Society 16, nos. 2–3 (1986): 2–7, https://doi.org/10.1145/15483.15484. CHAPTER TEN 1. Richard H. Thaler and Cass R. Sunstein, Nudge: Improving Decisions About Health, Wealth, and Happiness, rev. ed. (New York: Penguin, 2009). 2. Elizabeth J. Lyons et al., “Behavior Change Techniques Implemented in Electronic Lifestyle Activity Monitors: A Systematic Content Analysis,” Journal of Medical Internet Research 16, no. 8 (2014), e192, https://doi.org/10.2196/jmir.3469. The commercial theory and practice of behavior modification assume an inescapable networked presence and its cornucopia of digital tools.

The third is already familiar as what behavioral psychologists refer to as “conditioning.” Strategies that produce economies of action vary according to the methods with which these approaches are combined and the salience of each. “Tuning” occurs in a variety of ways. It may involve subliminal cues designed to subtly shape the flow of behavior at the precise time and place for maximally efficient influence. Another kind of tuning involves what behavioral economists Richard Thaler and Cass Sunstein call the “nudge,” which they define as “any aspect of a choice architecture that alters people’s behavior in a predictable way.”1 The term choice architecture refers to the ways in which situations are already structured to channel attention and shape action. In some cases these architectures are intentionally designed to elicit specific behavior, such as a classroom in which all the seats face the teacher or an online business that requires you to click through many obscure pages in order to opt out of its tracking cookies.


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Big Mistakes: The Best Investors and Their Worst Investments by Michael Batnick

activist fund / activist shareholder / activist investor, Airbnb, Albert Einstein, asset allocation, bitcoin, Bretton Woods, buy and hold, buy low sell high, cognitive bias, cognitive dissonance, Credit Default Swap, cryptocurrency, Daniel Kahneman / Amos Tversky, endowment effect, financial innovation, fixed income, hindsight bias, index fund, invention of the wheel, Isaac Newton, John Meriwether, Kickstarter, Long Term Capital Management, loss aversion, mega-rich, merger arbitrage, Myron Scholes, Paul Samuelson, quantitative easing, Renaissance Technologies, Richard Thaler, Robert Shiller, Robert Shiller, Snapchat, Stephen Hawking, Steve Jobs, Steve Wozniak, stocks for the long run, transcontinental railway, value at risk, Vanguard fund, Y Combinator

The best way to guard against overconfidence when making speculative investments is to have a plan ahead of time. Know when you're wrong; use price levels, dollar loss levels, or percentage loss levels. Making decisions ahead of time, especially decisions that involve admitting defeat, can help conquer one of the biggest hurdles investors face; looking in the mirror and seeing an ability that we just do not possess. Notes 1. Daniel Kahneman, Jack L. Knetsch, and Richard H. Thaler, “Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias,” Journal of Economic Perspectives 5, no. 1 (Winter 1991): 193–206. 2. Robert Shiller, Irrational Exuberance (Princeton, NJ: Princeton University Press, 2000), 60. 3. David Dreman, Contrarian Investment Strategies: The Psychological Edge (New York: Free Press, 2012), 176. 4. Roger Lowenstein, Buffett (New York: Random House, 2008), 62. 5.


The Economics Anti-Textbook: A Critical Thinker's Guide to Microeconomics by Rod Hill, Anthony Myatt

American ideology, Andrei Shleifer, Asian financial crisis, bank run, barriers to entry, Bernie Madoff, business cycle, cognitive dissonance, collateralized debt obligation, credit crunch, Credit Default Swap, credit default swaps / collateralized debt obligations, David Ricardo: comparative advantage, different worldview, endogenous growth, equal pay for equal work, Eugene Fama: efficient market hypothesis, experimental economics, failed state, financial innovation, full employment, gender pay gap, Gini coefficient, Gunnar Myrdal, happiness index / gross national happiness, Home mortgage interest deduction, Howard Zinn, income inequality, indoor plumbing, information asymmetry, Intergovernmental Panel on Climate Change (IPCC), invisible hand, John Maynard Keynes: Economic Possibilities for our Grandchildren, Joseph Schumpeter, Kenneth Arrow, liberal capitalism, low skilled workers, market bubble, market clearing, market fundamentalism, Martin Wolf, medical malpractice, minimum wage unemployment, moral hazard, Pareto efficiency, Paul Samuelson, Peter Singer: altruism, positional goods, prediction markets, price discrimination, principal–agent problem, profit maximization, profit motive, publication bias, purchasing power parity, race to the bottom, Ralph Nader, random walk, rent control, rent-seeking, Richard Thaler, Ronald Reagan, shareholder value, The Myth of the Rational Market, the payments system, The Spirit Level, The Wealth of Nations by Adam Smith, Thorstein Veblen, ultimatum game, union organizing, working-age population, World Values Survey, Yogi Berra

Take two mathematically identical options and dress one up as a loss, and the other as a gain, and we choose the one dressed up as a gain. For example, if the risk associated with a medical procedure is expressed as a 10 per cent risk of dying, fewer people will accept the procedure than when the risk is expressed as a 90 per cent chance of living (Redelmeier et al. 1993). don’t. It has proved an intractable problem. But through a better understanding of our psychology, the behavioural economist Richard Thaler (Thaler and Bernartzi 2004) came up with a solution: the Save More Tomorrow programme. The idea is that people commit a portion of their future salary increases into a retirement savings account. Brilliant! There is no sacrifice today; we do our savings tomorrow as we would prefer. When this plan was offered in several firms, a high proportion (78 per cent) joined. Those enrolled increased their saving rates from an average of 3.5 per cent to 13.6 per cent.

The polite one is ‘data mining’ and, according to an article by Denton (1985), it’s a pretty prolific industry. 7 William Broad and Nicholas Wade, in Betrayers of the Truth (1983), present examples where the inability of other researchers to replicate published scientific findings revealed both inadvertent errors and outright fraud. On the other hand, Dewald et al. found that the errors did not significantly affect the conclusions in the majority of cases. 8 Another example would be whether asset markets are efficient. There has been a long-running battle between Eugene Fama and his associates in support of the efficient market hypothesis, and Andrei Shleifer, Richard Thaler and others in support of the inefficient market hypothesis. 9 Donald McCloskey and Deirdre McCloskey are the same person, the transition occurring (from Donald to Deirdre) in 1995. 10 A good Internet source is the History of Economic Thought website developed through the New School of Economic Research. Check out the website at cepa. newschool.edu/het/. 11 www.census.gov/foreign-trade/balance/c0004.html#2008. 4 People as consumers 1 This is from a summary of Schor (1992: 107–37). 2 There are technical problems with this measure of consumers’ surplus (e.g. the requirement that the marginal utility of income be constant and that con­ sumers’ utilities can be added up) that we will not discuss (Takayama 1987). 3 Bowles et al. (2005: ch. 3) has an excellent discussion. 4 Advertising Age (adage.com) data centre reported an estimate by Robert Coen of $294 billion for all forms of advertising in 2008.


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The Mesh: Why the Future of Business Is Sharing by Lisa Gansky

Airbnb, Amazon Mechanical Turk, Amazon Web Services, banking crisis, barriers to entry, carbon footprint, Chuck Templeton: OpenTable:, cloud computing, credit crunch, crowdsourcing, diversification, Firefox, fixed income, Google Earth, industrial cluster, Internet of things, Joi Ito, Kickstarter, late fees, Network effects, new economy, peer-to-peer lending, recommendation engine, RFID, Richard Florida, Richard Thaler, ride hailing / ride sharing, sharing economy, Silicon Valley, smart grid, social web, software as a service, TaskRabbit, the built environment, walkable city, yield management, young professional, Zipcar

Setzer, Glenn. “House Swaps—Not Just for Vacationers Anymore?” Mortgage News Daily, February 20, 2008, http://www.mortgagenewsdaily.com/2202008_Permanent_House_Swap.asp (accessed March 17, 2010). Siegler, M. G. “Twitter Can Now Know Where You Tweet.” TechCrunch, August 20, 2009, http://www.techcrunch.com/2009/08/20/twitter-can-now-know-where-you-tweet (accessed March 17, 2010). Sunstein, Cass R., and Richard H. Thaler. Nudge: Improving Decisions about Health, Wealth, and Happiness. New York: Caravan, 2008. “Survive in ’09: Neighborhood Sharing on the Rise.” CBS3, August 26, 2009, http://cbs3.com/topstories/sharing.neighborhood.survive.2.1145308.html (accessed March 16, 2010). Taylor, Tanis. “Meet the Urban Sharecroppers.” Guardian, September 4, 2008, http://www.guardian.co.uk/environment/2008/sep/04/ethicalliving.organics (accessed March 17, 2010).


pages: 207 words: 57,959

Little Bets: How Breakthrough Ideas Emerge From Small Discoveries by Peter Sims

Amazon Web Services, Black Swan, Clayton Christensen, complexity theory, David Heinemeier Hansson, deliberate practice, discovery of penicillin, endowment effect, fear of failure, Frank Gehry, Guggenheim Bilbao, Jeff Bezos, knowledge economy, lateral thinking, Lean Startup, longitudinal study, loss aversion, meta analysis, meta-analysis, PageRank, Richard Florida, Richard Thaler, Ruby on Rails, Silicon Valley, statistical model, Steve Ballmer, Steve Jobs, Steve Wozniak, theory of mind, Toyota Production System, urban planning, Wall-E

John Legend and Kevin Brereton: Interviews with Legend and Brereton. Status quo bias and loss aversion: Origin of status quo bias terminology and research: “Status Quo Bias in Decision Making,” by William Samuelson and Richard Zeckhauser, Journal of Risk and Uncertainty, vol. 1, 1988, 7–59. Addition of loss aversion and endowment effect: “The Endowment Effect, Loss Aversion, and Status Quo Bias,” by Daniel Kahneman, Jack L. Knetsch, Richard H. Thaler, Journal of Economic Perspectives, vol. 5, 193–206. “Timid Choices and Bold Forecasts,” by Daniel Kahneman and Dan Lavallo, Management Science, 39, 17–31. Chet Pipkin: Interview with Pipkin. Procter & Gamble: Interviews with P&G innovation-focused executives Karl Ronn and Chris Thoen. The Game-Changer: How You Can Drive Revenue and Profit Growth with Innovation by A.G. Lafley and Ram Charam, Crown Business (1988).


pages: 165 words: 45,397

Speculative Everything: Design, Fiction, and Social Dreaming by Anthony Dunne, Fiona Raby

3D printing, augmented reality, autonomous vehicles, Berlin Wall, Buckminster Fuller, Cass Sunstein, computer age, corporate governance, David Attenborough, en.wikipedia.org, Fall of the Berlin Wall, game design, global village, Google X / Alphabet X, haute couture, life extension, Mark Zuckerberg, mouse model, New Urbanism, Peter Eisenman, RAND corporation, Richard Thaler, Ronald Reagan, self-driving car, Silicon Valley, social software, technoutopianism, Wall-E

Interview with Jan Boelen. Available at http://www.arterritory.com/en/ texts/interviews/ 538-between-art-and-designwithout-borders/2. Accessed December 24, 2012. CHAPTER 9 1. From Nico Macdonald's seminar "Designerly Thinking and Beyond" for design interactions MA students at the RCA (January 25, 2006). Available at http:// www.spy.co.uk/Communication/Talks/Colleges/RCA_ID/2006. Accessed December 24, 2012. 2. See Richard Thaler and Cass Sunstein, Nudge: Improving Decisions about Health, Wealth, and Happiness (London: Penguin, 2009). 3. For more on this, see B.J.Fogg, Persuasive Technology: Using Computers to Change What We Thin k and Do (Burlington, MA: Morgan Kaufmann, 2003). 4. Available at http://www.cabinetoffice.gov.uk/behavioural-insights-team. Accessed December 23, 2012. 5. Eric Olin Wright, E nvisioning Real Utopias (London: Verso, 2010), 23. 6.


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People, Power, and Profits: Progressive Capitalism for an Age of Discontent by Joseph E. Stiglitz

"Robert Solow", affirmative action, Affordable Care Act / Obamacare, barriers to entry, basic income, battle of ideas, Berlin Wall, Bernie Madoff, Bernie Sanders, business cycle, Capital in the Twenty-First Century by Thomas Piketty, carried interest, central bank independence, clean water, collective bargaining, corporate governance, corporate social responsibility, creative destruction, Credit Default Swap, crony capitalism, deglobalization, deindustrialization, disintermediation, diversified portfolio, Donald Trump, Edward Snowden, Elon Musk, Erik Brynjolfsson, Fall of the Berlin Wall, financial deregulation, financial innovation, financial intermediation, Firefox, Fractional reserve banking, Francis Fukuyama: the end of history, full employment, George Akerlof, gig economy, global supply chain, greed is good, income inequality, information asymmetry, invisible hand, Isaac Newton, Jean Tirole, Jeff Bezos, job automation, John Maynard Keynes: Economic Possibilities for our Grandchildren, John von Neumann, Joseph Schumpeter, labor-force participation, late fees, low skilled workers, Mark Zuckerberg, market fundamentalism, mass incarceration, meta analysis, meta-analysis, minimum wage unemployment, moral hazard, new economy, New Urbanism, obamacare, patent troll, Paul Samuelson, pension reform, Peter Thiel, postindustrial economy, price discrimination, principal–agent problem, profit maximization, purchasing power parity, race to the bottom, Ralph Nader, rent-seeking, Richard Thaler, Robert Bork, Robert Gordon, Robert Mercer, Robert Shiller, Robert Shiller, Ronald Reagan, secular stagnation, self-driving car, shareholder value, Shoshana Zuboff, Silicon Valley, Simon Kuznets, South China Sea, sovereign wealth fund, speech recognition, Steve Jobs, The Chicago School, The Future of Employment, The Great Moderation, the market place, The Rise and Fall of American Growth, the scientific method, The Wealth of Nations by Adam Smith, too big to fail, trade liberalization, transaction costs, trickle-down economics, two-sided market, universal basic income, Unsafe at Any Speed, Upton Sinclair, uranium enrichment, War on Poverty, working-age population

Al could, for instance, detect someone with an addictive personality who might fall into the clutches of a gambling casino, and incentivize him to go to Las Vegas or the nearest casino. As sociologist Zeynep Tüfekçi is fond of pointing out, it could exploit each of our weaknesses, an irrational desire for new shoes or handbags or trips to warm beaches, and feed us information that leads us to dissipate our incomes, our emotional self prevailing over our more deliberative self.21 Research by Nobel Prize winner Richard Thaler has described what might be viewed as a war going on inside many individuals between these different identities. These new technologies intervene in this war on behalf of our lesser selves. The fear is that Big Data and AI will allow firms to have near perfect insight into these dynamics, and adjust their practices accordingly to maximize profits. Big Data is also invaluable in many areas of research.

Yochai Benkler, Julia Angwin, and Zeynep Tüfekçi have contributed to my understanding of the special issues posed by disinformation. As I return to the issues of globalization, I need to thank Dani Rodrik as well as Danny Quah, Rohinton Medhora, and Mari Pangestu; and on the role of globalization in tax avoidance, Mark Pieth and the Independent Commission for Reform of International Corporate Taxation, chaired by José Antonio Ocampo, on which I serve. Daniel Kahneman, Richard Thaler, and especially Karla Hoff have greatly influenced my thinking on the role of culture, our society, and our economy in shaping individuals, and other aspects of behavioral economics. As I’ve thought about how to respond to the challenges of globalization, financialization, and new technologies, I need to acknowledge my indebtedness to Akbar Noman, Giovanni Dosi, Justin Yifu Lin, and Mario Cimoli for insights about industrial policy; and to Karl Ove Moene, Leif Pagrotsky, Isabel Ortiz, and other members of the Initiative for Policy Dialogue/Roosevelt project on revisiting the welfare state, for insights on the welfare state, including the Scandinavian model.


Adam Smith: Father of Economics by Jesse Norman

"Robert Solow", active measures, Andrei Shleifer, balance sheet recession, bank run, banking crisis, Basel III, Berlin Wall, Black Swan, Branko Milanovic, Bretton Woods, British Empire, Broken windows theory, business cycle, business process, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, centre right, cognitive dissonance, collateralized debt obligation, colonial exploitation, Corn Laws, Credit Default Swap, credit default swaps / collateralized debt obligations, crony capitalism, David Brooks, David Ricardo: comparative advantage, deindustrialization, Eugene Fama: efficient market hypothesis, experimental economics, Fall of the Berlin Wall, Fellow of the Royal Society, financial intermediation, frictionless, frictionless market, future of work, George Akerlof, Hyman Minsky, income inequality, incomplete markets, information asymmetry, intangible asset, invention of the telescope, invisible hand, Isaac Newton, Jean Tirole, John Nash: game theory, joint-stock company, Joseph Schumpeter, Kenneth Arrow, Kenneth Rogoff, lateral thinking, loss aversion, market bubble, market fundamentalism, Martin Wolf, means of production, money market fund, Mont Pelerin Society, moral hazard, moral panic, Naomi Klein, negative equity, Network effects, new economy, non-tariff barriers, Northern Rock, Pareto efficiency, Paul Samuelson, Peter Thiel, Philip Mirowski, price mechanism, principal–agent problem, profit maximization, purchasing power parity, random walk, rent-seeking, Richard Thaler, Robert Shiller, Robert Shiller, Ronald Coase, scientific worldview, seigniorage, Socratic dialogue, South Sea Bubble, special economic zone, speech recognition, Steven Pinker, The Chicago School, The Myth of the Rational Market, The Nature of the Firm, The Rise and Fall of American Growth, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, theory of mind, Thomas Malthus, Thorstein Veblen, time value of money, transaction costs, transfer pricing, Veblen good, Vilfredo Pareto, Washington Consensus, working poor, zero-sum game

THE EFFICIENT MARKET HYPOTHESIS But there is another view of markets, which is often contrasted with the Graham–Buffett view. This is the so-called Efficient Market Hypothesis. It does not date from the dawn of political economy; rather, it was first developed by Eugene Fama, an economist at the University of Chicago, in the late 1960s. It comes in different varieties: strong, semi-strong and weak. But at their heart these varieties all have two key ideas: what the behavioural economist Richard Thaler has aptly called ‘The Price is Right’ and ‘No Free Lunch’. The Price is Right is the idea that the prices in financial markets reflect all available information about the assets being traded, so that capital allocations through financial markets are economically efficient. No Free Lunch is the idea that market prices are impossible to predict, so that any investor will struggle to beat the market, after adjusting for risk.

Chs. 1–2 Wollstonecraft and Smith: interestingly, Wollstonecraft refers to Smith as a ‘respectable authority’ (Ch. 8), engages with and sometimes echoes the arguments of TMS and also takes aim at Rousseau (and arguably Mandeville) Behavioural economics: see Nava Ashraf, Colin F. Camerer and George Loewenstein, ‘Adam Smith, Behavioral Economist’, Journal of Economic Perspectives, 19.3, Summer 2005 CHAPTER 8: ADAM SMITH AND MARKETS ‘He’s kind of a drunken psycho’: Warren Buffett, quoted on Benzinga.com, 6 January 2015 Benjamin Graham: The Intelligent Investor, Harper & Bros. 1949 Efficient Market Hypothesis: Richard Thaler, ‘Markets can be wrong and the price is not always right’, Financial Times, 4 August 2009. On the theory, see e.g. Andrei Shleifer, Inefficient Markets, Oxford University Press 2000. A highly readable overview of the history is Justin Fox, The Myth of the Rational Market, Harriman House 2009 Information incentives and efficient markets: see Sanford J. Grossman and Joseph E. Stiglitz, ‘On the Impossibility of Informationally Efficient Markets’, American Economic Review, 70.3, 1980 ‘There is no other proposition in economics which has more solid empirical evidence’: Michael Jensen, ‘Some Anomalous Evidence Regarding Market Efficiency’, Journal of Financial Economics, 6.2–3, 1978.


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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, business cycle, 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, longitudinal study, 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

(Trust me—it makes sense.) Mindless Eating: Why We Eat More Than We Think by Brian Wansink. The opposite of clarity is murkiness. And murkiness’s close cousin is mindlessness—the state of being unaware. Wansink shows how mindlessness allows us to fall prey to hidden persuaders that make us overeat without even knowing it. Nudge: Improving Decisions About Health, Wealth, and Happiness by Richard H. Thaler and Cass R. Sunstein. Two professors harvest the field of behavioral economics to reveal how altering “choice architecture” can nudge people to make better decisions about their lives. Ask the Five Whys. Those of you with toddlers in the house are familiar with, and perhaps annoyed by, the constant why-why-why. But there’s a reason the little people are constantly asking that question.


pages: 202 words: 62,199

Essentialism: The Disciplined Pursuit of Less by Greg McKeown

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, lateral thinking, loss aversion, low cost airline, Mahatma Gandhi, microcredit, minimum viable product, Nelson Mandela, North Sea oil, Peter Thiel, Ralph Waldo Emerson, Richard Thaler, Rosa Parks, Shai Danziger, side project, Silicon Valley, Silicon Valley startup, sovereign wealth fund, Stanford prison experiment, Steve Jobs, Vilfredo Pareto

“Ministers Knew Aircraft Would Not Make Money,” Independent, http://www.independent.co.uk/news/uk/ministers-knew-aircraft-would-not-make-money-concorde-thirty-years-ago-harold-macmillan-sacked-a-third-of-his-cabinet-concorde-was-approved-the-cuba-crisis-shook-the-world-and-ministers-considered-pit-closures-anthony-bevins-and-nicholas-timmins-review-highlights-from-1962-government-files-made-public-yesterday-1476025.html 3. Gillman, “Supersonic Bust.” 4. Michael Rosenfield, “NH Man Loses Life Savings on Carnival Game,” CBS Boston, April 29, 2013, http://boston.cbslocal.com/2013/04/29/nh-man-loses-life-savings-on-carnival-game/. 5. Daniel Kahneman, Jack L. Knetsch, and Richard H. Thaler, “Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias,” Journal of Economic Perspective 5, no. 1 (1991): 193–206, http://users.tricity.wsu.edu/~achaudh/kahnemanetal.pdf. 6. Tom Stafford, “Why We Love to Hoard … and How You Can Overcome It,” BBC News, July 17, 2012, www.bbc.com/future/story/20120717-why-we-love-to-hoard. 7. I originally wrote this in a blog post for Harvard Business Review called “The Disciplined Pursuit of Less,” August 8, 2012, http://blogs.hbr.org/2012/08/the-disciplined-pursuit-of-less/. 8.


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