mental accounting

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pages: 302 words: 87,776

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

But—as we explained earlier—we do assign money to mental categories, and this categorization controls how we think about it from that point on. How comfortable we feel about spending it, on what, and how much we have left at the end of the month. MENTAL ACCOUNTING: A VERY SPECIAL PROBLEM Unlike most of the problems we discuss in this book, mental accounting is more complex than just “It’s a mistake to use mental accounting.” Mental accounting—like the others—is not a rational approach to money, but when we take into account the reality of our lives and our cognitive limitations, it can be a useful strategy. This is particularly true if mental accounting is used wisely. Of course, we don’t often use it wisely, which is why the rest of this chapter exists. For now let’s talk about why mental accounting is particularly unique. Imagine there are three types of people: 1) the perfectly rational person—Homo economicus; 2) a somewhat rational person with cognitive limitations—he or she can determine the best decision if they have the time and mental capacity to figure it out; and 3) a somewhat rational person with cognitive limitations who also has emotions—that is, a human being.

Having limited himself to one cigar a day, he started shopping for bigger and bigger cigars, until he had each one made to such proportions that he “could have used it as a crutch.”4 Social scientists call this type of creative bookkeeping MALLEABLE MENTAL ACCOUNTING. We play with malleable mental accounting when we allow ourselves to classify expenses ambiguously and when we creatively assign expenses to different mental accounts. In a way, that helps us trick the account owner (ourselves). If our mental accounting weren’t malleable, we’d be strictly bound by rules of income and expenses. But, since it is malleable, we manipulate our mental accounts to justify our spending, allowing us the luxury of overspending and feeling good about it. In other words, even though we knew our budget shouldn’t allow it, we found a way to make dinner work. Maybe we shifted the meal from the “food” to the “entertainment” account.

For the perfectly rational person—all kneel before our robot masters!—mental accounting is unambiguously a mistake. In a perfectly rational world, we should treat money in one account the same as we treat money in any other account. After all, it’s just money. Money is money is money. It’s totally interchangeable. In the perfectly rational world we have an infinite capacity for financial computations, so it’s a mistake to compartmentalize because it violates the principle of fungibility and denies us that major benefit of money. For the person with cognitive limitations, with the real-life limits of our brain’s capacity to hold and process information, mental accounting can, however, help. In the real world, it’s extremely difficult to figure out the opportunity costs and multifaceted trade-offs of every single financial transaction. Mental accounting provides us a useful heuristic—or shortcut—for what decisions to make.


pages: 500 words: 145,005

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

In a nutshell it is: “How do people think about money?” Early on I called this process “psychological accounting,” but in a later paper on the topic Amos and Danny changed the name to “mental accounting,” and I followed suit. I have continued to think, write, and talk about mental accounting for the rest of my career. I still find it fascinating, exciting, and incisive; it is a lens that helps me understand the world. The next few chapters are devoted to mental accounting basics, but the topic permeates the rest of the book. Thinking about mental accounting can be contagious. You may soon find yourself blurting, “Well, that is really a mental accounting problem.” 7 Bargains and Rip-Offs My friend Maya Bar-Hillel was shopping for a quilt to use as a comforter on her double bed. She went to the store and found one she liked that was on sale.

In the model, it does not matter whether the wealth is held in cash, home equity, a retirement plan, or an heirloom painting passed on from a prior generation. Wealth is wealth. We know from the previous chapters on mental accounting that this assumption is no more innocuous or accurate than the assumptions about cognitive abilities and willpower. To relax the assumption that wealth is fungible and incorporate mental accounting into a theory of consumption and savings behavior, Hersh Shefrin and I proposed what we called the behavioral life-cycle hypothesis. We assume that a household’s consumption in a given year will not depend just on its lifetime wealth, but also on the mental accounts in which that wealth is held. The marginal propensity to consume from winning $1,000 in a lottery is likely to be much higher than a similar increase in the value of a household’s retirement holdings.

The examples discussed in chapter 13 are also relevant. 52 failing to act in accordance with the rational agent model is not fatal: For a thorough analysis of these kinds of arguments see Russell and Thaler (1985), Haltiwanger and Waldman (1985), and Akerlof and Yellen (1985). 53 “An Economic Theory of Self-Control”: Thaler and Shefrin (1981). Section II: Mental Accounting 55 “mental accounting”: My paper was Thaler (1980), and they suggested the term “mental accounting” in Kahneman and Tversky (1984). Chapter 7: Bargains and Rip-Offs 62 Macy’s: Barbaro (2007). 62 surprisingly candid press release: Tuttle (2012). 63 JC Penney claimed the end price consumers paid was effectively the same: Chernev (2012). 63 Johnson was ousted and coupons returned: Clifford and Rampell (2013). 63 [Walmart’s] “savings catcher” app: https://savingscatcher.walmart.com.


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

This distinction is a subtle one, and it is important to recognize that both motives are driven by a self-control problem and the inability to commit to a consumption plan.4 For this to affect an interpretation of the heterogeneity in the gg values as according with dynamically inconsistent behavior, the use of mental accounts must be correlated with the portfolio allocation groups, and the groups that want to overwithhold the most must also be the ones most likely to apply mental-accounting rules. To distinguish these two stories, this chapter presents data on whether tax filers view their refunds as windfall gains and use them to purchase durable goods. If there are similarities in these outcomes across the portfolio allocation groups, then it is less likely that the heterogeneity in overwithholding preferences across the portfolio allocation groups proxies for differences in mental accounting. 4. More generally, the mental-accounting framework holds the view that not all sources of income are the same and that different types of windfall gains result in different changes in consumption (Thaler 1990).

To avoid this particular problem of inference owing to these omitted variables, the study attempts to control for both risk tolerance and time preference with survey measures also used by Robert Barsky and his colleagues (1997). The study also explores whether mental accounting explains individuals’ desire to overwithhold. An attractive feature of the dynamically inconsistent model with present-biased preferences is that it allows for a mental-accounting framework (Thaler and Shefrin 1981; Thaler 1990). As David Laibson (1997, 1998) shows, windfalls to liquid wealth result in different changes to consumption than do windfalls to illiquid wealth: present-biased individuals splurge more, given changes to liquid wealth. In this “mental-accounting” framework, having a preference for overwithholding may represent a preference for receiving a liquid windfall upon receiving one’s refund rather than for using overwithholding as a precommitment device.

As individuals with mostly illiquid assets and those with one liquid asset are more likely than those with no assets to express a preference for overwithholding, it follows that dynamically 12864-10_CH10_3rdPgs.indd 233 3/23/12 11:57 AM 234 michael s. barr and jane k. dokko inconsistent behavior occurs independently of individuals’ preference for the behavioral default. Table 10-5 addresses whether “mental accounting” and loss aversion are better explanations than the study’s interpretation of the relationship between wanting excess withholding and portfolio allocation. The results in the first and second columns support the conclusion that differences in mental accounting are unlikely to explain the heterogeneity in wanting excess withholding across the portfolio allocation groups. The first column shows that, conditional on receiving a refund, 28 percent of tax filers report they view their refund as a windfall, which the study defines as survey respondents’ agreeing with the statement, “I Table 10-5. Mental-Accounting and Loss-Aversion Explanations for Wanting to Overwithhold a Percent unless otherwise noted Dependent variable Refund is “windfall” Buys durable goods Wants to overwithhold All filers No assets 28b 43b 33b 27b 55 62 Mostly illiquid assets -0.076 (0.062) -0.003 (0.064) -0.139* (0.076) -0.037 (0.053) 0.118* (0.065) 0.094 (0.058) 0.113 (0.092) 0.097* (0.055) 0.183* (0.098) 0.001 (0.106) 0.124 (0.151) 0.127 (0.104) Yes All 650 Yes All 650 Yes Refund ≤ $1,200 312 Mostly liquid assets One illiquid asset One liquid asset All controls Sample Sample size Source: Detroit Area Household Financial Services study. a.


pages: 261 words: 70,584

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

Jim: Or two. The Retirement Brain Game Mental Accounting—So we spend too much and save and invest too little. And when we do this, we often make mistakes, even though our intentions are good. Behavioral finance studies show that some financial errors can be attributed to a behavior known as mental accounting. Imagine an inbox inside your head where you store accounting files, and you label your mental folders, assign them values, and make financial decisions based on them. For example, emergency money, bill money, birthday money, gas money, fun money—you get the idea. In and of itself, categorizing money is not a problem; however, as we will see, mental accounting can become a detriment when it influences the way we spend, save, and invest money. Mental accounting can influence decisions in unexpected ways and can keep us from maximizing the dollars in each account.

When you crunch the numbers, you may see that you are better served paying the high interest account in full with the savings. For example, if she is paying 16% a year in interest on her credit card but earning only 2% on her emergency fund, that’s a yearly loss of $140 for every $1,000 spent. It adds up. The way we mentally account for our money, however, can prohibit us from parting with the safety net. The good news is that mental accounting can be used in a positive manner. I’ll discuss how you can turn the pitfalls of mental accounting into a benefit, and for the sake of this discussion, I’ll refer to that as mental budgeting. One measure that proves useful in understanding how we mentally account for money is how transparent or opaque the given question is. The more transparent the money question is, the more conscious we are in our decision making. The more opaque it is, the easier it is to make less conservative decisions with our money.

The Heritage Foundation insists that these rising capital gains taxes will only serve to promote a “lock-in effect,” where investors simply keep invested money where it is to avoid taxes.72 It also means that the government will have to go somewhere else to get money. Be ready. The Retirement Brain Game Mental Accounting—Money does not come with labels; people put labels on their money. People assign different purposes for different amounts of money. They’ll keep cash in a low-interest savings account for one purpose while borrowing money at a higher rate for another, thus losing money overall. The brain makes accounts for different purposes; for instance, the savings account could be going toward a television whereas the borrowed money could go toward a car. As one of those certainties in life, taxes never sleep, nor do they retire. But before you can manage them, you may need to perceive taxes differently than you do now. In Chapter 2, “Gold Dust on Sushi,” we explored how mental accounting affects our spending and saving behavior. This behavior can also be used to illustrate the way many of us view taxes.


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

Often we pay for self-control, for instance simultaneously putting money in a savings account and maintaining debt on credit cards. The Econs of the rational-agent model do not resort to mental accounting: they have a comprehensive view of outcomes and are driven by external incentives. For Humans, mental accounts are a form of narrow framing; they keep things under control and manageable by a finite mind. Mental accounts are used extensively to keep score. Recall that professional golfers putt more successfully when working to avoid a bogey than to achieve a birdie. One conclusion we can draw is that the best golfers create a separate account for each hole; they do not only maintain a single account for their overall success. An ironic example that Thaler related in an early article remains one of the best illustrations of how mental accounting affects behavior: Two avid sports fans plan to travel 40 miles to see a basketball game.

As a result, we refuse to cut losses when doing so would admit failure, we are biased against actions that could lead to regret, and we draw an illusory but sharp distinction between omission and commission, not doing and doing, because the sense of responsibility is greater for one than for the other. The ultimate currency that rewards or punishes is often emotional, a form of mental self-dealing that inevitably creates conflicts of interest when the individual acts as an agent on behalf of an organization. Mental Accounts Richard Thaler has been fascinated for many years by analogies between the world of accounting and the mental accounts that we use to organize and run our lives, with results that are sometimes foolish and sometimes very helpful. Mental accounts come in several varieties. We hold our money in different accounts, which are sometimes physical, sometimes only mental. We have spending money, general savings, earmarked savings for our children’s education or for medical emergencies. There is a clear hierarchy in our willingness to draw on these accounts to cover current needs.

Since the dispersion of prices is surely controlled by shoppers’ efforts to find the best buy, these results suggest that consumers hardly exert more effort to save $15 on a $150 purchase than to save $5 on a $50 purchase. The topical organization of mental accounts leads people to evaluate gains and losses in relative rather than in absolute terms, resulting in large variations in the rate at which money is exchanged for other things, such as the number of phone calls made to find a good buy or the willingness to drive a long distance to get one. Most consumers will find it easier to buy a car stereo system or a Persian rug, respectively, in the context of buying a car or a house than separately. These observations, of course, run counter to the standard rational theory of consumer behavior, which assumes invariance and does not recognize the effects of mental accounting. The following problems illustrate another example of mental accounting in which the posting of a cost to an account is controlled by topical organization: Problem 8 (N= 200): Imagine that you have decided to see a play and paid the admission price of $10 per ticket.


pages: 304 words: 22,886

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

Your Planner may have set the course for the yogurt and fruit stand, but the Cinnabon outlet blasts the aromas from their ovens directly into the walkway in front of the store. Care to guess which of the two stores always has the longer line? Mental Accounting Alarm clocks and Christmas clubs are external devices people use to solve their self-control problems. Another way to approach these problems is to adopt internal control systems, otherwise known as mental ac- counting. Mental accounting is the system (sometimes implicit) that households use to evaluate, regulate, and process their home budget. Almost all of us use mental accounts, even if we’re not aware that we’re doing so. The concept is beautifully illustrated by an exchange between the actors Gene Hackman and Dustin Hoffman in one of those extra features offered on DVDs.

Twenty dollars in the rent jar can buy just as much food as the same amount in the food jar. But households adopt mental accounting schemes that violate fungibility for the same reasons that organizations do: to control spending. Most organizations have budgets for various activities, and anyone who has ever worked in such an organization has experienced the frustration of not being able to make an important purchase because the relevant account is already depleted. The fact that there is unspent money in another account is considered no more relevant than the money sitting in the rent jar on Dustin Hoffman’s kitchen counter. At the household level, violations of fungibility are everywhere. One of the most creative examples of mental accounting was invented by a finance professor we know. At the beginning of each year, he designates a certain amount of money (say $2,000) as his intended gift to the United Way charity.

At the beginning of each year, he designates a certain amount of money (say $2,000) as his intended gift to the United Way charity. Then if anything bad happens to him during the year—a parking ticket, for example—he mentally deducts the fine against the United Way gift. This provides him “insurance” against minor financial mishaps.* You can also see mental accounting in action at the casino. Watch a gambler who is lucky enough to win some money early in the evening. You might see him take the money he has won and put it into one pocket and put the money he brought with him to gamble that evening (yet another mental account) into a different pocket. Gamblers even have a term for this. The money that has recently been won is called “house money” because in gambling parlance the casino is referred to as the house. Betting some of the money that you have just won is referred to as “gambling with the house’s money,” as if it were, somehow, different from some other kind of money.


pages: 39 words: 9,543

Lying by Sam Harris

Mark Zuckerberg, mental accounting, Socratic dialogue

One of the worst things about breaking the law is that it puts one at odds with an indeterminate number of other people. This is among the many corrosive effects of having unjust laws: They tempt peaceful and (otherwise) honest people to lie so as to avoid being punished for behavior that is ethically blameless. Mental Accounting One of the greatest problems for the liar is that he must keep track of his lies. Some people are better at this than others. Psychopaths can assume this burden of mental accounting without any obvious distress. That is no accident: They are psychopaths. They do not care about others and are quite happy to sever relationships whenever the need arises. Some people are monsters of egocentricity. But there is no question that lying comes at a psychological cost for the rest of us.

Cialdini, “Deceiver’s Distrust: Denigration as a Consequence of Undiscovered Deception,” Personality and Social Psychology Bulletin 24, no. 11 (1998): 1167–1176. [11] http://healthland.time.com/2011/01/06/study-linking-vaccines-to-autism-is-fraudulent/ Table of Contents What Is a Lie? The Mirror of Honesty Two Types of Lies White Lies Trust Faint Praise Secrets Lies in Extremis Mental Accounting Integrity Big Lies Conclusion Acknowledgments Other Books by Sam Harris Table of Contents What Is a Lie? The Mirror of Honesty Two Types of Lies White Lies Trust Faint Praise Secrets Lies in Extremis Mental Accounting Integrity Big Lies Conclusion Acknowledgments Other Books by Sam Harris

Table of Contents What Is a Lie? The Mirror of Honesty Two Types of Lies White Lies Trust Faint Praise Secrets Lies in Extremis Mental Accounting Integrity Big Lies Conclusion Acknowledgments Other Books by Sam Harris Lying Sam Harris Among the many paradoxes of human life, this is perhaps the most peculiar and consequential: We often behave in ways that are guaranteed to make us unhappy. Many of us spend our lives marching with open eyes toward remorse, regret, guilt, and disappointment.And nowhere do our injuries seem more casually self-inflicted, or the suffering we create more disproportionate to the needs of the moment, than in the lies we tell to other human beings. Lying is the royal road to chaos. As an undergraduate at Stanford I took a seminar that profoundly changed my life.


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. The psychological ease with which such funds tend to be spent was no doubt a factor in my using the unexpected money to buy some shares of WorldCom (abbreviated WCOM), “the pre-eminent global communications company for the digital generation,” as its ads boasted, at $47 per share.

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.

The man goes to a bigger casino, wins yet again, and now commands hundreds of millions of dollars. He hesitates and then decides to bet it all one more time. This time he loses. In a daze, he stumbles back up to his hotel room where his wife yawns and asks how he did. “Not too bad. I lost $5.” It’s not only in casinos and the stock market that we categorize money in odd ways and treat it differently depending on what mental account we place it in. People who lose a $100 ticket on the way to a concert, for example, are less likely to buy a new one than are people who lose $100 in cash on their way to buy the ticket. Even though the amounts are the same in the two scenarios, people in the former one tend to think $200 is too large an expenditure from their entertainment account and so don’t buy a new ticket, while people in the latter tend to assign $100 to their entertainment account and $100 to their “unfortunate loss” account and buy the ticket.


pages: 415 words: 125,089

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

It would follow that cutting your losses is also a good idea, but investors hate to take losses, because, tax considerations aside, a loss taken is an acknowledgment of error. Loss-aversion combined with ego leads investors to gamble by clinging to their mistakes in the fond hope that some day the market will vindicate their judgment and make them whole. Von Neumann would not approve. The failure of invariance frequently takes the form of what is known as "mental accounting," a process in which we separate the components of the total picture. In so doing we fail to recognize that a decision affecting each component will have an effect on the shape of the whole. Mental accounting is like focusing on the hole instead of the doughnut. It leads to conflicting answers to the same question. Kahneman and Tversky ask you to imagine that you are on your way to see a Broadway play for which you have bought a ticket that cost $40.14 When you arrive at the theater, you discover you have lost your ticket.

There is no difference other than in accounting conventions between a cost and a loss. Prospect Theory suggests that the inconsistent responses to these choices result from two separate mental accounts, one for going to the theater, and one for putting the $40 to other uses-next month's lunch money, for example. The theater account was charged $40 when the ticket was purchased, depleting that account. The lost $40 was charged to next month's lunch money, which has nothing to do with the theater account and is off in the future anyway. Consequently, the theater account is still awaiting its $40 charge. Thaler recounts an amusing real-life example of mental accounting.15 A professor of finance he knows has a clever strategy to help him deal with minor misfortunes. At the beginning of the year, the professor plans for a generous donation to his favorite charity.

Anything untoward that happens in the course of the year-a speeding ticket, replacing a lost possession, an unwanted touch by an impecunious relative-is then charged to the charity account. The system makes the losses painless, because the charity does the paying. The charity receives whatever is left over in the account. Thaler has nominated his friend as the world's first Certified Mental Accountant. In an interview with a magazine reporter, Kahneman himself confessed that he had succumbed to mental accounting. In his research with Tversky he had found that a loss is less painful when it is just an addition to a larger loss than when it is a free-standing loss: losing a second $100 after having already lost $100 is less painful than losing $100 on totally separate occasions. Keeping this concept in mind when moving into a new home, Kahneman and his wife bought all their furniture within a week after buying the house.


pages: 296 words: 87,299

Portfolios of the poor: how the world's poor live on $2 a day by Daryl Collins, Jonathan Morduch, Stuart Rutherford

Cass Sunstein, clean water, failed state, financial innovation, financial intermediation, income per capita, informal economy, job automation, M-Pesa, mental accounting, microcredit, moral hazard, profit motive, purchasing power parity, RAND corporation, randomized controlled trial, The Fortune at the Bottom of the Pyramid, transaction costs

Literate people—and so usually the 255 NOTES TO CHAPTER FIVE better off—get picked as treasurers because they can keep accounts, but even the best-intentioned of them can be cavalier with balances that mean much more to their poorer fellow members than they do to themselves. Particularly in recent years since the rise of microfinance, rural Bangladeshis have made less use of ASCAs. 19. For a fascinating account of attitudes toward RoSCAs, see Vander Meer 2009. Vander Meer studied 60 rural RoSCAs in Taiwan over a 21-year period. 20. Studying “mental accounts” has become a central part of behavioral economics; see Thaler 1990. People who use mental accounts may designate a specific savings account or device for a particular purpose (like sending money to relatives) and designate other accounts for other purposes (household needs, say, or school fees). Doing so may add costs, but it can help instill the discipline to keep some pots of money safe for their intended purposes. 21. The microlenders have since improved their products, as chapter 6 will show. 22.

At one level this is a mental battle waged inside the head of the user: we all know we should save regularly, but we also know how difficult it is to carry out our good intentions. We seek external help—automatic payments, accounts with penalties for early withdrawal or missed payments—or we devise mental tricks, keeping the rent money in a special place (the teapot that belonged to grandma) and erecting taboos against dipping into it. These “mental accounts” have been the subject of much recent enquiry.20 But at another level this is a practical matter. In Bangladesh, to keep things simple, the microcredit lenders offered only one loan term— a year—and only one repayment schedule—equal invariable weekly installments. Such a tight schedule is wonderful for discipline— but quite tough on borrowers with very small and very variable cash flows. So in Bangladesh, we found that the very poorest have been either unable to join microcredit schemes, or, having joined, soon leave after failing to complete a repayment on time.

Working Paper 56, Finance and Development Research Programme, Institute for Development Policy and Management, Manchester University. Stiglitz, Joseph. 2005. Globalization and Its Discontents. New York: Norton. Swibel, Matthew, and Forbes Staff. 2007. “The world’s top 50 microfinance institutions.” Forbes, December 20. Available at www.forbes.com. Thaler, Richard H. 1990. “Anomalies: Saving, fungibility and mental accounts.” Journal of Economic Perspectives 4 (1): 193–205. Thaler, Richard H., and Cass R. Sunstein. 2008. Nudge: Improving Decisions about Health, Wealth, and Happiness. New Haven: Yale University Press. Thomas, Duncan. 1990. “Intra-household resource allocation: An inferential approach.” Journal of Human Resources 25 (4): 635–64. Thomas, Duncan. 1994. “Like father, like son or like mother, like daughter: Parental education and child health.”


pages: 335 words: 94,657

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

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

Call it The Beardstown Ladies Effect. Since most believe they're above average, they conclude that their returns are above average, too. Mental Accounting This emotional trap causes us to be poor savers, rather than poor investors. Nevertheless, since you can't invest what you don't save, it's a habit to be aware of. Mental accounting is the habit of treating money differently, based on where it comes from. Of course, all money is money regardless of how we obtain it. But not being totally rational, we tend not to treat it that way. For example, when you get an income tax refund, do you think of it as found money and a nice windfall with which to reward yourself? If you do, you're practicing mental accounting. The truth is, you should kick yourself for giving the government an interest-free loan. Tell your employer to reduce the amount of income taxes withheld from your paycheck.

As another example of mental accounting, you buy a nonrefundable air ticket for a trip you are planning to take. Circumstances change and you don't want to take the trip but feel obligated to go because you don't want to waste the ticket. So, you go on the trip, spend more money on meals and lodging, and have a miserable time. The truth is that the airfare is a sunk cost that should be ignored when deciding whether to take the trip. To do otherwise is to risk pouring good money after bad. Do you keep all of your retirement money in very safe investments but carry credit card balances? Do you spend more when you pay by credit card than when you pay with cash? Do you think of yourself as a good money manager but have trouble saving? All of these are symptoms of someone who practices mental accounting. Anchoring Do you stick with a money manager, broker, or financial planner without knowing if they earned you more or less than the market return?

Every day you don't invest is a day less you'll have the power of compounding working for you. Put together an intelligent investment plan and get started. If you need help, seek out a good financial planner to assist you. • The endowment effect. Just because you own it, or are a part of it, doesn't automatically mean it's worth more. Get an objective evaluation. Invest no more than 10 percent of your portfolio in your employer's stock. • Mental accounting. Remember that all money spends the same, regardless of where it comes from. Money already spent is a sunk cost and should play no part in making future decisions. • Anchoring. Holding out until you get your price to sell an investment is playing a fool's game. So is blindly assuming that your financial person is doing a great job without getting an objective reading of what's really going on.


pages: 700 words: 201,953

The Social Life of Money by Nigel Dodd

accounting loophole / creative accounting, bank run, banking crisis, banks create money, Bernie Madoff, bitcoin, blockchain, borderless world, Bretton Woods, BRICs, business cycle, capital controls, cashless society, central bank independence, collapse of Lehman Brothers, collateralized debt obligation, commoditize, computer age, conceptual framework, credit crunch, cross-subsidies, David Graeber, debt deflation, dematerialisation, disintermediation, eurozone crisis, fiat currency, financial exclusion, financial innovation, Financial Instability Hypothesis, financial repression, floating exchange rates, Fractional reserve banking, German hyperinflation, Goldman Sachs: Vampire Squid, Hyman Minsky, illegal immigration, informal economy, interest rate swap, Isaac Newton, John Maynard Keynes: Economic Possibilities for our Grandchildren, joint-stock company, Joseph Schumpeter, Kickstarter, Kula ring, laissez-faire capitalism, land reform, late capitalism, liberal capitalism, liquidity trap, litecoin, London Interbank Offered Rate, M-Pesa, Marshall McLuhan, means of production, mental accounting, microcredit, mobile money, money market fund, money: store of value / unit of account / medium of exchange, mortgage debt, negative equity, new economy, Nixon shock, Occupy movement, offshore financial centre, paradox of thrift, payday loans, Peace of Westphalia, peer-to-peer, peer-to-peer lending, Ponzi scheme, post scarcity, postnationalism / post nation state, predatory finance, price mechanism, price stability, quantitative easing, quantitative trading / quantitative finance, remote working, rent-seeking, reserve currency, Richard Thaler, Robert Shiller, Robert Shiller, Satoshi Nakamoto, Scientific racism, seigniorage, Skype, Slavoj Žižek, South Sea Bubble, sovereign wealth fund, special drawing rights, The Wealth of Nations by Adam Smith, too big to fail, trade liberalization, transaction costs, Veblen good, Wave and Pay, Westphalian system, WikiLeaks, Wolfgang Streeck, yield curve, zero-coupon bond

As Zelizer herself has noted (Zelizer 2012: 14–18), there are some suggestive parallels between the process of monetary differentiation that takes place through what she calls earmarking, and the phenomenon that is known by behavioral economists as mental accounting. Mental accounting—defined by Richard Thaler as “a set of cognitive operations used by individuals and households to organize, evaluate, and keep track of financial activities” (Thaler 1999: 183)—takes place when individuals allocate different portions of the monies they possess to distinct cognitive spaces according to how those monies will be used. According to Thaler, people do this primarily because it is more efficient: they save time and effort through not having to think about certain choices where specific portions of their monies are concerned. Others suggest that emotional issues may also be involved: mental accounting becomes emotional accounting when particular monies are given “affective tags” (Levav and McGraw 2009).

Others suggest that emotional issues may also be involved: mental accounting becomes emotional accounting when particular monies are given “affective tags” (Levav and McGraw 2009). As Zelizer points out, however, this approach fails to treat social relations as playing a constitutive—as opposed to merely contextual—role in money’s differentiation. Even apparently selfish forms of mental accounting take others into consideration; indeed, they invariably emerge from social interactions—and social histories—of one kind or another. This consideration is why Zelizer prefers the notion of relational accounting to mental accounting, because monetary differentiation is closely linked to the ways in which we manage our ties to others. Zelizer’s approach is richly suggestive as a critique of mainstream monetary thought, and she opens up some intriguing questions and possibilities. For example, there are several possible interpretations of what earmarking means and thus of its implications for the analysis of money.

Cambridge, MA/London, The Belknap Press of Harvard University Press: 389–400. Benjamin, W. (2009). The Origin of German Tragic Drama, London/New York, Verso. Bernstein, P. L. (2004). The Power of Gold: The History of an Obsession, Chichester, U.K., John Wiley and Sons. Berry, S. (2001). Chiefs Know Their Boundaries: Essays on Property, Power and the Past in Asante, 1896–1996, Portsmouth, NH, Heinemann. Besharat, A. (2012). “Essays on Mental Accounting and Consumers’ Decision Making.” Ph.D. thesis, Tampa, FL, University of South Florida. Binswanger, H. C. (1994). Money and Magic: A Critique of the Modern Economy in the Light of Goethe’s “Faust,” Chicago, University of Chicago Press. Blackburn, R. (2010). “Socialism and the Current Crisis.” Dissent 57 (3): 29–32. Blanc, J. (2000). Les Monnaies Paralleles, Paris, L’Harmattan. Bloch, E. (2000).


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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

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). The poor should be less prone to show this effect: Data collected with Anuj Shah in 2012 support this prediction.

We act as if we’re “poorer” even when the added cost of gas does not materially affect our overall budget. And even then, we act as if we’re poorer “in gasoline.” (Think about it—if money were the problem, you could just as easily save by buying cheaper cookies or by golfing less.) This is because money is kept in local accounts: a negative shock to the gas account (higher prices) leads to penny pinching (and lower quality) in that account. This idea of mental accounting has many implications. For example, it is the reason we might spend a $2,000 tax refund very differently from a $2,000 increase in the value of our stock holdings. We are wealthier by $2,000 in both cases, but we treat the two accounts (“free money” versus “retirement account”) as separate and unequal, often with very different propensities to consume from the two accounts. The poor should be less prone to show this effect.

Since this book is not intended to be a careful cross-country comparison of incomes, for ease of reading we simply use nominal exchange rates. But the reader should keep this distinction in mind. Imagine you have spent the day shopping: This is a slightly updated (for inflation) version of Tversky and Kahneman’s famous “jacket-calculator” problem; A. Tversky and D. Kahneman, “The Framing of Decisions and the Psychology of Choice,” Science 211, no. 4481 (1981): 453–58. See also R. Thaler, “Mental Accounting Matters,” Journal of Behavioral Decision Making 12 (1999): 183–206. one can change the value of an hour: Ofer H. Azar, “Relative Thinking Theory,” The Journal of Socio-Economics 36, no. 1 (2007): 1–14. college students, MBAs, professional gamblers, and executives of all stripes: Some studies have found similar effects using incentives. In one study, people were asked to solve algebra questions and were paid 6¢ for each correct answer.


pages: 312 words: 93,836

Barometer of Fear: An Insider's Account of Rogue Trading and the Greatest Banking Scandal in History by Alexis Stenfors

Asian financial crisis, asset-backed security, bank run, banking crisis, Big bang: deregulation of the City of London, bonus culture, capital controls, collapse of Lehman Brothers, credit crunch, Credit Default Swap, Eugene Fama: efficient market hypothesis, eurozone crisis, financial deregulation, financial innovation, fixed income, game design, Gordon Gekko, inflation targeting, information asymmetry, interest rate derivative, interest rate swap, London Interbank Offered Rate, loss aversion, mental accounting, millennium bug, Nick Leeson, Northern Rock, oil shock, price stability, profit maximization, regulatory arbitrage, reserve currency, Rubik’s Cube, Snapchat, the market place, The Wealth of Nations by Adam Smith, too big to fail, transaction costs, Y2K

Another bias that complicates standard economics and finance theory is called ‘mental accounting’.3 In a nutshell, it refers to the way in which we often segregate different gambles into different accounts, and in so doing use very different criteria to assess how we utilise the various accounts. The brain acts like a chest of drawers, with different types of problems sorted into different compartments. For instance, we might count the pennies when shopping for groceries, but when celebrating a birthday or a special occasion we are often less sensitive to the shockingly high price of a bottle of champagne. Likewise, an individual might speculate on a volatile stock market yet be extremely careful when saving for a future retirement. Traders also do a lot of mental accounting. An FX trader watches every minuscule currency movement in the dealing room during the day, yet when on holiday in Spain will withdraw euros from the nearest ATM, oblivious to the outrageous bank fees and commissions.

However, the main question also involves a form of psychological self-assessment on the part of the interviewee, essentially asking: ‘What kind of mental accounting do you perform within your environment?’ A trader might do hundreds of deals during the day in an attempt to profit from tiny short-term price movements and customer deals. Depending on the market in which the trader is active, there might also be arbitrage opportunities from which to profit. At the same time, however, the same trader might have positions that are deliberately left untouched for days, weeks or even months – reflecting a very different, more long-term view of the market. Being able to combine both, sometimes conflicting, approaches often requires considerable recourse to mental accounting. It is not a straightforward process to assess the individual contribution of such ‘accounts’.

Cambridge: Cambridge University Press. Story, L. and Dash, E. (2009) ‘Undisclosed losses at Merrill Lynch lead to a trading inquiry’. The New York Times, 5 March. Available from: http://www.nytimes.com/2009/03/06/business/06wall.html?n=Top%2fReference%2fTimes%20Topics%2fSubjects%2fF%2fFinances [accessed 21 December 2016]. Strange, S. (1986) Casino Capitalism. Oxford: Basil Blackwell. Thaler, R. (1985) ‘Mental accounting and consumer choice’. Marketing Science, 4 (3), 199–214. The Telegraph (2015) ‘Tom Hayes LIBOR trial: the top quotes’. The Telegraph, 4 August. Available from: http://www.telegraph.co.uk/finance/financial-crime/11780670/Tom-Hayes-LIBOR-trial-the-top-quotes.html [accessed 21 December 2016]. Thornton, D. L. (2009) ‘What the Libor–OIS spread says’. Economic Synopses No. 24. St. Louis MO: Federal Reserve Bank of St.


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

This means aligning incentives at all levels of the firm with the appropriate value drivers is central in getting the execution managers and owners demand.7 Managers often trumpet an “ownership culture” and seek to distribute equity widely throughout the organization. While employees are pleased to be shareholders, I suspect that most think about their stake using “mental accounting.” They consider the stock in a mental account that is separate from their cash income, don’t count on the stock for day-to-day budgeting, and don’t consider it when they do their jobs. Another critical judgment is whether managers are paid to deliver accounting or economic performance. In the cases where there is a large owner-manager, this potentially huge agency cost rarely arises. But for managers who are paid to deliver earnings per share (EPS) growth, or for those who perceive EPS growth to be the be-all and end-all (still too large a group), the risk of significant agency costs is immense.

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. Bernstein, “Of Risk and Myopia.”

Brookings Institution and Carnegie Mellon University Working Paper, September 2000. Baer, Gregory, and Gary Gensler. The Great Mutual Fund Trap. New York: Broadway Books, 2002. Bak, Per. How Nature Works: The Science of Self-Organized Criticality. New York: Springer-Verlag, 1996. Barabási, Albert-László. Linked: The New Science of Networks. Cambridge, Mass.: Perseus, 2002. Barberis, Nicholas, and Ming Huang. “Mental Accounting, Loss Aversion, and Individual Stock Returns.” Journal of Finance 56, no. 4 (August 2001): 1247-92. Batten, David F. Discovering Artificial Economics: How Agents Learn and Economies Evolve. New York: Westview Press, 2000. Batty, Michael. “Rank Clocks.” Nature 444 (November 2006): 592-96. Bazerman, Max. Judgment in Managerial Decision Making. 4th ed. New York: Wiley, 1998. Bechara, Antoine, Hanna Damasio, Daniel Tranel, and Antonio R.


pages: 306 words: 85,836

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

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

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.) Even people who deny that they are affected by mental accounts often fall prey to them. I’ve got a buddy in that category who won a big bet on NFL football (big relative to his usual football bet, but very, very small relative to his overall wealth) and the next day he spent the proceeds on a fancy new driver.

., 109 Mandic, Pinar, 88 Manjoo, Farhad, 136 Maréchal, Michel André, 228–29 Margolis, Michael, 165 Martinelli, César, 138–40 Masters, Will, 77–88 Matthews, H. Scott, 171–72 McCain, John, 35–36 McDonald’s, workers in, 273 McKibben, Bill, 179–84 McLaughlin, Dan, 202–4 McWilliams, James, 175–78, 179–84 meat, eating, 179–84 media: and charitable giving, 324–28 fears caused by, 113 medical care, limitations of, 297 medical system, interactions with, 289 medicine, and statistics, 280–82 memoirs, fake, 146–48 mental accounts, 68–69 Merton, Robert C., 336 Mickelson, Phil, 73–74 Miles, Tom, 130 military draft, 23–25 Minty, Jessica H., 326 Moonen, Scott, 47 morality vs. economics, 288 Morgan, Yourhighness, 40 morphine, value of, 297 Moscowitz, Toby, 209–12 motorcycle accidents, 102–3 Mullainathan, Sendhil, 347 Mumbai train system, 140–41 Murphy, Kevin, 59 Myanmar, cyclone in, 324–28 Myers, Mike, 306 Nadal, Rafael, 74 names, 37 aptonyms, 43–47 first, 40, 41 heavenly, 41 middle, 38–40 unpredictability of, 42–43 National Health Service (U.K.), 26–29 National Highway Traffic Safety Administration (NHTSA), 249–50 National Violent Death Reporting System, 250 natural field experiment, 322 Neckermann, Susanne, 338 negative externality, 87 Newark-Liberty airport, 21–22 New York state senate, 233–36 New York Times, The, 3, 8, 11, 41, 96, 109–16, 167, 276 Nielsen ratings, TV viewing, 322–24 “No Gas Day,” 311–14 Noll, Chuck, 218 Noll, Thomas, 228–29 Nostradamus, 109 Obama, Barack, 33, 214, 278–80 obesity, 116–19 oil, “peak,” 109–16 Oliver, Eric, 118 online dating, 268–69 OPEC, 111–12 Oportunidades, 138–39 opportunity cost, 349–50 orange juice, 174–75 Osgood, Daniel, 165 packaging, 175–78 Pacquiao, Manny, 72–3 Pakistan earthquake, 325–27 panhandlers, 328–37 Pape, Robert, 10 paper vs. plastic bags, 167 Pardo, Bruce, 130–32 Pareto efficiency, 30 Pariah (TV show), 253–55 Parker, Susan W., 138–40 Pataki, George, 119 Paulos, John Allen, 286 Paulson, Henry, 236 Peltzman, Sam, 166 penny, 61–65 penny floor, 65 Pepsico, 59–60 perfect substitutes, 60 petroleum extraction, 109–16 Pettitte, Andy, 149–50 Pham, David “the Dragon,” 193 pilots, 83–86 pirates, 314–19 Pittsburgh Steelers, 212–19 Plack, Les, 47 Planned Parenthood, 65–67 Pledge-a-Picket, 66 poker: cheating, 154–58 how not to cheat, 153–55 Internet, 127–30, 157 one card away from final table, 192–95 record that can never be broken, 192 shootout tournament, 193 World Series of Poker, 187–88, 192–95 Polamalu, Troy, 216 Poland Spring bottled water, 3–4 Pollan, Michael, 169 postage, exemption from, 141–43 practice, ten thousand hours, 199, 201–2 praise, 351 Pre-Implantation Genetic Diagnosis (PGD), 280–82 prices: anchoring, 309 of autographed baseballs, 80–81 bounty on bin Laden, 57–59 of cars, 54–57 of chicken wings, 75–77 and corporate sponsorships, 81 discrimination in, 173 of food, 116 of gas, 86–90 for hate mail, 49–51 housing, 67–69 of kiwifruits, 77–80 peak oil, 109–16 of a penny, 61–65 of prescription drugs, 52–54 rising, 110, 111 of shrimp, 344 of songs, 69–71 and substitutes, 113 supply and demand, 78–80, 110, 112, 115, 128, 341–44 of voices in animated films, 306 priming, 228–29 principal-agent problem, 209 Prius Effect, 185 procrastination, 121 profits, going green for, 172–74 pro-life movement, 65 prostitution: Berlin brothel, 173 escort service, 261–67 legalization of, 255–56, 265–67 race: in the marketplace, 315–22 TV viewing habits, 322–24 rain forest, saving, 174–75 randomization, 322 rational addictions, 92–94 Reeve, Christopher, 102 Reilly, Barry, 225–26 Rickman, Neil, 225–26 RICO (federal racketeering statutes), 232 Rios, Brandon, 72 risk-aversion, 125–27 risk-taking, 121 Rochambeau (Rock, Paper, Scissors), 188–89 Rodriguez, Alex, 149 Roethlisberger, Ben, 103 Roe v.


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

CHAPTER 19 Behavioral Finance and the Psychology of Investing 329 IC: Exactly. Often the reference point is the purchase price that investors pay for the stock. Investors become fixated on this reference point to the exclusion of any other information. Richard Thaler from the University of Chicago, who has done seminal work in investor behavior, refers to this as mental accounting.18 When you buy a stock, you open a mental account with the purchase price as the reference point. Similarly, when you buy a group of stocks together, you will either think of the stocks individually or you may aggregate the accounts together.19 Whether your stocks are showing a gain or loss will influence your decision to hold or sell the stock. Moreover, in accounts with multiple losses, you are likely to aggregate individual losses together because thinking about one big loss is an easier pill for you to swallow than thinking of many smaller losses.

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.

., 326n The Limited Stores, 156 Lintner, John, 140n Litzenberger, Robert, 145 Lo, Andrew, 304n, 327n Local risk, 169 London Stock Exchange, 188 Long-Term Capital Management (LTCM), 88, 282 Long-term returns, 12–14, 13i Lorie, James, 45, 84 Lorillard, 60i “The Loser’s Game” (Ellis), 350 Losing trades, holding on to, 328–330 Loss aversion, 328–330 myopic, 332–333 Lowenstein, Roger, 77q, 86 Lynch, Peter, 207q, 251q, 268, 346, 348 Lyondell Chemical, 48 Ma Bell, 57, 58 MacCauley, Frederick, 291 Mackay, Charles, 324 MacKinlay, Craig, 327n Maddison, Angus, 181n Magellan Fund, 345–346, 348 Major Market Index, stock market crash of 1987 and, 273 Malkiel, Burton, 303, 345n, 348 Mamaysky, Harry, 304n Marathon Oil Company, 57 Market capitalization, ratio to GDP, 120 Index Market expectation, 239 Market movements: causes of, 223–226, 224i, 225i political parties and, 227–228, 228i–230i, 230 terrorist attacks and, 221–223, 222i, 226 uncertainty and, 226–227 war and, 225, 231–235 Market orders, 275 Market peaks, returns from, 27, 28i Market timers, 27 Market valuation, 110–120 book value and, 117 corporate profits and national income and, 115–116, 116i Fed model and, 113–115, 114i price-earnings ratio for, 110–112, 111i, 112i Tobin Q and, 117–119, 118i value relative to GDP and other ratios and, 119–120, 119i, 120i Market value, 117 ratio to dividend yield, 120, 120i ratio to GDP, 120, 120i ratio to price-earnings ratio, 120, 120i Market volatility, 14, 269–287 circuit breakers and, 276–277 distribution of large daily changes and, 283–284, 284i economics of, 285–286 historical trends of, 278–279, 279i, 280i, 281 implied, 281 nature of, 277–278 recent, low, 283 significance of, 286–287 stock market crash of 1987 and, 271–276 VIX and, 281–282, 282i Markowitz, Harry, 159n Marsh, Paul, 18, 19n, 20 Marshall, John, 65q Martingale, 292n Materials sector, in GICS, 53 Matsushita Electric Industrial, 176 Mayer, Martin, 165n, 274n McGraw-Hill Book Co., 59i, 61 The McGraw-Hill Companies, 37 McGraw, James H., 61 McKinley, William, 226–227 McNees, Stephen K., 216 McQuaid, Charles, 346 Mean aversion, 30 Mean reversion, of equity returns, 13 Mean-variance efficiency, 354 Measuring Business Cycles (Mitchell), 209 Melamed, Leo, 165, 251q, 274 Melville, Frank, 61 Melville Shoe Corp., 59i, 61 MENA (Middle East and North Africa), 179 Mental accounting, 329 Mercantile Exchange, 256 Merck, 59i, 177 Merrill, Lynch, Pierce, Fenner & Smith, 45 Merton, Robert, 35n, 266n Metz, Michael, 86, 253 Meyers, Thomas A., 295–296 Michelin Group, 49 Microsoft, 38, 57n, 118, 144, 156, 158, 176i on Nasdaq, 44 Middle East: growing market share of, 178 oil reserves of, 178 Millennium Chemicals, 48 Miller, Bill, 348 Miller, G. William, 195 Miller, Merton H., 99n Mitchell, Wesley C., 209, 210n Mitsubishi, 177 Mitsui, 177 Mittal Steel USA, 57 Mohawk and Hudson Railroad, 22 Index Mohn, Robert, 346 Molodovsky, Nicholas, 97 Momentum investing, 302–303 Monetary policy: postdevaluation, 193–194 postgold, 194–195 Money creation, 195–196 Money managers, skilled, finding, 346–348, 347i Money supply, inflation and, 189–190, 191i Moore, Philip, 355n, 356 Morgan, J.


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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

The third framing was an inheritance of $2,400 to be placed in an interest-bearing account for five years; at the end of that period the subject would receive the $2,400 plus all the interest (so that the present value of the inheritance remains $2,400). Subjects’ median response was that none of the inheritance would be spent this year.3 Rational economic theory would imply that the subjects would spend the same portion of the extra money in all three framings. Shefrin and Thaler interpreted these results as confirming that people behave as if they put different kinds of income or wealth into different “mental accounts”—in this case current income, asset, and future income accounts—and view these accounts with such sharply different psychology that they spend very differently from each of them. How much they wish to spend depends crucially on how they frame the question “How much should I save?” Generalizing from these results, it is clear that context and point of view are crucially important in determining saving.

With a capital output ratio of 3 and a net savings rate of 1/3 the capital stock will be growing at the rate of 1/9. The contribution of savings to GDP growth will be between 1/36 and 1/27. 22. The information that follows comes from Andy Di Wu’s personal interviews. 23. Feinberg (1986, p. 355). 24. Prelec and Simester (2001). 25. Laibson et al. (2000, p. 38) argue that people “appear to be of two minds” about their savings. They have separate mental accounts for retirement savings (which they put in liquid assets) and credit card debt. This can help explain the widespread practice of running up a substantial credit card debt that has a higher interest rate than is earned on the retirement assets. 26. Barenstein (2002). CHAPTER ELEVEN WHY ARE FINANCIAL PRICES AND CORPORATE INVESTMENTS SO VOLATILE? 1. Parts of this chapter are based on Shiller’s joint work with John Y.

., 191n6 Maharashtra, India, 34 Malaysia, 126 Mao Zedong, 26, 126 marginal propensity to consume (MPC), 14–15 Mark, Rebecca, 34 mark-to-market accounting, 33–34 marriage, stories in, 52 Marsh, Terry A., 193n6 Martin Luther King Day, 163 Mason, Joseph R., 181n18 Massachusetts Institute of Technology (MIT), 113, 141 Matsusaka, John G., 179n9 Meadows, Dennis L., 194n29 Meadows, Donella H., 194n29 Melino, Angelo, 191n9 mental accounts, 120–21, 192n25 Merrill Lynch, 133 Merton, Robert C., 84, 193n6 Meston, Lord, 71 Mexico, 53–54, 109 Miami, Florida, 36, 169, 198n8 Michigan Consumer Sentiment Index, 16–17, 179n2,9 Milken, Michael, 31–32 Mincer, Jacob, 19 minorities, 6, 157–66, 174, 196–97n1–24; anger in, 161–62; characteristics of those left behind, 161–63; education and, 165–66; importance of trying to assist, 166; real estate market and, 154–55; remedy for economic problems of, 163–66; why they are left behind, 158–60 Minsky, Hyman, xxiv, 177n2,7,8, 186n3 Mishkin, Frederic S., 180n9, 187n9, 191n9, 193n15 MIT.


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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

Available at www2.simon-kucher.com/index.php/us/publications/white-papers.html. Thaler, Richard H. (1980). “Toward a Positive Theory of Consumer Choice.” Journal of Economic Behavior and Organization 1, 39–60. ———(1983). “Transaction Utility Theory.” Advances in Consumer Research 10, 229. ———(1985). “Mental Accounting and Consumer Choice.” Marketing Science 4, 199– 214. ———(1988). “Anomalies: The Ultimatum Game.” The Journal of Economic Perspectives 2, 195–206. ———(1997). “Irving Fisher: Modern Behavioral Economist.” The American Economic Review 87, 439–41. ———(1999). “Mental Accounting Matters.” Journal of Behavioral Decision Making 12, 183–206. ———, and Cass R. Sunstein (2008). Nudge: Improving Decisions About Health, Wealth, and Happiness. New Haven: Yale University Press. Thompson, Andrea (2009). “Study: You Touch It, You Buy It.”

Infomercials are as stylized as a Kabuki drama. There is a reason for that. The infomercials that succeed are those best at pushing consumers’ buttons. However different the products, human nature is pretty much the same. Central to the infomercial industry is a principle that Richard Thaler calls “Don’t wrap all the Christmas presents in one box.” In a 1985 paper in the journal Marketing Science, “Mental Accounting and Consumer Choice,” Thaler presented an original view of how consumers decide what’s worth buying and at what price. Thaler applied prospect theory to typical transactions, in which one side surrenders a price (a loss) to acquire something of value (a gain). There are diminishing returns to both gains and losses. A $30,000 bonus is nice, but it’s not three times as nice as a $10,000 bonus.

Steak” at www.bigtexan.com. 144 Questions about meat consumption: Jacowitz and Kahneman 1995, 1163. 145 35 percent discount on a Nikon camera: Hermann Simon interview, Feb. 24, 2009. 145 “willingness to pay”: Simon 2008, 214. 146 “Imagine that you are about to purchase a jacket”: Tversky and Kahneman 1981, 459. 146 “Why are we more willing”: Thaler 1999, 186. 147 “What we’re saying”: Transcript of 2008 Edge Master Class, www.edge.org/3rd_culture/thaler_sendhil08/thaler_sendhil_index.html. 147 Professional Pricing Society, founded in 1984: See the PPS website, pricingsociety.com/Page4782.aspx. 147 Skeptical about the application of behavioral theory: See Simon 2008, 212, where he calls Thaler’s “mental accounting” model a “flop” for business applications. 147 Pack of Wrigley’s gum first item scanned: See Wikipedia entry for “Universal Product Code,” en.wikipedia.org/wiki/Universal_Product_Code. 147 Simon-Kucher & Partners history: Hermann Simon interview, Feb. 24, 2009. 148 “Indeed, retail pricing software”: Michaud n.d., 5. 148 “Pricing is a dangerous lever”: Tacke and Luby n.d., 9. 148 increases profit margins by about 2 percentage points: Simon 2008, 215. 148 1 to 4 percent: Michaud n.d., 5. 25.


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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

Evaluating each trade on a standalone basis is easier and may be more natural than assessing it by its contribution to our total portfolio, as modern portfolio theory prescribes. Thus, many people focus too much on asset-specific risks (volatility, default) and underappreciate correlation effects. The more general finding in experimental studies is that framing matters. People make different choices depending on how a given problem is presented to them [3]. Mental accounting refers to the process by which people formulate problems for themselves. It involves assigning gains and/or losses related to decisions into separate mental accounts (e.g., expenditure accounts and investment accounts) which may be broad or narrow (narrowness in the extreme being to view each trade in isolation) and which may have different evaluation periods. Decisions may be influenced by the extent to which their outcomes are mentally integrated with, or segregated from, the outcomes of other choices—with other assets in the portfolio or across time (i.e., with the outcomes of past trading).

Kahneman and Tversky do not specify this but note that in many cases the status quo (doing nothing, one’s current asset position) is a natural reference point:• For investments already made, the buying price becomes an important reference point against which gains and losses are measured. The disposition effect refers to investors’ tendency to hang on to losers, hoping to see the price recover back to the buying level. Prospect theory and mental accounting may explain such reluctance to realize losses. (I recall from my days as a young bond portfolio manager how hard it was to resist this bias even though my colleagues warned me on my first workweek to ignore the purchase price! “The stock does not know that you own it, let alone at what price.”) • The reference point could also be coded with respect to an expected or aspirational level of wealth different from the status quo.

Such a difference could reflect incomplete adaptation to recent changes in wealth, so past experiences can matter: “A person who has not made peace with his losses is likely to accept gambles that would be unacceptable to him otherwise.” Standard PT is sometimes mistakenly interpreted to say that people become risk seeking after they have lost money but this really depends on framing (as discussed next). More risk preferences The house money effect is an important example of mental accounting. Gamblers tend to become less loss averse and more willing to take risks when they are ahead (“playing with house money)”. Greater willingness to gamble after recent gains suggests that losses are easier to take when they can be mentally added to earlier gains. At first blush, this may sound inconsistent with PT. However, PT as described above pertains to one-off gambles. Risk preferences in a sequence of gambles depend on how prior gains and losses influence loss aversion over time.


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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

Yes, a stock that has done poorly is quite likely to go bankrupt. But enough of these companies will rebound in price, making up for the ones that fail. In fact, Thaler has found that stocks that have recently fallen have, on average, higher expected returns than the market. This should not surprise anyone, since these tend to be value stocks. But it highlights a much more serious problem, which is known as “mental accounting.” This refers to our tendency to compartmentalize our successful and unsuccessful investments, mentally separating our winners and losers. This is particularly dangerous because it distracts us from what should be our main focus: the whole portfolio. A perfect example was the advisor I mentioned earlier who was extremely proud of his “ability” to pick successful active domestic and foreign stock managers but who ignored the fact that his overall portfolio performance was poor.

The wealthy are different than you and I: they have many more ways of having their wealth stripped away. Summing It Up In the words of Walt Kelly, “We have met the enemy, and he is us.” I’ve described the major behavioral mistakes made by investors—the herd mentality, overconfidence, recency, the need to be entertained, myopic risk aversion, the great company/great stock illusion, pattern hallucination, mental accounting, and the country club syndrome. This shopping list of maladaptive behaviors will corrode your wealth as surely as a torrential rain strips an unplanted hillside. 8 Behavioral Therapy In the last chapter, we examined the many sins to which the frail investment flesh is heir. In the next pages, we’ll formulate strategies for defeating the enemy in the mirror. As always, the execution is a good deal harder than the planning, since we are attempting to vanquish some of the most primeval forces of human nature.

The sooner you realize that no system, guru, or pattern is of benefit, the better off you will be. Most importantly, ignore market strategists who use financial and economic data to forecast market direction. If we have learned anything over the past 70 years from the likes of Cowles, Fama, Graham, and Harvey, it’s that this is a fool’s errand. Barton Biggs’s job is to make Miss Cleo look good. Unify Your Mental Accounting I guarantee you that each month, quarter, year, or decade, you will have one or two asset classes that you will kick yourself for not owning more of. There will also be one or two dogs you will wish you had never laid eyes on. Certain asset classes, particularly precious metals and emerging markets stocks, are quite capable of losing 50% to 75% of their value within a year or two. This is as it should be.


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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

But you cannot possibly ignore all the other financial risks he is taking: if he has a car parked outside that can be scratched, if he has a financial portfolio that can lose money, if he has a bakery that may risk a fine, if he has a child in college who may cost unexpectedly more, if he can be laid off, if he may be unexpectedly ill in the future. All these risks add up, and the attitude of the subject reflects them all. Ruin is indivisible and invariant to the source of randomness that may cause it. Another common error in the psychology literature concerns what is called “mental accounting.” The Thorp, Kelly, and Shannon school of information theory requires that, for an investment strategy to be ergodic and eventually capture the return of the market, agents increase their risks as they are winning, but contract after losses, a technique called “playing with the house money.” 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.

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.

But, once again, this may be apocryphal. CHAPTER 19: THE LOGIC OF RISK TAKING fn1 As with my “Fat Tails” project, economists may have been aware of the ensemble-time problem, but in a sterile way. Further, they keep saying “we’ve known about fat tails,” but somehow they don’t realize that taking the idea to the next step contradicts much of their work. It is the consequences that matter. fn2 Mental accounting refers to the tendency of people to mentally (or physically) put their funds in separate insulated accounts, focusing on the source of the money, and forgetting that as net owners the source should not matter. For instance, someone who would not buy a tie because it is expensive and appears superfluous gets excited when his wife buys for his birthday the same tie using funds from a joint checking account.


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Why Stock Markets Crash: Critical Events in Complex Financial Systems by Didier Sornette

Asian financial crisis, asset allocation, Berlin Wall, Bretton Woods, Brownian motion, business cycle, buy and hold, capital asset pricing model, capital controls, continuous double auction, currency peg, Deng Xiaoping, discrete time, diversified portfolio, Elliott wave, Erdős number, experimental economics, financial innovation, floating exchange rates, frictionless, frictionless market, full employment, global village, implied volatility, index fund, information asymmetry, intangible asset, invisible hand, John von Neumann, joint-stock company, law of one price, Louis Bachelier, mandelbrot fractal, margin call, market bubble, market clearing, market design, market fundamentalism, mental accounting, moral hazard, Network effects, new economy, oil shock, open economy, pattern recognition, Paul Erdős, Paul Samuelson, quantitative trading / quantitative finance, random walk, risk/return, Ronald Reagan, Schrödinger's Cat, selection bias, short selling, Silicon Valley, South Sea Bubble, statistical model, stochastic process, stocks for the long run, Tacoma Narrows Bridge, technological singularity, The Coming Technological Singularity, The Wealth of Nations by Adam Smith, Tobin tax, total factor productivity, transaction costs, tulip mania, VA Linux, Y2K, yield curve

This violates the law-of-one-price that one drink is worth the same as another, and it suggests that people care as much about being treated fairly as they do about the actual value of what they are paying for [227, 228]. An important discovery, extending the framing principle of Kahneman and Tversky, was “mental accounting” [423, 373]. “Framing” says that the positioning of choices prejudices the outcome, an issue that received a lot of publicity in the 2000 U.S. presidential election. “Mental accounting” says that people draw their own frames, and that where they place the boundaries subtly affects their decisions. For instance, most people sort their money into accounts like “current income” and “savings” and justify different expenditures from each [425]. Applied to the stock market, Thaler noticed that some behavioral patterns like “categorization” may provide arbitrage opportunities: for instance, when Lucent Technologies was riding high, people categorized it as a “good stock” and mentally coded news about it in a favorable way.

They can sell a fraction of their stock without feeling poorer since the accelerating stock market compensates for the reduction in capital, providing a still rising capital. For instance, if investors are used to a stock market growth of 10% per year, they expect their capital to appreciate from $100 to $110 in a year. If during the following year, the growth rate rises to 20%, their capital rises to $120 instead of the expected $110. They can thus spend $10 without having the impression of eating their capital, a psychological process associated with mental accounting [423, 373] (see the section titled “Behavioral Economics” in chapter 4). On the other hand, if there is not acceleration of stock market prices, capital gain only makes a one-time addition to the stock of wealth without changing the future flow of income. If the market is not accelerating, capital gains have only a transitory effect on expenditure. But even a faster-than-exponential accelerating market is unsustainable, as we have seen in preceding chapters.

Statistical properties of deterministic threshold elements—The case of the market price, Physica A 184, 127–134. 422. Tesar, L. T. and Werner, I. M. (1997). The Internationalization of Securities Markets Since the 1987 Crash, Papers presented at the October 1997 conference, published in Vol. II of the annual Brookings-Wharton Papers on Financial Services, http://wrdsenet.wharton.upenn.edu/fic/wfic/papers/97/b6.html. 423. Thaler, R. H. (1985). Mental accounting and consumer choice, Marketing Science 4, 199–214. 424. Thaler, R. H., Editor (1993). Advances in Behavioral Finance (Russell Sage Foundation, New York). r efe rences 417 425. Thaler, R. H. and Johnson, E. J. (1990). Gambling with the house money and trying to break even: The effects of prior outcomes on risky choice, Management Science 36, 643–660. 426. Toner, J. and Tu, Y. H. (1998). Flocks, herds, and schools: A quantitative theory of flocking, Physical Review E 58, 4828–4858. 427.


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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

Even though the real change in salary is –6 percent for the first worker and 2 percent for the second worker, the pay raises are framed and compared separately from inflation rates. Consequently, the first worker is likely to be happier than the second. In the same vein, investors look at each stock individually, not as part of a portfolio as traditional economists assume. As a result, investors engage in mental accounting. They tend to value stocks that pay dividends more than stocks that pay capital gains. They tend to be loss-averse rather than risk averse. Some experiments find that investor behavior is consistent with frame dependence. For example, investors are known to hold losers for too long because they are averse to realizing a loss. On the other hand, investors sell winners too quickly because they don’t want to see the winner become a loser.

The errors are listed below with a brief explanation. The next subsection contains suggestions for foolproofing your investments. Individual security decisions, underdiversification, and too much risk. As investors study and learn about a small subset of all stocks, they become overconfident in their evaluation of those stocks. Consequently, they invest in a few stocks, resulting in underdiversification and excessive risk. In addition, mental accounting causes investors to examine each security in isolation without looking at the overall portfolio, again creating inefficient portfolios. Research has found that a typical individual investor account holds only four stocks, with a median of three stocks, and nearly one-quarter of all individual accounts hold only one stock. While individuals may have multiple accounts, there seems to be uncontestable evidence of high concentration in a few stocks.

Warren Buffett of Berkshire Hathaway and Peter Lynch of Fidelity frequently tell investors to look for good companies, leaders in their industry, and so on. Unfortunately, that is only half the story. Not all good companies are good investments. In addition to being a good company, the company should also be attractively valued before it is considered for investment. Another common error is that investors tend to pay too much for dividendpaying stocks. This is a case of mental accounting. When returns are examined, it is necessary to look at the total return rather than at dividends and capital gains separately. Though dividends are more certain than capital gains, that certainty is already reflected in the risk of that stock and should not be counted twice. HOW TO OVERCOME BEHAVIORAL BIASES The behavioral biases arise from fear and greed associated with investing. And investors make mistakes in investing when they mix emotions with rational decision making.


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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

Dave: I calculate how much the stock has gone up or down since I bought it. IC: Exactly. Often the reference point is the purchase price that investors pay for the stock. Investors become fixated on this reference point to the exclusion of any other information. Richard Thaler from the University of Chicago, who has done seminal work in investor behavior, refers to this as mental accounting or narrow framing.19 When you buy a stock, you open a mental account, with the purchase price as the reference point. Similarly, when you buy a group of stocks together, either you will think of the stocks individually, or you may aggregate the accounts together.20 Whether your stocks are showing a gain or loss will influence your decision to hold or sell the stock. Moreover, in accounts with multiple losses, you are likely to aggregate individual losses together because thinking about one big loss is an easier pill for you to swallow than thinking of many smaller losses.

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.


pages: 93 words: 24,584

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

According to their data, lower prices and increased time on the market do not significantly influence loss-aversion. Dražen Prelec and George Lowenstein believe that people do an accounting in their heads that affects their behavior. The linkages tying together specific acts of consumption with specific payments “generates pleasure or pain depending on whether the accounts are in the red or in the black.” In an article entitled “The Red and the Black: Mental Accounting of Savings and Debt” which appeared as a chapter in Exotic Preferences: Behavioral Economics and Human Motivation, the authors’ modeling predicts that most people are debt averse and show “that people generally like sequences of events that improve over time and dislike sequences that deteriorate.” Prelec and Lowenstein’s work reflects a preference for prepayment, making the enjoyment of the purchased product unencumbered.


pages: 315 words: 93,522

How Music Got Free: The End of an Industry, the Turn of the Century, and the Patient Zero of Piracy by Stephen Witt

4chan, barriers to entry, Berlin Wall, big-box store, cloud computing, collaborative economy, crowdsourcing, game design, Internet Archive, invention of movable type, inventory management, iterative process, Jason Scott: textfiles.com, job automation, late fees, mental accounting, moral panic, packet switching, pattern recognition, peer-to-peer, pirate software, Ronald Reagan, security theater, sharing economy, side project, Silicon Valley, software patent, Steve Jobs, zero day

On most weeks Glover would work more than seventy, clocking six 12-hour days in a row. On the seventh day he rested—but only because plant regulations required him to take a day off. His gross take-home was more than a thousand bucks a week. It was good money for an unskilled laborer with no college education, but it wasn’t enough. There were just so many things to buy. Glover had a remarkable facility for mental accounting. He didn’t budget or keep records, but tracked his cash flows in a mental ledger. On one side was earnings, where, going all the way back to his days as a dishwasher, he could quickly estimate what he had earned in a given week in a given year. On the other side was living expenses, which contained entries for things like utilities, groceries, and rent. Net those two amounts, and you arrived at Glover’s ultimate bottom line: the cash available for high-end discretionary purchases.

He worked 12 hours a day, came home, spent two hours on the computer burning discs, went to sleep, woke up a few hours later, brushed his teeth with his kids at his side, spent another half hour on the computer burning discs, then went back to work another 12-hour shift. But the net bottom line was a terrific influx of physical cash. Working every available overtime shift from a management position meant he pulled in nearly $1,500 a week in legitimate earnings. On top of that came another two grand in cash sales from the barbers, plus whatever he moved himself. By his mental accounting, in 2004 and 2005 he made more from bootlegging than he did from more than 3,000 hours a year of legitimate work. All told he was pulling in almost four grand a week—nearly $200,000 a year. He began to make extravagant purchases. He bought rims for his girlfriend Karen Barrett—“Rims on a Honda,” he said, shaking his head. He bought game consoles for the kids. He took his family to Disney World.


pages: 130 words: 32,279

Beyond the 4% Rule: The Science of Retirement Portfolios That Last a Lifetime by Abraham Okusanya

asset allocation, diversification, diversified portfolio, high net worth, longitudinal study, market design, mental accounting, Paul Samuelson, quantitative easing, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, transaction costs

Sequence risk vs. stupidity risk A cash reserve may not help with mitigating sequence risk but it could be very effective in reducing stupidity risk. It’s hard to argue against the positive impact it has on managing the cognitive and behavioural biases that damage returns if retirees panic during market stress. The knowledge that they always have six to 12 months’ income in cash, which is not subject to the whims of the market, is an effective ‘framing’ and ‘mental accounting’ technique to help people sleep better at night during market declines. To quote Wall Street Journal columnist Jason Zweig, when markets fall, ‘an investor who has courage but lacks cash is as powerless as one who has cash but no courage.’ Yet it’s important not to be overly conservative, as a lower allocation to equities invariably reduces a portfolio’s longevity. Keeping more than one year of income in cash does more harm than good, and the trade-off in lost return is too high.


pages: 387 words: 110,820

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

., 7. 122 to buy the product: Carrie Heilman, Kyryl Lakishyk, Sonja Radas, “The Effectiveness of In-Store Free Samples on Sample Takers,” 2006, available online at http://www.commerce.virginia.edu/faculty__research/Research/Papers/FreeSa- mples__July26__2006.pdf. 123 “five shillings besides”: From the essay “Advice to a Young Tradesman Written in the Year 1748,” in Autobiography of Benjamin Franklin (New York: Macmillan Company, 1921), 188. 123 “an opportunity cost”: Diip Soman, “The Mental Accounting of Sunk Time Costs: Why Time Is Not Like Money,” Journal of Behavioral Decision Making 14, no 3 (2001), 169-85. 123 we tend to underestimate its value: Richard Thaler, “Mental Accounting Matters,” Journal of Behavioral Decision Making 12 (1999), 183-206. CHAPTER SIX: DEATH OF A CRAFTSMAN 125 “let’s pull the legs off”: Oliver Burkeman, “The Miracle of Almhult,” The Guardian, June 17, 2004. 125 among the world’s richest men: In March 2008, Forbes magazine estimated Kamprad’s fortune at U.S. $31 billion, making him the seventh richest person in the world, while other sources, such as the Swedish business weekly Veckans Affärer, argue that he is in fact the wealthiest.


pages: 274 words: 93,758

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

"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

Greg Kaplan, Giovanni Violante, and Justin Weidner, “The Wealthy Hand-to-Mouth,” Brookings Papers on Economic Activity (Spring 2014): 98, table 2, “Household Income, Liquid Income, Liquid and Illiquid Wealth Holdings, and Portfolio Composition, Sample Countries.” They report that, while median household income was $47,040, median household holdings of cash and checking, savings, and money market accounts was $2,640 (or about two-thirds of one month’s income) according to the 2010 Survey of Consumer Finances. 7. David Huffman and Matias Barenstein, “A Monthly Struggle for Self-Control? Hyperbolic Discounting, Mental Accounting, and the Fall in Consumption between Paydays,” Institute for the Study of Labor (IZA) Discussion Paper 1430 (December 2005): 3. 8. FINRA Investor Education Foundation, Financial Capability in the United States: Report of Findings from the 2012 National Financial Capability Study, p. 23, last accessed May 14, 2015, http://www.usfinancialcapability.org/downloads/NFCS_2012_Report_Natl_Findings.pdf. 9.

The Age of Reform: From Bryan to FDR. New York: Random House, 1955. Hopkins, Claude. My Life in Advertising and Scientific Advertising: Two Works by Claude C. Hopkins. New York: McGraw Hill, 1997. Horowitz, Joseph. Dvořák in America: In Search of the New World. Chicago: Cricket Books, 2003. Huffman, David, and Matias Barenstein. “A Monthly Struggle for Self-Control? Hyperbolic Discounting, Mental Accounting, and the Fall in Consumption between Paydays.” Institute for the Study of Labor (IZA) Discussion Paper 1430 (December 2005). Interactive Advertising Bureau. Internet Advertising Revenue Report: 2013 Full-Year Results. Conducted by PricewaterhouseCoopers (PwC). Accessed March 7, 2015. http://www.iab.net/media/file/IAB_Internet_Advertising_Revenue_Report_FY_2013.pdf. International Health, Racquet, and Sportsclub Association.


pages: 360 words: 113,429

Uneasy Street: The Anxieties of Affluence by Rachel Sherman

American ideology, Bernie Sanders, Capital in the Twenty-First Century by Thomas Piketty, deindustrialization, Donald Trump, estate planning, financial independence, gig economy, high net worth, income inequality, Mark Zuckerberg, McMansion, mental accounting, NetJets, new economy, Occupy movement, plutocrats, Plutocrats, precariat, school choice, sharing economy, Silicon Valley, Steve Jobs, The Spirit Level, Thorstein Veblen, transaction costs, upwardly mobile, We are the 99%, women in the workforce, working poor

But it also seems as if they work as a way to legitimate spending their inherited money to support more comfortable lifestyles than their salaries would permit. Like spending reasonably, as we will see in chapter 3, requiring themselves to work is a way of setting limits on their own entitlements. The earners I described earlier saw their earned money as precious, to be saved, while imagining that they would spend inherited money more freely. Inheritors reversed this “mental accounting”: they felt they had to be restrained with the money they didn’t earn, whereas they could spend that which they had earned.16 Nicholas, an inheritor who also had a salaried job, said of the money he earned, “I feel a little bit more entitled to blow that money.” Donovan, who was in a similar situation, told me, “I’m more willing to spend money I’ve made myself, on whatever I want to.” Inheritors described a sense of moral obligation to spend inherited money to help others rather than on themselves, which felt self-indulgent.

Why Women Really Quit Careers and Head Home. Berkeley: University of California Press. Strasser, Susan. 1982. Never Done: A History of American Housework. New York: Pantheon Books. Streib, Jessi. 2013. “Class Origin and College Graduates’ Parenting Beliefs.” Sociological Quarterly 54: 670–693. ———. 2015. The Power of the Past: Understanding Cross-Class Marriages. New York: Oxford University Press. Thaler, Richard H. 1999. “Mental Accounting Matters.” Journal of Behavioral Decision Making 12: 183–206. Tichenor, Veronica. 2005. Earning More and Getting Less: Why Successful Wives Can’t Buy Equality. New Brunswick, NJ: Rutgers University Press. Treas, Judith. 1993. “Money in the Bank: Transaction Costs and the Economic Organization of Marriage.” American Sociological Review 58 (5): 723–734. U.S. Census Bureau. 2016. “QuickFacts, New York City, New York.” https://www.census.gov/quickfacts/table/PST045215/3651000.


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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

Anticipation is about delivering what people need before they know to ask for it. Thanks to 30 Rock, we call these instances of perfect anticipation “french fry moments.” Take the $500 we give each Googler after childbirth to spend on home delivery of meals. The first few days and weeks after bringing a new child home are exhausting. The last thing anyone wants to do is cook. Even though Googlers can afford to order a pizza for dinner, the mental accounting is different when someone gives you $500 specifically for takeout meals. And new parents tell us they love it. Ironically, our first executive development programs like the ones I had proposed to Eric in our initial meeting turned out to be a classic french fry moment. When Evan Wittenberg (then a member of our learning team and now SVP of People at Box, an online data-storage company), Paul Russell (an early leader of our learning team, now retired), and Karen May (at the time a consultant and our current VP of People Development) created Google’s first Advanced Leadership Lab in 2007, it was intensely controversial because Google at the time was organized by function—engineering, sales, finance, legal, for example—and the groups didn’t interact unless necessary.

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.


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

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

Stendahl, David, Staying Afloat. Omega Research (1999). Szala, Ginger. William Eckhardt: Doing by Learning. Futures, Vol. 21, No. 1 (January 1992). Taleb, Nassim Nicholas. Fooled By Randomness. New York: Texere, 2001. Teweles, Richard J. and Frank J. Jones. The Futures Game. Who Wins? Who Loses? Why? New York: McGraw-Hill, 1987. Thaler, Richard H. Mental Accounting Matters. Journal of Behavioral Decision Making, 12 (1999): 183–206. Thaler, Richard H. Saving, Fungibility, and Mental Accounts. Journal of Economic Perspectives, Vol. 4, No. 1 (Winter 1990): 193–205. Tharp, Van K. Trade Your Way to Financial Freedom. New York: McGraw-Hill, 1999. Thorp, Edward O. Beat the Dealer. New York: Vintage Books, 1966. Toffler, Alvin. Future Shock. New York: Bantam Books, 1971. Tully, Shawn. Princeton’s Rich Commodity Scholars.


pages: 229 words: 61,482

The Gig Economy: The Complete Guide to Getting Better Work, Taking More Time Off, and Financing the Life You Want by Diane Mulcahy

Affordable Care Act / Obamacare, Airbnb, Amazon Mechanical Turk, basic income, Clayton Christensen, cognitive bias, collective bargaining, creative destruction, David Brooks, deliberate practice, diversification, diversified portfolio, fear of failure, financial independence, future of work, gig economy, helicopter parent, Home mortgage interest deduction, housing crisis, job satisfaction, Kickstarter, loss aversion, low skilled workers, Lyft, mass immigration, mental accounting, minimum wage unemployment, mortgage tax deduction, negative equity, passive income, Paul Graham, remote working, risk tolerance, Robert Shiller, Robert Shiller, Silicon Valley, Snapchat, TaskRabbit, Uber and Lyft, uber lyft, universal basic income, wage slave, Y Combinator, Zipcar

Christensen asserts that we need to resist the allure of shorter-term gratification and make an explicit effort to keep our longer-term priorities “front and center” so that we allocate sufficient time and energy toward them. Like the exercises you did previously in chapter 1, explicitly identifying our priorities and values and reminding ourselves of them can be an effective way to overcome this bias. Do You Know How Much Time Your Stuff Costs You? We also have a less-rigorous model of mental accounting for time than money, which means that we don’t track time investments as closely as investments of money. We keep a closer eye on our checkbook than our calendar. For instance, if we make $75,000 per year, after subtracting 30 percent for taxes, etc., let’s say for ease of math that we bring home about $1,000 per week, or around $25 per hour. In this example, a new pair of $200 shoes costs us the equivalent of an eight-hour working day.


pages: 275 words: 77,017

The End of Money: Counterfeiters, Preachers, Techies, Dreamers--And the Coming Cashless Society by David Wolman

addicted to oil, Bay Area Rapid Transit, Berlin Wall, Bernie Madoff, bitcoin, Bretton Woods, carbon footprint, cashless society, central bank independence, collateralized debt obligation, corporate social responsibility, credit crunch, cross-subsidies, Diane Coyle, fiat currency, financial innovation, floating exchange rates, German hyperinflation, greed is good, Isaac Newton, Kickstarter, M-Pesa, Mahatma Gandhi, mental accounting, mobile money, money: store of value / unit of account / medium of exchange, offshore financial centre, P = NP, Peter Thiel, place-making, placebo effect, Ponzi scheme, Ronald Reagan, seigniorage, Silicon Valley, special drawing rights, Steven Levy, the payments system, transaction costs, WikiLeaks

But that’s exactly what’s happening. Pennies, nickels, and dimes can barely be described as money anymore. Legally they are, sure, but they don’t exactly circulate. A store of value? Practically nil. Medium of exchange? Only if you have a boatload of them, which won’t exactly endear you to whomever you’re transacting with. A unit of account? Technically, but I don’t know anyone who uses the hundredths place in his mental accounting. Marketing types will be quick to tell you that consumers treat $2.99 differently from $3.00, but that’s because of the hypnotic power of the left digit. No one cares about the right one anymore. It’s no wonder then that people so willingly pay the usurious 8.9 percent fee to use one of Coinstar’s 20,000 kiosks to convert unwieldy jarfuls of metal into paper money.14 In the United States, the question of killing at least the penny and nickel surfaces whenever the price of metals spikes.


pages: 241 words: 75,516

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

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

Or suppose you are Many examples of phenomena discussed in this section can be found in articles collected in D. Kahneman and A. Tversky (eds.), Choices, Values, and Frames (New York: Cambridge University Press, 2000). On the endowment effect, see D. Kahneman, J. Knetsch, and R. Thaler, “Anomalies: The Endowment Effect, Loss Aversion, and Status Quo Bias.” On decisions to sell stock, see T. Odean, “Are Investors Reluctant to Realize Their Losses?” On sunk costs, see R. Thaler, “Mental Accounting Matters,” and R. Thaler, “Toward a Positive Theory of Consumer Choice.” On health insurance decisions, see E. Johnson, J. Hershey, J. Mezaros, and H. Kunreuther, “Framing, Probability Distortions, and Insurance Decisions.” On health plans and pension plans, see C. Camerer, “Prospect Theory in the Wild: Evidence from the Field” [the original research on this is in W. Samuelson and R. Zeckhauser, “Status Quo Bias in Decision Making,” Journal of Risk and Uncertainty, 1988, 1, 7–59].


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

The only problem is, sometimes behavior that is irrational in the strictest sense of the word can greatly aid our quest to reach our financial goals. 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.


pages: 260 words: 77,007

Are You Smart Enough to Work at Google?: Trick Questions, Zen-Like Riddles, Insanely Difficult Puzzles, and Other Devious Interviewing Techniques You ... Know to Get a Job Anywhere in the New Economy by William Poundstone

affirmative action, Albert Einstein, big-box store, Buckminster Fuller, car-free, cloud computing, creative destruction, en.wikipedia.org, full text search, hiring and firing, index card, Isaac Newton, Johannes Kepler, John von Neumann, lateral thinking, loss aversion, mental accounting, new economy, Paul Erdős, RAND corporation, random walk, Richard Feynman, rolodex, Rubik’s Cube, Silicon Valley, Silicon Valley startup, sorting algorithm, Steve Ballmer, Steve Jobs, The Spirit Level, Tony Hsieh, why are manhole covers round?, William Shockley: the traitorous eight

“A Problem in Probability.” Letter to the editor. American Statistician 29 (1975): 67. ———. “On the Monty Hall Problem.” Letter to the editor. American Statistician 29 (1975): 134. Stone, Dianna L., and Gwen E. Jones. “Perceived Fairness of Biodata as a Function of the Purpose of the Request for Information and Gender of the Applicant.” Journal of Business and Psychology 11 (1997): 313–23. Thaler, Richard. “Mental Accounting and Consumer Choice.” Marketing Science 4 (1985): 199–214. Tierney, John. “Behind Monty Hall’s Doors: Puzzle, Debate, and Answer?” New York Times, July 21, 1991. Time. “An Eggalitarian Education.” May 18, 1970, 50. Torrance, E. Paul. Guiding Creative Talent. Englewood Cliffs, N.J.: Prentice-Hall, 1962. Tugend, Alina. “Getting Hired, Never a Picnic, Is Increasingly a Trial.” New York Times, October 9, 2009.


pages: 274 words: 72,657

The Power of Moments: Why Certain Experiences Have Extraordinary Impact by Chip Heath, Dan Heath

Cal Newport, call centre, clean water, cloud computing, crowdsourcing, desegregation, fear of failure, Mahatma Gandhi, mental accounting, meta analysis, meta-analysis, school choice, six sigma, Steve Ballmer

It’s the ‘fresh start effect’ . . . all of my past failures are from last year and I can think, ‘Those are not me. That’s old me. That’s not new me. New me isn’t going to make these mistakes.’ ” In other words, New Year’s resolutions are not really about the resolutions. After all, for most people, the resolutions haven’t changed. Most people wanted to lose weight and save money on December 31, too. What we’re doing on New Year’s Day is more like a mental accounting trick. Our past failures are left on the ledger of Old Me. New Me starts today. New Year’s resolutions should really be called New Year’s absolutions. Milkman realized that if her “fresh start” theory was right, then the slate-cleaning effect shouldn’t be confined to New Year’s Day. It should also be true for other landmark dates that would give us an excuse to reset our record, such as the start of a new month or even a new week.


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The Happiness Industry: How the Government and Big Business Sold Us Well-Being by William Davies

1960s counterculture, Airbnb, business intelligence, corporate governance, dematerialisation, experimental subject, Exxon Valdez, Frederick Winslow Taylor, Gini coefficient, income inequality, intangible asset, invisible hand, joint-stock company, lifelogging, market bubble, mental accounting, nudge unit, Panopticon Jeremy Bentham, Philip Mirowski, profit maximization, randomized controlled trial, Richard Thaler, road to serfdom, Ronald Coase, Ronald Reagan, science of happiness, selective serotonin reuptake inhibitor (SSRI), sentiment analysis, sharing economy, Slavoj Žižek, smart cities, Smart Cities: Big Data, Civic Hackers, and the Quest for a New Utopia, social intelligence, Social Responsibility of Business Is to Increase Its Profits, Steve Jobs, The Chicago School, The Spirit Level, theory of mind, urban planning, Vilfredo Pareto

Historical Explorations of an Instrument’, Science in Context 11: 1, 1998. 2Jonathan Haidt, The Righteous Mind: Why Good People Are Divided by Politics and Religion, New York: Pantheon Books, 2012. 3See Maren Martell, ‘The Race to Find the Brain’s “Buy-Me Button”’, welt.de, 20 January 2011, transl. worldcrunch.com, 2 July 2011. 4Robert Gehl, ‘A History of Like’, thenewinquiry.com, 27 March 2013. 5Lea Dunn and JoAndrea Hoegg, ‘The Impact of Fear on Emotional Brand Attachment’, Journal of Consumer Research 41: 1, 2014. 6Jeffrey Zaslow, ‘Happiness Inc.’, online.wsj.com, 18 March 2006. 7Keith Coulter, Pilsik Choi and Kent Monroe, ‘Comma N’ Cents in Pricing: The Effects of Auditory Representation Encoding on Price Magnitude Perceptions’, Journal of Consumer Psychology 22: 3, 2012. 8Drazen Prelec and George Loewenstein, ‘The Red and the Black: Mental Accounting of Savings and Debt’, Marketing Science 17: 1, 1998. 9Jonathan Crary, Suspensions of Perception: Attention, Spectacle, and Modern Culture, Cambridge, Mass.: MIT Press, 2001. 10Robert Rieber and David Robinson, eds., Wilhelm Wundt in History: The Making of a Scientific Psychology, Dordrecht: Kluwer Academic Publishers, 2001. 11See James Beniger, The Control Revolution: Technological and Economic Origins of the Information Society, Cambridge, MA: Harvard University Press, 1988. 12Robert Rieber, ed., Wilhelm Wundt and the Making of a Scientific Psychology, New York: Plenum Publishing Company Limited, 1980. 13Ibid. 14The American psychologist Edward Thorndike wrote in 1907: ‘Psychology supplies or should supply the fundamental principles upon which sociology, history, anthropology, linguistics and the other sciences dealing with human thought and action should be based … The facts and laws of psychology … should provide the general basis for the interpretation and explanation of the great events studied by history.’


pages: 289 words: 87,292

The Strange Order of Things: The Biological Roots of Culture by Antonio Damasio

Albert Einstein, biofilm, business process, Daniel Kahneman / Amos Tversky, double helix, Gordon Gekko, invention of the wheel, invention of writing, invisible hand, job automation, mental accounting, meta analysis, meta-analysis, microbiome, Norbert Wiener, pattern recognition, Peter Singer: altruism, planetary scale, profit motive, Ray Kurzweil, Richard Feynman, self-driving car, Silicon Valley, Steven Pinker, Thomas Malthus

I can also envision feelings in a different species somewhere in our galaxy, where life sprang forth and where organisms would have followed a homeostatic imperative similar to ours and generated, on a physiologically different but living substrate, a variant of our feelings. The experience that the mysterious species would have of its feelings would be formally akin to ours, albeit not the same, because the substrate was not exactly the same. If you change the substrate of feelings, you change what gets to be interactively imaged and so you change the feelings as well. In brief, substrates do count because the mental process to which we are referring is a mental account of those substrates. Phenomenology counts. There is plenty of evidence that artificial organisms can be designed so as to operate intelligently and even surpass the intelligence of human organisms. But there is no evidence that such artificial organisms, designed for the sole purpose of being intelligent, can generate feelings just because they are behaving intelligently. Natural feelings emerged in evolution, and there they remained because they have made live or die contributions to the organisms lucky enough to have them.


pages: 321 words: 92,258

Lift: Fitness Culture, From Naked Greeks and Acrobats to Jazzercise and Ninja Warriors by Daniel Kunitz

barriers to entry, creative destruction, feminist movement, glass ceiling, Islamic Golden Age, mental accounting, Ronald Reagan, Saturday Night Live, Upton Sinclair, Works Progress Administration

I’ve since come to understand that the old canard about choosing between the life of the body and the life of the mind (a bastardized version of the ancient and more valid distinction between the via activa and the via contemplativa, the active, political life versus the contemplative way) sets up a false distinction. It’s a bias based on the assumption that energy expended physically must be deducted from our mental account. Contrary to what I believed in high school, jocks need not be stupid, while eggheads, to the extent that they deny their physical lives, are fools. In the New York literary world of the nineties, almost everyone—though not George—remained still gleefully stuck in that high school mentality. We thought physical culture was an oxymoron (with the emphasis on moron—we preferred our oxy with contin).


pages: 342 words: 94,762

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

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. Men appear to be more overconfident than women about their trading: one study shows that men trade 45 percent more than women, which costs them almost a full percentage point in terms of their net annual returns.


pages: 329 words: 93,655

Moonwalking With Einstein by Joshua Foer

Albert Einstein, Asperger Syndrome, Berlin Wall, conceptual framework, deliberate practice, Fall of the Berlin Wall, Frank Gehry, lifelogging, mental accounting, patient HM, pattern recognition, Rubik’s Cube, speech recognition, Stephen Hawking, zero-sum game

The Greeks had an acrophonic system, wherein the first letter of each numeral could be used to represent the number, so that, for example, P represented the number five, for penta. In Hebrew, each letter of the aleph bet corresponds to a number, a quirk that Kabbalists have used to seek out hidden numerical meanings in Scripture. Nobody knows whether these systems were ever used to memorize numbers, but it’s hard to imagine that some Mediterranean businessman who had to do mental accounting wouldn’t have stumbled onto such an obvious idea. 166 advance the sport of competitive memory by a quantum leap: Ed gave me the following example of his Millennium PAO system at work: “The number 115 is Psmith, the stylish character from the P. G. Wodehouse books (the P is silent, by the way, as in ‘phthisis’ or ‘ptarmigan’). His action is that he gives away an umbrella that doesn’t belong to him to a delicate young lady he sees stranded in a rainstorm.


pages: 299 words: 92,782

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

In one study, researchers asked people which new employee was happier, the person making $36,000 in a firm where the average starting salary is $40,000 or the one making $34,000 in a firm where the average starting salary is $30,000. Eighty percent of the respondents said the employee earning $34,000 would be happier.33 In investing, the reference point is what you paid for a stock. When you buy a stock at $30, for instance, you effectively open a mental account. You have a gain if the stock rises above $30 and a loss if it drops below that price. Rather than viewing the value of the stock in the context of a larger portfolio, the natural tendency is to consider each stock relative to its reference point. Loss aversion is another feature of prospect theory. We suffer roughly two times more from a loss than we enjoy a gain of the same size. The combination of the reference point and loss aversion leads investors to hold on to losing stocks and sell winners, because it is painful to take losses.34 Because good decisions can have bad outcomes, not everyone has a temperament that is well suited to making decisions about activities that involve luck.


pages: 111 words: 1

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

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

This phenomenon is not surprising given the important role that gaze direction plays in primate social communications—the averted gaze of guilt, shame or embarrassment; the intense, direct gaze of a lover, or the threatening stare of an enemy.” CHAPTER 12 Pigeons in a box: Skinner (1948). Illusion of knowledge: Barber and Odean (2001) presents a discussion of the literature on the tendency to make a stronger inference than warranted by the data, which they call “Illusion of Knowledge.” CHAPTER 13 Arabic skeptics: al-Ghazl (1989). Rozan’s book: Rozan (1999). Mental accounting: Thaler (1980) and Kahneman, Knetch and Thaler (1991). Portfolio theory (alas): Markowitz (1959). The conventional probability paradigm: Most of the conventional discussions on probabilistic thought, especially in the philosophical literature, present minor variants of the same paradigm with the succession of the following historical contributions: Chevalier de Méré, Pascal, Cardano, De Moivre, Gauss, Bernouilli, Laplace, Bayes, von Mises, Carnap, Kolmogorov, Borel, De Finetti, Ramsey, etc.


pages: 327 words: 97,720

Loneliness: Human Nature and the Need for Social Connection by John T. Cacioppo

Alfred Russel Wallace, biofilm, butterfly effect, Celebration, Florida, corporate governance, delayed gratification, experimental subject, impulse control, income inequality, Jane Jacobs, longitudinal study, mental accounting, meta analysis, meta-analysis, placebo effect, post-industrial society, Rodney Brooks, Ted Kaczynski, The Death and Life of Great American Cities, theory of mind, urban planning, urban renewal, Walter Mischel

Combined with ever more sophisticated mental capacities—the ability to maintain the image of a prey animal when it is no longer in sight, the ability to continue to focus persistently on a certain goal for days or even years—running allowed us to move from scavenging on the savannahs to becoming competent hunters.2 With the expansion of our brain and our field of vision came an even wider expansion—not just of our range of habitation, but of our range in terms of the global and temporal nature of our concerns. It is this expansion that lies at the heart of the Third Adaptation. We became creatures not just of the moment, but of the future and the past. We could internalize lessons from experience, learn from our mistakes, and also plan ahead. We could defer gratification and we could keep mental accounts of treachery and of kindness extending back for generations, even centuries. With highly sophisticated and fully functional executive control, we could much more precisely sort out what served our own interests, while also taking into consideration our membership in various wider communities of interest, extending all over the world and into the future our great-grandchildren will inhabit. And thus, despite all the other human advantages, our most singularly beneficial adaptation remains the self-regulation and nuanced social cognition provided by our neocortex.


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

Their research led to an article that was substantially similar to the version of the story published here: Stephen J. Dubner and Steven D. 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.


pages: 297 words: 96,509

Time Paradox by Philip G. Zimbardo, John Boyd

Albert Einstein, cognitive dissonance, Drosophila, endowment effect, hedonic treadmill, impulse control, indoor plumbing, loss aversion, mental accounting, meta analysis, meta-analysis, Necker cube, Ronald Reagan, science of happiness, The Wealth of Nations by Adam Smith, twin studies

Pratt, D. A. Wise, and R. Zeckhauser, “Price Differences in Almost Competitive Markets,” Quarterly Journal of Economics 93: 189–211 (1979); A. Tversky and D. Kahneman, “The Framing of Decisions and the Psychology of Choice,” Science 211: 453–58 (1981); R. H. Thaler, “Toward a Positive Theory of Consumer Choice,” Journal of Economic Behavior and Organization 1: 39–60 (1980). 20. R. H. Thaler, “Mental Accounting Matters,” Journal of Behavioral Decision Making 12: 183–206 (1999). 21. R. B. Cialdini et al., “Reciprocal Concessions Procedure for Inducing Compliance: The Door-in-the-Face Technique,” Journal of Personality and Social Psychology 31: 206–15 (1975). There is some controversy about whether this effect is, in fact, due to the contrast between the large and small requests. See J. P. Dillard, “The Current Status of Research on Sequential-Request Compliance Techniques,” Personality and Social Psychology Bulletin 17: 283–88 (1991). 22.


pages: 331 words: 96,989

Irresistible: The Rise of Addictive Technology and the Business of Keeping Us Hooked by Adam L. Alter

Alexey Pajitnov wrote Tetris, augmented reality, barriers to entry, call centre, Cass Sunstein, cognitive dissonance, Daniel Kahneman / Amos Tversky, easy for humans, difficult for computers, en.wikipedia.org, experimental subject, game design, Google Glasses, IKEA effect, Inbox Zero, Kickstarter, loss aversion, Mark Zuckerberg, Menlo Park, mental accounting, meta analysis, meta-analysis, Oculus Rift, Richard Thaler, side project, Skype, Snapchat, Steve Jobs, telemarketer

Friedman, “Here’s Why People Work Like Crazy, Even When They Have Everything They Need,” Business Insider, July 10, 2014, www.businessinsider.com/why-people-work-too-much-2014-7; International Labour Organization, “Case Study: Karoshi: Death from Overwork,” International Labour Relations, April 23, 2013, www.ilo.org/safework/info/publications/WCMS_211571/lang—en/index.htm ; China Post News Staff, “Overwork Confirmed to Be Cause of Nanya Engineer’s Death,” China Post, October 15, 2011, www.chinapost.com.tw/taiwan/national/national-news/2011/03/15/294686/Overwork-confirmed.htm. In a classic paper: Dražen Prelec and Duncan Simester, “Always Leave Home Without It: A Further Investigation of the Credit-Card Effect on Willingness to Pay, Marketing Letters 12, no. 1 (2001): 5–12; see also: Dražen Prelec and George Loewenstein, “The Red and the Black: Mental Accounting of Savings and Debt,” Marketing Science 17, no. 1 (1998): 4–28. CHAPTER 8: CLIFFHANGERS In their own: Responses to the ending of The Italian Job on the Internet Movie Database: www.imdb.com/title/tt0064505/reviews. Forty years earlier: Background material on Bluma Zeigarnik and her eponymous effect: A. V. Zeigarnik, “Bluma Zeigarnik: A Memoir,” Gestalt Theory 29, no. 3 (December 8, 2007): 256–68; Bluma Zeigarnik, “On Finished and Unfinished Tasks,” in A Source Book of Gestalt Psychology, W.


pages: 391 words: 105,382

Utopia Is Creepy: And Other Provocations by Nicholas Carr

Air France Flight 447, Airbnb, Airbus A320, AltaVista, Amazon Mechanical Turk, augmented reality, autonomous vehicles, Bernie Sanders, book scanning, Brewster Kahle, Buckminster Fuller, Burning Man, Captain Sullenberger Hudson, centralized clearinghouse, Charles Lindbergh, cloud computing, cognitive bias, collaborative consumption, computer age, corporate governance, crowdsourcing, Danny Hillis, deskilling, digital map, disruptive innovation, Donald Trump, Electric Kool-Aid Acid Test, Elon Musk, factory automation, failed state, feminist movement, Frederick Winslow Taylor, friendly fire, game design, global village, Google bus, Google Glasses, Google X / Alphabet X, Googley, hive mind, impulse control, indoor plumbing, interchangeable parts, Internet Archive, invention of movable type, invention of the steam engine, invisible hand, Isaac Newton, Jeff Bezos, jimmy wales, Joan Didion, job automation, Kevin Kelly, lifelogging, low skilled workers, Marc Andreessen, Mark Zuckerberg, Marshall McLuhan, means of production, Menlo Park, mental accounting, natural language processing, Network effects, new economy, Nicholas Carr, Norman Mailer, off grid, oil shale / tar sands, Peter Thiel, plutocrats, Plutocrats, profit motive, Ralph Waldo Emerson, Ray Kurzweil, recommendation engine, Republic of Letters, robot derives from the Czech word robota Czech, meaning slave, Ronald Reagan, self-driving car, SETI@home, side project, Silicon Valley, Silicon Valley ideology, Singularitarianism, Snapchat, social graph, social web, speech recognition, Startup school, stem cell, Stephen Hawking, Steve Jobs, Steven Levy, technoutopianism, the medium is the message, theory of mind, Turing test, Whole Earth Catalog, Y Combinator

It is only when a sense that time may consist of something other than the immediate moment is allowed to impinge on the child’s consciousness that maladaptation becomes a real possibility. Hence, the most pressing job for the parent is to ensure that the virtual child is kept in a device-rich networked environment at all times. It is also essential that the virtual child never be allowed to run a cognitive surplus. His or her mental accounts must always be kept in perfect balance, with each synaptic firing being immediately deployed for a well-defined chore, preferably involving the manipulation of symbols on a computer screen in a collaborative social-production exercise. If cognitive cycles are allowed to go to waste, the child may drift into an introspective “dream state” outside the flow of the digital stream. It is wise to ensure that your iPhone is well populated with apps suitable for children, as this will provide a useful backup should your child break, lose, or otherwise be separated from her own network-enabled devices.


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

If they cannot meet the monthly payments on their mortgages, the bank could foreclose and take their homes away from them. Their whole way of life could be damaged. This imbalance in their family balance sheet does not concern many home owners, because they simply do not think about such matters as diversification and management of risk, at least where their houses are concerned. They tend to employ what has come to be known as “mental accounting,” which means they maintain a separate basket in their heads for their home and its mortgage, another basket for their 401(k) accounts, still another for their savings accounts, one for their consumer credit, and another to store their concerns about the cost of their children’s education. No basket has a relation to any of the other baskets. As a result, they seldom—if ever—take the time to develop an overview of the total amount of the assets and liabilities in all the baskets considered together.


pages: 480 words: 119,407

Invisible Women by Caroline Criado Perez

Affordable Care Act / Obamacare, augmented reality, Bernie Sanders, collective bargaining, crowdsourcing, Diane Coyle, Donald Trump, falling living standards, first-past-the-post, gender pay gap, gig economy, glass ceiling, Grace Hopper, Hacker Ethic, Indoor air pollution, informal economy, lifelogging, low skilled workers, mental accounting, meta analysis, meta-analysis, Nate Silver, new economy, obamacare, Oculus Rift, offshore financial centre, pattern recognition, phenotype, post-industrial society, randomized controlled trial, remote working, Silicon Valley, Simon Kuznets, speech recognition, stem cell, Stephen Hawking, Steven Levy, the built environment, urban planning, women in the workforce, zero-sum game

Uniforms and tools are in; emergency day care is out.128 In the US, what is an allowable work expense is decided by the IRS, which explains that ‘Generally you cannot deduct personal, living, or family expenses.’129 But what counts as a personal expense is debatable – which is where Dawn Bovasso comes in. Bovasso is one of the few female creative directors in US advertising. She is also a single mother. So when her firm announced that it was hosting a directors’ dinner, Bovasso had a decision to make: was this dinner worth the $200 it would cost her for a sitter and travel?130 Bovasso’s male colleagues on the whole had to do no such mental accounting: yes, men can be single parents, but they are a rare beast. In the UK, 90% of single parents are women.131 In the US the figure is over 80%.132 In Bovasso’s case, her male colleagues were able to just check their calendar and accept or decline. And most of them accepted. In fact not only did they accept, they also booked the hotel next to the restaurant, so they could drink. And unlike her sitter, this cost was claimable on company expenses.


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

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). Thaler thought these types of behaviors might be linked to the mental shortcuts and biases that Kahneman and Tversky had identified. In 1980, he published a paper outlining some of his ideas in a reputable but somewhat obscure publication, The Journal of Economic Behavior and Organization, and in 1987 he began writing a regular column entitled “Anomalies,” in the much more influential Journal of Economic Perspectives.


pages: 420 words: 130,714

Science in the Soul: Selected Writings of a Passionate Rationalist by Richard Dawkins

agricultural Revolution, Alfred Russel Wallace, anthropic principle, Any sufficiently advanced technology is indistinguishable from magic, Boris Johnson, David Attenborough, Donald Trump, double helix, Drosophila, epigenetics, Fellow of the Royal Society, Google Earth, John Harrison: Longitude, Kickstarter, lone genius, Mahatma Gandhi, mental accounting, Necker cube, nuclear winter, out of africa, p-value, phenotype, place-making, placebo effect, random walk, Ray Kurzweil, Richard Feynman, Search for Extraterrestrial Intelligence, stem cell, Stephen Hawking, Steve Wozniak, Steven Pinker, the scientific method, twin studies

.*2 Thanks to evidence-based reason we are blessedly liberated from ancient fears of ghosts and devils, evil spirits and djinns, magic spells and witches’ curses. Who then would rally against reason? The following statements will sound all too familiar. ‘I don’t trust educated intellectuals, elitists who know more than I do. I’d prefer to vote for somebody like me, rather than somebody who is actually qualified to be President.’ What other than this mentality accounts for the popularity of Donald Trump, Sarah Palin, George W. Bush – politicians who flaunt their ignorance as a vote-winning virtue?*3 You want your airline pilot to be educated in aeronautics and navigation. You want your surgeon to be learned in anatomy. Yet when you vote for a President to lead a great country, you prefer somebody who is ignorant and proud of it, someone you’d enjoy having a drink with, rather than somebody qualified for high office?


pages: 517 words: 155,209

Kingdom of Olives and Ash: Writers Confront the Occupation by Michael Chabon

airport security, banking crisis, Berlin Wall, Boycotts of Israel, call centre, clean water, Donald Trump, facts on the ground, Fellow of the Royal Society, glass ceiling, land tenure, mental accounting, Nelson Mandela, off grid, Right to Buy, Skype, traveling salesman, WikiLeaks

Just minutes later, a few blocks away in her top-floor apartment, Ruti Ben Ezra heard three quick pops. A sinewy woman with jet-black hair and cobalt-blue eyes, she came to Israel in 1977 from Argentina when she was eight years old. Ten years later, she served in the army in Gaza during the first intifada, so she had no doubt that what she heard were gunshots. As she rushed down the stairs to see what had happened, she did a mental accounting of the whereabouts of her five children. Two were still at school, two had gone to play football, and one, Ofek, had just left to visit his grandmother. It was Ofek who came barreling back towards the apartment, screaming. “Mum! Mum! Orlev, Na’or . . . Terrorist!” “Go upstairs! Close the door!” she told him, and ran out into the road towards the shopping area. A terrified Orlev ran to her.


pages: 667 words: 149,811

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

In their own way, and in every way, they personified dignity. NOTES INTRODUCTION 1. 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.


Blueprint: The Evolutionary Origins of a Good Society by Nicholas A. Christakis

agricultural Revolution, Alfred Russel Wallace, Amazon Mechanical Turk, assortative mating, Cass Sunstein, crowdsourcing, David Attenborough, different worldview, disruptive innovation, double helix, epigenetics, experimental economics, experimental subject, invention of agriculture, invention of gunpowder, invention of writing, iterative process, job satisfaction, Joi Ito, joint-stock company, land tenure, Laplace demon, longitudinal study, Mahatma Gandhi, Marc Andreessen, means of production, mental accounting, meta analysis, meta-analysis, microbiome, out of africa, phenotype, Pierre-Simon Laplace, placebo effect, race to the bottom, Ralph Waldo Emerson, replication crisis, Rubik’s Cube, Silicon Valley, social intelligence, social web, stem cell, Steven Pinker, the scientific method, theory of mind, twin studies, ultimatum game, zero-sum game

Was that person really your friend? If the object of one’s assistance becomes permanently disabled, emigrates, or dies, then one’s investment in that person would be lost. But if the problems are temporary—requiring, for example, that you extend a branch to a drowning person while safely standing on the shore—then that person would be a good investment and would make a good friend. A system that allowed a sort of fluid mental accounting for these sorts of exchanges would be very valuable. Evolving the capacity to help others when they need it and when it does not cost much, as well as the capacity to track such connections, would be useful, evolutionarily speaking, for all involved. Tooby and Cosmides argue that, in foraging societies, infection, injuries, food shortages, bad weather, bad luck, and attacks from other groups were constant threats with major evolutionary impact.


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

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

At times, they adjust insufficiently (the conservatism bias), whereas at other times they are overly sensitive to change and alter their expectations more than is justified. Investors are especially likely to overreact to new information that is prominent. Either a single large price change or a sequence of similar changes can induce investors to alter their expectations too much. These price changes can feed on themselves, thus generating price momentum that may lead to a bubble or crash. A judgment error that sometimes contributes to positive feedback is mental accounting. This is the irrational tendency to think about money as if it belonged in separate accounts, which should be treated differently. Gains from prior speculative ventures may be assigned to the hot-action account, whereas money accumulating in the home-equity account is treated with greater conservatism. Rationally, all of an investor’s money, regardless of how it was made or in which asset it is invested, should be treated in the same way.


pages: 1,737 words: 491,616

Rationality: From AI to Zombies by Eliezer Yudkowsky

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

If we’re operating under the assumption that everyone by default is an altruistic akrasic (someone who wishes they could choose to do more)—or at least, that most potential supporters of interest fit this description—then fighting it out over which cause is the best to support may have the effect of decreasing the overall supply of altruism. “But,” you say, “dollars are fungible; a dollar you use for one thing indeed cannot be used for anything else!” To which I reply: But human beings really aren’t expected utility maximizers, as cognitive systems. Dollars come out of different mental accounts, cost different amounts of willpower (the true limiting resource) under different circumstances. People want to spread their donations around as an act of mental accounting to minimize the regret if a single cause fails, and telling someone about an additional cause may increase the total amount they’re willing to help. There are, of course, limits to this principle of benign tolerance. If someone’s pet project is to teach salsa dance, it would be quite a stretch to say they’re working on a worthy sub-task of the great common Neo-Enlightenment project of human progress.


pages: 1,073 words: 314,528

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

“IRRATIONALITY: Rethinking thinking,” The Economist, December 16, 1999, available at http://www.economist.com/node/268946. 14. 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.


pages: 1,351 words: 385,579

The Better Angels of Our Nature: Why Violence Has Declined by Steven Pinker

1960s counterculture, affirmative action, Alan Turing: On Computable Numbers, with an Application to the Entscheidungsproblem, Albert Einstein, availability heuristic, Berlin Wall, Bonfire of the Vanities, British Empire, Broken windows theory, business cycle, California gold rush, Cass Sunstein, citation needed, clean water, cognitive dissonance, colonial rule, Columbine, computer age, conceptual framework, correlation coefficient, correlation does not imply causation, crack epidemic, cuban missile crisis, Daniel Kahneman / Amos Tversky, David Brooks, delayed gratification, demographic transition, desegregation, Doomsday Clock, Douglas Hofstadter, Edward Glaeser, en.wikipedia.org, European colonialism, experimental subject, facts on the ground, failed state, first-past-the-post, Flynn Effect, food miles, Francis Fukuyama: the end of history, fudge factor, full employment, George Santayana, ghettoisation, Gini coefficient, global village, Henri Poincaré, Hobbesian trap, humanitarian revolution, impulse control, income inequality, informal economy, Intergovernmental Panel on Climate Change (IPCC), invention of the printing press, Isaac Newton, lake wobegon effect, libertarian paternalism, long peace, longitudinal study, loss aversion, Marshall McLuhan, mass incarceration, McMansion, means of production, mental accounting, meta analysis, meta-analysis, Mikhail Gorbachev, moral panic, mutually assured destruction, Nelson Mandela, open economy, Peace of Westphalia, Peter Singer: altruism, QWERTY keyboard, race to the bottom, Ralph Waldo Emerson, random walk, Republic of Letters, Richard Thaler, Ronald Reagan, Rosa Parks, Saturday Night Live, security theater, Skype, Slavoj Žižek, South China Sea, Stanford marshmallow experiment, Stanford prison experiment, statistical model, stem cell, Steven Levy, Steven Pinker, The Bell Curve by Richard Herrnstein and Charles Murray, The Wealth of Nations by Adam Smith, theory of mind, transatlantic slave trade, Turing machine, twin studies, ultimatum game, uranium enrichment, Vilfredo Pareto, Walter Mischel, WikiLeaks, women in the workforce, zero-sum game

In fact, most of the residents—ranchers, farmers, insurance adjustors, even lawyers and judges—held beliefs about the applicable laws that were flat wrong. But the residents got along by adhering to a few tacit norms. Cattle owners were always responsible for the damage their animals caused, whether a range was open or closed; but if the damage was minor and sporadic, property owners were expected to “lump it.” People kept rough long-term mental accounts of who owed what, and the debts were settled in kind rather than in cash. (For example, a cattleman whose cow damaged a rancher’s fence might at a later time board one of the rancher’s stray cattle at no charge.) Deadbeats and violators were punished with gossip and with occasional veiled threats or minor vandalism. In chapter 9 we’ll take a closer look at the moral psychology behind such norms, which fall into a category called equality matching.47 As important as tacit norms are, it would be a mistake to think that they obviate a role for government.