Daniel Kahneman / Amos Tversky

198 results back to index


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

I also highly recommend Steven Crist, Betting on Myself: Adventures of a Horseplayer and Publisher (New York: Daily Racing Form Press, 2003). 5 From Robert Rubin’s commencement address, University of Pennsylvania, 1999, http://www.upenn.edu/almanac/v45/n33/speeches99.html. 6 See chapter 5. 7 Sarah Lichenstein, Baruch Fischhoff, and Lawrence D. Phillips, “Calibration of Probabilities,” in Judgment Under Uncertainty: Heuristics and Biases, ed. Daniel Kahneman, Paul Slovic, and Amos Tversky (Cambridge: Cambridge University Press, 1982), 306-34. 8 Peter Schwartz, Inevitable Surprises: Thinking Ahead in a Time of Turbulence (New York: Gotham Books, 2003). 9 Roger Lowenstein, When Genius Failed: The Rise and Fall of Long-Term Capital Management (New York: Random House, 2000); Nassim Nicholas Taleb, The Black Swan: The Impact of the Highly Improbable (New York: Random House, 2007). 10 Daniel Kahneman and Amos Tversky, “Prospect Theory: An Analysis of Decision Under Risk,” Econometrica 47 (1979): 263-91. 11 Nassim Nicholas Taleb, Fooled By Randomness: The Hidden Role of Chance in Markets and in Life (New York: Texere, 2001), 89-90.

Jensen, and Richard Roll, “The Adjustment of Stock Prices to New Information,” International Economic Review 10, no. 1 (February 1969); 1-21. 9 Stefano DellaVigna and Joshua Pollet, “Attention, Demographics, and the Stock Market,” Working Paper, November 23, 2003, http://fisher.osu.edu/fin/dice/seminars/pollet.pdf. 10 See chapter 1. 11 http://www2.cio.com/techpoll/index.cfm. 12 Amos Tversky and Daniel Kahneman, “Extensional Versus Intuitive Reasoning: The Conjunction Fallacy in Probability Judgment,” in Heuristics and Biases: The Psychology of Intuitive Judgment, ed. Thomas Gilovich, Dale Griffin, and Daniel Kahneman (Cambridge: Cambridge University Press, 2002), 19-48. 13 Sanford J. Grossman and Joseph E. Stiglitz, “On the Impossibility of Informationally Efficient Markets,” American Economic Review 70 (1980): 393-408. 18. The Wright Stuff 1 Evolutionary economists Richard Nelson and Sidney Winters echo the same theme.

Thaler, Richard H. The Winner’s Curse: Paradoxes and Anomalies of Economic Life. Princeton, N.J.: Princeton University Press, 1994. Thaler, Richard H., Amos Tversky, Daniel Kahneman, and Alan Schwartz. “The Effect of Myopia and Loss Aversion on Risk Taking: An Experimental Test.” The Quarterly Journal of Economics (May 1997): 647-61. Thorp, Edward O. Beat the Dealer. New York: Vintage Books, 1966. Tilson, Whitney. “Charlie Munger Speaks.” Fool.com. May 15, 2000. http://www.fool.com/boringport/2000/boringport00051500.htm. Treynor, Jack L. “Market Efficiency and the Bean Jar Experiment.” Financial Analysts Journal (May-June 1987): 50-53. Tversky, Amos, and Daniel Kahneman. “Belief in the Law of Small Numbers.” Psychological Bulletin 76 (1971): 105-10. ——. “Extensional Versus Intuitive Reasoning: The Conjunction Fallacy in Probability Judgment.”


pages: 336 words: 113,519

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

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

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

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

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


pages: 519 words: 104,396

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

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

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

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

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


pages: 654 words: 191,864

Thinking, Fast and Slow by Daniel Kahneman

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

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

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

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


pages: 256 words: 60,620

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

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

Evidence from Professional Football,” The Journal of Political Economy 114, no. 2 (2006): 340–365. 21. Daniel Kahneman and Amos Tversky, “Intuitive Prediction: Biases and Corrective Procedures,” in Judgment Under Uncertainty: Heuristics and Biases, ed. Daniel Kahneman, Paul Slovic, and Amos Tversky (Cambridge: Cambridge University Press, 1982), 414–421. For a simplified version, see Lovallo and Kahneman, “Delusions of Success.” 22. Stephen Jay Gould, Full House: The Spread of Excellence from Plato to Darwin (New York: Harmony Books, 1996), 45–56. 23. Chuck Bower and Frank Frigo, “What Was Coach Thinking?” New York Times, February 1, 2009. Chapter 2—Open to Options: How Your Telephone Number Can Influence Your Decisions 1. Steven Schultz, “Freshman Learn About Thinking from Nobel Laureate,” Princeton Weekly Bulletin 94, no. 3 (2004). 2. Amos Tversky and Daniel Kahneman, “Judgment under Uncertainty: Heuristics and Biases,” Science 185, no. 4157 (1974): 1124–1131. 3.

Cambridge: Cambridge University Press, 2004. ___. How We Reason. Oxford: Oxford University Press, 2006. Kahneman, Daniel. “Maps of Bounded Rationality: A Perspective on Intuitive Judgment and Choice.” Nobel Prize Lecture, December 8, 2002. Kahneman, Daniel, and Amos Tversky. “Prospect Theory: An Analysis of Decision Making Under Risk.” Econmetrica 47, no. 2 (1979): 263–291. Kahneman, Daniel, and Amos Tversky. “Intuitive Prediction: Biases and Corrective Procedures.” In Judgment Under Uncertainty: Heuristics and Biases, edited by Daniel Kahneman, Paul Slovic, and Amos Tversky, 414–421. Cambridge: Cambridge University Press, 1982. Kahneman, Danny. “A Short Course in Thinking about Thinking.” Edge.org, 2007. Katz, Elihu, and Paul F. Lazarsfeld. Personal Influence: The Part Played by People in the Flow of Mass Communications.

Recognize, too, there is no lack of commentary about systems that are strongly influenced by chance. As the story of George Steinbrenner made us aware, luck plays an important role in baseball, especially in the short term. Yet baseball announcers analyze the games play-by-play with little awareness that luck explains most of what’s going on. This same principle applies in business and markets. 2. Carefully consider the sample size. Daniel Kahneman and Amos Tversky established that people extrapolate unfounded conclusions from small sample sizes.24 But thinking clearly about sample size is essential for a few reasons. The more that luck contributes to the outcomes you observe, the larger the sample you will need to distinguish between skill and luck. Baseball is a good example. Over a 162-game season, chances are good the best teams will rise to the surface.


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

Bet on a Fortune Cookie,” New York Times, May 11, 2005; and Michelle Garcia, “Fortune Cookie Has Got Their Numbers,” Washington Post, May 12, 2005. 2. Gary Belsky, “A Checkered Career: Marion Tinsley Hasn't Met a Man or Machine That Can Beat Him at His Game,” Sports Illustrated, December 28, 1992. 3. Jonathan Schaeffer, “Marion Tinsley: Human Perfection at Checkers?” Games of No Chance 26 (1996): 115–118. 4. Shlomo Maital, “Daniel Kahneman, Nobel Laureate 2002: A Brief Comment,” SABE Newsletter 10, no. 2 (Autumn 2002): 2. 5. Daniel Kahneman and Amos Tversky, “On the Psychology of Prediction,” Psychological Review 80, no. 4 (July 1973): 237–251. 6. Stanley Lieberson, “Modeling Social Processes: Some Lessons from Sports,” Sociological Forum 12, no. 1 (March 1997): 11–35. 7. Strictly speaking, sabermetrics is the study of baseball through the use of statistics, and a sabermetrician focuses only on that sport.

Scott Patterson, “Old Pros Size Up the Game,” Wall Street Journal, March 22, 2008. 31. For a good summary of the heuristics and biases research, see Max H. Bazerman and Don Moore, Judgment in Managerial Decision Making, 7th ed. (Hoboken, NJ: John Wiley & Sons, 2009), 13–41. 32. Kahneman, Thinking, Fast and Slow, 278–288; and Daniel Kahneman and Amos Tversky, eds., Choices, Values, and Frames (Cambridge, UK: Cambridge University Press, 2000). 33. Eldar Shafir, Peter Diamond, and Amos Tversky, “Money Illusion,” Quarterly Journal of Economics 112, no. 2 (May 1997): 341–374. 34. Hersh Shefrin and Meir Statman, “The Disposition to Sell Winners Too Early and Ride Losers Too Long: Theory and Evidence,” Journal of Finance 40, no. 3 (July 1985): 777–790; and Terrance Odean, “Are Investors Reluctant to Realize Their Losses?”

The purpose of this book is to show you how you can understand the relative contributions of skill and luck and how to use that understanding in interpreting past results as well as making better decisions in the future. Ultimately, untangling skill and luck helps with the challenging task of prediction, and better predictions lead to greater success. Skill, Luck, and Prediction Shortly after winning the Nobel Prize in Economics in 2002, Daniel Kahneman, a retired professor of psychology at Princeton, was asked which of his 130-plus academic papers was his all-time favorite.4 He chose “On the Psychology of Prediction,” a paper he cowrote with the late Amos Tversky that was published in Psychological Review in 1973. The paper argues that intuitive judgments are often unreliable because people base predictions on how well an event seems to fit a story. They fail to consider either how reliable the story is or what happened before in similar situations.


pages: 317 words: 100,414

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

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

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

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

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


pages: 461 words: 128,421

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

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

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

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

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


pages: 542 words: 132,010

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

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

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

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

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


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

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

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

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

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


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

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

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

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

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


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

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

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

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

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


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

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

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

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

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


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

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

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

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

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


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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

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

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

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


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

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

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

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

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


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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

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

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

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


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

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

For example, when people are asked to state within which of a number of ranges their income falls, their answers are influenced by the ranges given. The ranges serve as “anchors” to which they make their answers conform. Psychologists have shown that people’s decisions in ambiguous situations are influenced by whatever available anchor is at hand. When you must come up with an estimate, and you are unsure what to say, you take whatever number is before you. Psychologists Amos Tversky and Daniel Kahneman demonstrated this tendency clearly in an experiment involving a wheel of fortune: a large wheel with the numbers from 1 to 100 on it, similar to those used in television game shows, that is designed to stop at a random number when it is spun. Subjects were asked questions whose answers were numbers between 1 and 100, difficult questions such as the percentage of African nations in the United Nations.

Chapter Seven Psychological Anchors for the Market 1. For a more comprehensive recent survey of the role of psychology in finance, see Hersh Shefrin, Beyond Greed and Fear: Understanding Behavioral Finance and the Psychology of Investing (Boston: Harvard Business School Press, 2000); or Andrei Shleifer, Inefficient Markets: An Introduction to Behavioral Finance (Oxford: Oxford University Press, 2000). 2. See Amos Tversky and Daniel Kahneman, “Judgment under Uncertainty: Heuristics and Biases,” Science, 185 (1974): 1124–31. 3. See Robert J. Shiller, “Comovements in Stock Prices and Comovements in Dividends,” Journal of Finance, 44 (1989): 719–29. 4. See Steven L. Heston and K. Geert Rouwenhorst, “Does Industrial Structure Explain the Benefits of International Diversification?” Journal of Financial Economics, 36 (1994): 3–27; John M.

“The Great Crash and the Onset of the Great Depression.” Quarterly Journal of Economics, 105 (1990): 597–624. Romer, David. Advanced Macroeconomics. New York: McGraw-Hill, 1996. Schäfer, Bodo. Der Weg zur finanziellen Freiheit: In sieben Jahren die erste Million. Frankfurt: Campus Verlag, 1999. Shafir, Eldar, Peter Diamond, and Amos Tversky. “Money Illusion.” Quarterly Journal of Economics, 112(2) (1997): 341–74. Shafir, Eldar, Itamar Simonson, and Amos Tversky. “Reason-Based Choice.” Cognition, 49 (1993): 11–36. Shafir, Eldar, and Amos Tversky. “Thinking through Uncertainty: Nonconsequential Reasoning and Choice.” Cognitive Psychology, 24 (1992): 449–74. Sharpe, Steven. “Stock Prices, Expected Returns and Inflation.” Unpublished paper, Board of Governors of the Federal Reserve System, Washington, D.C., 1999. Shefrin, Hersh. Beyond Greed and Fear: Understanding Behavioral Finance and the Psychology of Investing.


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

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

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

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

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


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

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

The world is telling us that the price of a soda is about a dollar, so we pay that price. Once we’ve purchased a can of soda for a dollar, that decision stays with us and influences how we determine its value from that point forward. We have married a monetary amount with a product, for better or worse, till death—or shaken can of soda—do us part. Anchoring’s impact was originally demonstrated by Amos Tversky and Daniel Kahneman in a 1974 experiment regarding the United Nations.2 They had a group of college students spin a wheel that, because it was rigged, landed on either 10 or 65. They then asked the students two questions: 1.Is the percentage of African nations in the UN higher or lower than 10 or 65 (whichever number the wheel had landed on)? 2.What is the percentage of African nations in the UN? For those students whose first question was whether the African nations were higher or lower than 10, the average answer to question 2 was 25 percent.

How long will it be until advertisers use technology to put images of us into the ads we see? That will be us, on the beach, drinking that cerveza with those unemployed twenty-year-olds. We just hope they include either virtual weight loss or a virtual appreciation for “Dad bod,” too. IT’S IN THE WAY THAT YOU LOSE IT The endowment effect is deeply connected to LOSS AVERSION. The principle of loss aversion, first proposed by Daniel Kahneman and Amos Tversky,6 holds that we value gains and losses differently. We feel the pain of losses more strongly than we do the same magnitude of pleasure. And it’s not just a small difference—it’s about twice as much. In other words, we feel the pain of losing $10 about twice as strongly as we do the pleasure of winning $10. Or, if we tried to make the emotional impact the same, it would take winning $20 to counteract the feeling of losing $10.

Uri Gneezy (UC San Diego), Ernan Haruvy (UT Dallas), and Hadas Yafe (Israel Institute of Technology), “The Inefficiency of Splitting the Bill,” Economic Journal 114, no. 495 (2004): 265–280. CHAPTER 7: WE TRUST OURSELVES 1. Gregory B. Northcraft (University of Arizona) and Margaret A. Neale (University of Arizona), “Experts, Amateurs, and Real Estate: An Anchoring-and-Adjustment Perspective on Property Pricing Decisions,” Organizational Behavior and Human Decision Processes 39, no. 1 (1987): 84–97. 2. Amos Tversky (Hebrew University) and Daniel Kahneman (Hebrew University), “Judgment under Uncertainty: Heuristics and Biases,” Science 185 (1974): 1124–1131. 3. Joseph P. Simmons (Yale), Robyn A. LeBoeuf (University of Florida), and Leif D. Nelson, (UC Berkeley), “The Effect of Accuracy Motivation on Anchoring and Adjustment: Do People Adjust from Provided Anchors?” Journal of Personality and Social Psychology 99, no. 6 (2010): 917–932. 4.


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Mindware: Tools for Smart Thinking by Richard E. Nisbett

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

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

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

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


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

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

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

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


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How to Predict the Unpredictable by William Poundstone

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

The odds remain the same, stacked against the player. By this point you may be confused. It sounds like I’m saying that people believe that random winning streaks will continue … except when they believe the complete opposite. The gambler’s fallacy and the hot hand theory are really two sides of the same coin. Both are consequences of the “law of small numbers.” That is a semifacetious rule proposed in 1971 by Amos Tversky and Daniel Kahneman. It runs, People’s intuitions about random sampling appear to satisfy the law of small numbers, which asserts that the law of large numbers applies to small numbers as well. To understand the point, and the verbal wit, you need to know what the “law of large numbers” is. It’s one of the most fundamental rules of probability. When I toss a fair coin a few times, I don’t necessarily get an even split of heads and tails.

Recap: How to Outguess Ponzi Schemes • Financial schemers may fabricate and manipulate data. Be suspicious when too many numbers just top a psychologically significant threshold. • A last-two-digits test can help detect fraudulent managers who unconsciously favor certain digit pairs. See notes on this chapter Part Two The Hot Hand Theory Thirteen In the Zone Basketball was an obsession of 5'9" Israeli-American psychologist Amos Tversky. He watched the game as a fan, and he played it with friends, aggressively. “He was a rough player,” Tversky’s wife, Barbara, told me. “He came home from a basketball game wounded. I said, ‘Basketball is not a contact sport!’” As a fan, Tversky was aware of the hot hand theory. This is a belief in winning streaks, widespread among basketball players, coaches, commentators, and fans. But not just any winning streaks: predictive winning streaks.

Washington Post, May 12, 2005. Gardner, Martin (1975). Mathematical Carnival. New York: Knopf. Geoghegan, Bernard Dionysius (2011). “From Information Theory to French Theory: Jakobson, Lévi-Strauss, and the Cybernetic Apparatus.” Critical Inquiry 38, 96–126. Gilovich, Thomas (1993). How We Know What Isn’t So: The Fallibility of Human Reason in Everyday Life. New York: Free Press. Gilovich, Thomas, Robert Vallone, and Amos Tversky (1985). “The Hot Hand in Basketball: On the Misperception of Random Sequences.” Cognitive Psychology 17, 295–314. Gladstone, Beth Pinsker (2012). “Abandon online shopping cart, reap discount?” Reuters, Jun. 7, 2012. Golden, Daniel (2009). “Cash Me If You Can.” Portfolio.com, Mar. 18, 2009. Goodfellow, Louis D. (1992). “A Psychological Interpretation of the Results of the Zenith Radio Experiments in Telepathy.”


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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

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

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

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


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

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

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

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

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


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The Irrational Bundle by Dan Ariely

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

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

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

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


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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

This exercise is one of many examples of how people behave in ways that confound the traditional equity theorists. In fact, the quaint notion that people will behave in ways that are predictable and observable ignores what 2002 Nobel Prize winner in Economics Dr. Daniel Kahneman calls “the human agent.” In an interview I conducted with Dr. Kahneman in 2004, this pioneer in behavioral finance told me about how his discipline doesn’t assume perfect rationality, which is why perceptual bias, complexity, and emotions like pride and anger, illustrated in our exercise, can overshadow sound financial decisions. For example, research from Dr. Kahneman and Dr. Amos Tversky showed that investors are more sensitive to decreases in the value of their portfolio than to increases in value.41 Even in good times, many investors tend to suffer from what experts refer to as “myopic loss aversion”—a basic tenet from the field of behavioral finance, which holds that people psychologically weigh losses twice as heavily as gains.

The result is that they end up working much shorter hours on the very lucrative rainy days, when everyone is looking for a cab, and giving up the opportunity to earn much more money. Conversely, when a cabbie works much longer hours on sunny days when cabs are plentiful, he gives up the opportunity to do something that may be more profitable or enjoyable than trying to meet the $200 threshold he’s set for himself driving the cab. “Opportunity costs,” according to Daniel Kahneman, Amos Tversky and Richard Thaler, “typically receive much less weight than out-of-pocket costs.”9 It’s conceivable that if the cab driver were to maximize the opportunity to earn money when the weather was bad, he’d easily earn an average of $200 a day. When investors try to calculate the returns on their portfolios, they often don’t bother to use calculators. Instead, they will eyeball the returns or rely on their memories.

November 17, 2009. 31 The Heritage Foundation, “The Obama Budget: Spending, Taxes, and Doubling the National Debt,” March 16, 2009. 32 Reuters, “Obama seeks estate tax hike,” May 11, 2009. 33 The Heritage Foundation, “The Obama Budget: Spending, Taxes, and Doubling the National Debt,” March 16, 2009. 34 Center on Budget and Policy Priorities, “Tax Measures Help Balance State Budgets: A Common and Reasonable Response to Shortfalls,” July 9, 2009. 35 TheTrumpet.com, “California Budget Crisis About to Affect People’s Everyday Lives,” January 21, 2009. 36 Los Angeles Times, “California faces financial meltdown as debt grows by $1.7m an hour,” December 12, 2008. 37 The Dallas Morning News, “In bad economy, many Californians packing up and leaving,” January 11, 2009. 38 National Coalition on Healthcare, “Insurance: Issue Areas,” 2009. 39 Center on Budget and Policy Priorities, “Poverty Rose, Median Income Declined, and Job-Based Health Insurance Continued to Weaken in 2008; Recession Likely to Expand Ranks of Poor and Uninsured in 2009 and 2010,” September 10, 2009. 40 The Pew Charitable Trusts, Financial Report: Entitlement Programs Underfunded by Trillions, December 16, 2008. 41 Kahneman, Daniel, and Amos Tversky, “Prospect Theory: An Analysis of Decision Under Risk,” Econometrica, Vol. 47, No. 2 (March 1979), pp. 263–292. 42 USA Today, “Is this the next baby boom?” July 16, 2008. 1. Great Expectations MONELERIOUS: [mun-ih-lair-ee-uhs] The state of being wildly incorrect in one’s thinking about any given money matter. Investors were monelerious before the Meltdown of 2008, convinced their home values would double in five years.


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

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

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

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

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


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Licence to be Bad by Jonathan Aldred

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

It becomes boring – and there is no point in cheating if you are just cheating yourself. THE WEIRD WORLD OF NUDGE A widely discussed development in economics in recent years has been the emergence of behavioural economics. In essence, behavioural economics tries to study how people actually behave – in contrast to fantasies such as homo economicus which dominate orthodox economics. It uses ideas and methods from psychology, and it was two psychologists, Daniel Kahneman and Amos Tversky, who perhaps did more than anyone else to dislodge old orthodoxies in economics about how we think and choose. One big idea in behavioural economics began with Kahneman and Tversky’s Asian disease problem: Suppose you are told that an unusual Asian disease is expected to kill 600 people in your country. Two alternative policies to combat the disease have been proposed. If Policy A is adopted, 200 people will be saved.

Understanding the future as a narrative evolving from the present is not just a way of literally ‘making sense’ of uncertainty, replacing doubt with explanation. It is cognitively easier too. The novelist E. M. Forster famously contrasted a simple succession of facts – ‘The king died and then the queen died’ – with a plot: ‘The king died, and then the queen died of grief.’ There is more information in this plot, yet it is no harder to remember: it is cognitively more efficient.16 However, there is a catch. Daniel Kahneman and Amos Tversky provided the first clear evidence. The Linda Problem remains one of their most famous experiments: Linda is thirty-one years old, single, outspoken, and very bright. She majored in philosophy. As a student, she was deeply concerned with issues of discrimination and social justice, and also participated in anti-nuclear demonstrations. Which is more probable? 1. Linda is a bank teller. 2.

But the critics seem not to have noticed that the rest of us have an active role here too. If economics needs deflating to a more humble and modest position in our culture, then we need not wait for economists to let the air out. Ultimately, we have the power to put economics back in its proper place. We should not delay. Further Reading At the end of his superb account of the collaboration between Daniel Kahneman and Amos Tversky, The Undoing Project, Michael Lewis provides a note on sources. But he warns the reader that when researchers write papers for publication in academic journals, they ‘aren’t trying to engage their readers, much less give them pleasure. They’re trying to survive them.’ In other words, most academic journal papers in fields such as economics don’t try to enter into dialogue with their readers.


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

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

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

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

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


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

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

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

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

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


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

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

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

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

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


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

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

Tren Griffin, Charlie Munger: The Complete Investor (New York: Columbia University Press, 2015). 20. Dale Griffin and Amos Tversky, “The Weighing of Evidence and the Determinants of Confidence,” Cognitive Psychology 24 (1992): 411–435. 21. Anthony Bianco, “The Warren Buffett You Don't Know,” Bloomberg.com, July 5, 1999. 22. Warren Buffett, 1999 Berkshire Hathaway annual letter, March 1, 2000. 23. Warren Buffett, 2000 Berkshire Hathaway annual letter, February 28, 2001. 24. Warren Buffett, 2014 Berkshire Hathaway annual letter, February 25, 2015. CHAPTER 9 Bill Ackman Get Of Your Soapbox Our satisfaction with our views of the world is part of our self esteem and personal identity. —Robert Shiller I once saw the Nobel Prize–winning psychologist Daniel Kahneman say, “Ideas are part of who we are. They become like possessions. Especially publicly.

Finally, and of paramount importance, Harold and Peter can be sure that they will get to run their business – an activity they dearly love – exactly as they did before the merger. At Berkshire, we do not tell .400 hitters how to swing. In Charlie Munger: The Complete Investor, Tren Griffin writes, “In doing their due‐diligence analysis for Dexter Shoes, Buffett and Munger made the mistake of not making sure the business had a moat and being too focused on what they thought was an attractive purchase price.”19 Psychologists Dale Griffin and Amos Tversky wrote, “Intuitive judgments are overly influenced by the degree to which the available evidence is representative of the hypothesis in question.”20 The evidence Buffett had available, other than Dexter's financials and the proposed purchase price, was the success he experienced less than two years earlier with his purchase of H. H. Brown. Buffett did what every person on earth does, he reached for whatever was easiest to remember in deciding whether or not to do something; in the case of buying Dexter's shoes, it was the success of purchasing H.

“It is quite possible to decide by inspection that a woman is old enough to vote without knowing her age or that a man is heavier than he should be without knowing his exact weight.”9 Graham was far ahead of his time, writing about behavioral economics, the study of how psychology affects financial decision making, long before the term even existed. Security Analysis was published the same year that Nobel laureate Daniel Kahneman, who took this field mainstream, was born. Graham identified some of the cognitive and emotional biases that caused investors to send a strong company diving 50% in 12 months. He examined the case of General Electric, which the stock market valued at $1.87 billion in 1937 and $784 million just one year later. Graham summarized it this way: Certainly nothing had happened within twelve months' time to destroy more than half the value of this powerful enterprise, nor did investors even pretend to claim that the falling off in earnings from 1937 to 1938 had any permanent significance for the future of the company.


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

Although these questions have always been central to understanding the way investors behave and how their responses affect the performance of financial markets, no one made any systematic effort to provide the answers until the mid-1960s. The most significant and inf luential effort to approach these problems, a field of study that has come to be known as Behavioral Finance, began to take shape quite by accident when two junior psychology professors at Hebrew University in Jerusalem, Daniel Kahneman and Amos Tversky, happened to compare notes one day about their work and their life experiences. The hugely productive result of their friendship and subsequent collaboration has created a competing vision to the rational model of how people make choices and reach decisions under conditions of uncertainty.* The essence of this work is the study of man—of human behavior. As Kahneman and Tversky wrote in 1992: “Theories of choice are at best approximate and incomplete. . . .

“Maps of Bounded Rationality: Psychology for Behavioral Economics,” American Economic Review, Vol. 93, No. 5 ( Fall), pp. 1449–1475. Kahneman, Daniel, Harry Markowitz, Robert C. Merton, Myron Scholes, Bill Sharpe, and Peter Bernstein, 2005. “Most Nobel Minds,” CFA Magazine, November-December, pp. 36–43. Kahneman, Daniel, Paul Slovic, and Amos Tversky, 1974. “Judgment Under Uncertainty,” Science, Vol. 185, pp. 1124 –1131. Kahneman, Daniel, Paul Slovic, and Amos Tversky, 1982. Judgment Under Uncertainty: Heuristics and Biases, New York: Cambridge University Press. Kahneman, Daniel, and Tversky, Amos, 1979. “Prospect Theory,” Econometrica, Vol. 47, No. 2 (March). Kim, E. Han, Adair Morse, and Luigi Zingales, 2006. “What Has Mattered to Economics Since 1970?” Journal of Economic Perspectives, Vol. 20, No. 4 ( Fall), pp. 189–202.

“Gambling with the House Money and Trying to Break Even: The Effects of Prior Outcomes on Risky Choice,” Management Science, Vol. 36, No. 6 ( June), pp. 643– 660. Thaler, Richard, Daniel Kahneman, and J. L. Knetsch, 1992. “The Endowment Effect, Loss Aversion and Status Quo Bias,” in Richard Thaler, The Winner ’s Curse, Princeton, NJ: Princeton University Press. Temin, Peter, and Hans-Joachim Voth, 2003. “Riding the South Sea Bubble,” MIT Economics Department Working Paper No. 04-02 ( December). Treynor, Jack, 1961. “Toward a Theory of Market Value of Risky Assets.” Unpublished manuscript. Treynor, Jack, and Fischer Black, 1973. “How to Use Security Analysis to Improve Portfolio Selection,” Journal of Business, Vol. 46, pp. 66–73. Tversky, Amos, and Daniel Kahneman, 1992. “Advances in Prospect Theory: Cumulative Representation of Uncertainty,” Journal of Risk and Uncertainty, Vol. 5, No. 4, pp. 297–323.


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Rationality: From AI to Zombies by Eliezer Yudkowsky

Albert Einstein, Alfred Russel Wallace, anthropic principle, anti-pattern, anti-work, Arthur Eddington, artificial general intelligence, availability heuristic, Bayesian statistics, Berlin Wall, Build a better mousetrap, Cass Sunstein, cellular automata, cognitive bias, cognitive dissonance, correlation does not imply causation, cosmological constant, creative destruction, Daniel Kahneman / Amos Tversky, dematerialisation, 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

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

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

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


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

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

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

This way, they were able to gain the potential custom of people who had previously avoided the product because of its artificiality, without creating an imagined taste change among its regular customers, who suddenly discovered they had been eating the healthier variant all along.* 6.9: The Focusing Illusion Attention affects our thoughts and actions far more than we realise. Daniel Kahneman, along with Amos Tversky, is one of the fathers of behavioural economics; ‘the focusing illusion’, as he calls it, causes us to vastly overestimate the significance of anything to which our attention is drawn. As he explains: ‘Nothing is as important as we think it is while we are thinking about it. Marketers exploit the focusing illusion. When people are induced to believe that they “must have” a good, they greatly exaggerate the difference that this good might make to the quality of their life.

For this reason, I have called consumer capitalism ‘the Galapagos Islands for understanding human motivation’; like the beaks of finches, the anomalies are small-but-revealing. Just as dog breeders and pigeon fanciers understood the principles of natural selection before Darwin codified them, many people involved in selling things have an instinctive grasp of the difference between what people say and what they do. When he won a MacArthur Foundation fellowship in 1984, Amos Tversky said of his work as a cognitive psychologist, ‘What we do is take what is already instinctively known by used-car salesmen and advertising executives, and we examine them in a scientific way.’ We do not have a similar mechanism for politics, or for areas where there is no mechanism for distinguishing unconscious feelings from post-rationalised beliefs. To me, this is the greatest cause for optimism: if we can honestly acknowledge the gulf between our unconscious emotional motivations and our post-rationalisations, many political disagreements may be easier to solve.


Virtual Competition by Ariel Ezrachi, Maurice E. Stucke

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

Ismat Sarah Mangla, “3 Tricks to Help You Snag the Best Deals Online,” Time, September 8, 2014, http://time.com/money/3136612/dynamic-pricing -amazon-best-buy-walmart/. 50. Daniel Kahneman and Amos Tversky, “Prospect Theory: An Analysis of Decision under Risk,” Econometrica 47 (1979): 263; U.K. Office of Fair Trading, Consumer Behavioural Biases in Competition: A Survey, Final Report, OFT1324 (May 2011), 3.10–3.201.11. 51. E. Vis and J. Toth, “ The Abolition of the No-Discrimination Rule,” (Amsterdam: ITM Research, March 2000), 7–10, http://www.creditslips.org/fi les /netherlands-no-discrimination-rule-study.pdf. Notes to Pages 111–115 293 52. Daniel Kahneman, Jack L. Knetsch, and Richard H. Thaler, “Fairness as a Constraint on Profit Seeking: Entitlements in the Market,” in Advances in Behavioral Economics, Colin F.

Federal Trade Commission, Data Brokers: A Call for Transparency and Accountability (Washington, DC: Federal Trade Commission, May 2014), 19–20, https://www.ftc.gov/system/fi les/documents/reports/data-brokers-call -transparency-accountability-report-federal-trade-commission-may-2014 /140527databrokerreport.pdf. 14. Lifehack Quotes, http://quotes.lifehack.org/edward-norton/we-buy-things -we-dont-need-with/. 15. Karen Freeman, “Amos Tversky, Expert on Decision Making, Is Dead at 59,” New York Times, June 6, 1996, http://www.nytimes.com/1996/06/06/us/amos -tversky-expert-on-decision-making-is-dead-at-59.html. 16. Ned Welch, “A Marketer’s Guide to Behavioral Economics,” McKinsey Quarterly, February 2010, http://www.mckinsey.com/insights/marketing _ sales/a _marketers _ guide _to_behavioral _economics. 17. Robert B. Cialdini, Influence: The Psychology of Persuasion (New York: HarperBusiness, 2007). 18.

It is also about getting us to buy things that we may not need or have previously wanted. One popu lar Internet quote is “We buy things we don’t need with money we don’t have to impress people we don’t like.”14 So to increase demand for their products and ser vices, companies will likely appeal to our emotional wants. As noted earlier, most of us are not rational, self-interested individuals with willpower. The field of behavioral economics, as one of its pioneers, Amos Tversky, noted, has quantified what every good advertiser and car salesman already knew.15 We have cognitive biases, which refer to our tendency to react, think, or operate in a certain way, which diverge from assumed rationality. Biases can be observed. But businesses and governments can trigger consumers’ biases to achieve certain goals.16 As noted by Cialdini, factors such as relative pricing, reciprocity, and the illusion of scarcity play a powerful role in the persuasion game.17 One competition authority official told us in 2015 that the behavioral economics literature identifies over one hundred human biases linked to decision making, information processing, memory, and social interaction.


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

Notes 27 Nathaniel Branden, The Psychology of Self-Esteem: A Revolutionary Approach to Self-Understanding that Launched a New Era in Modern Psychology (Jossey-Bass, 2001). 28 Daniel Crosby, You’re Not That Great (Word Association Publishers, 2012). 29 Dan Gilbert, ‘The surprising science of happiness’ TED Talk (February 2004). 30 Ibid. 31 Lee Ross and Craig Anderson, ‘Shortcomings in the attribution process: On the origins and maintenance of erroneous social assessments,’ in Daniel Kahneman, Paul Slovic and Amos Tversky (eds.), Judgment Under Uncertainty: Heuristics and Biases (Cambridge University Press, 1982), pp. 129–152. 32 2014 NTSB US Civil Aviation Acccident Statistics. 33 Gerd Gigerenzer, Risk Savvy: How to Make Good Decisions (Penguin, 2015). 34 Justin Kruger and David Dunning, ‘Unskilled and unaware of it: How difficulties in recognizing one’s own incompetence lead to inflated self-assessments,’ Journal of Personality and Social Psychology 77:6 (1999), pp. 1121–34.

No matter what exotic economic measures professors and pundits may dream up in the future, there will always be some that show some fleeting correlation with stock returns, but fail to pass the sniff test of “Should it matter when determining whether or not to become partial owner of a business?” The coming wave of big data seems just as likely to yield a ton of false positives as it is any great new insights about the way markets behave. Too much of a good thing Daniel Kahneman and Amos Tversky’s ‘Linda the Bank Teller’ study provides yet another powerful example of how more information is not always better. The two researchers set out to prove something that they had observed empirically – that emotional signals can overwhelm probability. We now refer to this as base rate fallacy. The two men posed the question: Linda is 31-years-old, single, outspoken and very bright.

As opposed to the American mantra of “If you’ve got it, flaunt it,” the Swiss take an “If you’ve got it, hide it” approach so as not to provoke envy in others. The Swiss model demonstrates that our views are an outcropping of a specific way of viewing wealth rather than something deterministic about human nature. We are not our worst impulses and it is up to us to determine to support each other on the way to balance and true happiness, rather than prodding each other toward jealousy and excess. How much is enough? Daniel Kahneman helmed a Princeton study set out to answer the age-old question, “Can money buy happiness?” Their answer? Sort of. Researchers found that making little money did not cause sadness in and of itself, but it did tend to heighten and exacerbate existing worries. For instance, among people who were divorced, 51% of those who made less than $1,000/month reported having felt sad or stressed the previous day, whereas that number fell to 24% among those earning more than $3,000/month.


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The Great Mental Models: General Thinking Concepts by Shane Parrish

Albert Einstein, Atul Gawande, Barry Marshall: ulcers, bitcoin, Black Swan, colonial rule, correlation coefficient, correlation does not imply causation, cuban missile crisis, Daniel Kahneman / Amos Tversky, dark matter, delayed gratification, feminist movement, index fund, Isaac Newton, Jane Jacobs, mandelbrot fractal, Pierre-Simon Laplace, Ponzi scheme, Richard Feynman, statistical model, stem cell, The Death and Life of Great American Cities, the map is not the territory, the scientific method, Thomas Bayes, Torches of Freedom

We know now that the future is inherently unpredictable because not all variables can be known and even the smallest error imaginable in our data very quickly throws off our predictions. The best we can do is estimate the future by generating realistic, useful probabilities. So how do we do that? Probability is everywhere, down to the very bones of the world. The probabilistic machinery in our minds—the cut-to-the-quick heuristics made so famous by the psychologists Daniel Kahneman and Amos Tversky—was evolved by the human species in a time before computers, factories, traffic, middle managers, and the stock market. It served us in a time when human life was about survival, and still serves us well in that capacity.2 But what about today—a time when, for most of us, survival is not so much the issue? We want to thrive. We want to compete, and win. Mostly, we want to make good decisions in complex social systems that were not part of the world in which our brains evolved their (quite rational) heuristics.

In order for someone to deliberately get in your way they have to notice you, gauge the speed of your car, consider where you are headed, and swerve in at exactly the right time to cause you to slam on the brakes, yet not cause an accident. That is some effort. The simpler and thus more likely explanation is that they didn’t see you. It was a mistake. There was no intent. So why would you assume the former? Why do our minds make these kinds of connections when the logic says otherwise? The famous Linda problem, demonstrated by the psychologists Daniel Kahneman2 and Amos Tversky in a 1982 paper, is an illuminating example of how our minds work and why we need Hanlon’s Razor. It went like this: Linda is 31 years old, single, outspoken, and very bright. She majored in philosophy. As a student, she was deeply concerned with issues of discrimination and social justice, and also participated in anti-nuclear demonstrations. Which is more probable? Linda is a bank teller.

Causation Whenever correlation is imperfect, extremes will soften over time. The best will always appear to get worse and the worst will appear to get better, regardless of any additional action. This is called regression to the mean, and it means we have to be extra careful when diagnosing causation. This is something that the general media and sometimes even trained scientists fail to recognize. Consider the example Daniel Kahneman gives in Thinking Fast and Slow:5 Depressed children treated with an energy drink improve significantly over a three-month period. I made up this newspaper headline, but the fact it reports is true: if you treated a group of depressed children for some time with an energy drink, they would show a clinically significant improvement. It is also the case that depressed children who spend some time standing on their head or hug a cat for twenty minutes a day will also show improvement.


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

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

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

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


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This Could Be Our Future: A Manifesto for a More Generous World by Yancey Strickler

basic income, big-box store, Capital in the Twenty-First Century by Thomas Piketty, Cass Sunstein, cognitive dissonance, corporate governance, Daniel Kahneman / Amos Tversky, David Graeber, Donald Trump, Doomsday Clock, effective altruism, Elon Musk, financial independence, gender pay gap, global supply chain, housing crisis, Ignaz Semmelweis: hand washing, invention of the printing press, invisible hand, Jeff Bezos, job automation, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Nash: game theory, Joi Ito, Joseph Schumpeter, Kickstarter, Louis Pasteur, Mark Zuckerberg, medical bankruptcy, new economy, Oculus Rift, off grid, offshore financial centre, Ralph Nader, RAND corporation, Richard Thaler, Ronald Reagan, self-driving car, shareholder value, Silicon Valley, Simon Kuznets, Snapchat, Social Responsibility of Business Is to Increase Its Profits, stem cell, Steve Jobs, The Wealth of Nations by Adam Smith, Thomas Kuhn: the structure of scientific revolutions, Travis Kalanick, universal basic income, white flight

If only it were as concrete as Jim Carrey touching the wall in The Truman Show. But it isn’t. Hidden defaults are deeply a part of us. They’re the customs, traditions, and social codes that form our tribes and nations. The rituals around births, weddings, and death. Why we wear one color and not another. They’re the narratives that we live within. The currents that pull us through life that are easy to miss. Behavioral economists Daniel Kahneman, Amos Tversky, Dan Ariely, Iris Bohnet, and others have demonstrated how susceptible we are to influence. Our choices are easily manipulated, especially when we’re not conscious it’s happening. This is the space where hidden defaults live. Kahneman and Tversky showed this with research on anchoring and bias—how the presence of a single word or irrelevant but memorable piece of information will shift our behavior.

keep getting spammed: Data on email unsubscribe rates comes from the email services provider MailChimp (“Email Marketing Benchmarks,” March 2018, https://mailchimp.com/resources/email-marketing-benchmarks). approval rate layered on top: Data on congressional approval ratings and reelection rates comes from the Center for Responsive Politics. “What’s water?”: The David Foster Wallace story is paraphrased from a commencement address he gave at Kenyon College called “This Is Water.” shift our behavior: Daniel Kahneman and Amos Tversky’s work is collected in the book Thinking, Fast and Slow. how we think: Dan Ariely writes about our emotions’ effect on our choices in his 2008 book Predictably Irrational: The Hidden Forces That Shape Our Decisions. 62 percent of personal bankruptcies: 62 percent of American bankruptcies are caused by medical bills according to a 2009 report published in the American Journal of Medicine (“Medical Bankruptcy in the United States, 2007: Results of a National Study” by David U.

But in the modern world, the need for financial security is as fundamental as the need for physical safety. This means money is very important. But in Maslow’s hierarchy, money is also quite “low” on the list. Though some people use money as a proxy for self-esteem, money is not a higher value on its own. It is, however, a necessary foundation for the pursuit of higher values. A 2010 study by the Nobel Prize–winning behavioral economist Daniel Kahneman sheds interesting light on this idea. Kahneman found a “statistically significant and quantitatively important” correlation between emotional well-being and income. The more money someone made, his research discovered, the happier the person was. But this was true only up to a point. The research found that up until a salary of $75,000 this was the case. But once someone made more than that, the impact of more money on their emotional well-being was much smaller.


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Critical: Science and Stories From the Brink of Human Life by Matt Morgan

agricultural Revolution, Atul Gawande, biofilm, Black Swan, Checklist Manifesto, cognitive dissonance, crew resource management, Daniel Kahneman / Amos Tversky, David Strachan, discovery of penicillin, en.wikipedia.org, hygiene hypothesis, job satisfaction, John Snow's cholera map, meta analysis, meta-analysis, personalized medicine, publication bias, randomized controlled trial, Silicon Valley, stem cell, Steve Jobs

They wouldn’t open again for two weeks. As I approached Joe’s bed in the white light of intensive care, there were all the telltale signs of what had happened. The book Blink by my hero, Malcolm Gladwell, beautifully describes the human brain’s immense ability to make accurate judgements from tiny snippets of information. (This was based on the work of Nobel Prize winner Daniel Kahneman and his late colleague Amos Tversky.) From simply a brief glance towards Joe’s bed, his problems were clear. Firstly, I could see the white propofol syringe slowly injecting its payload to keep him deeply unconscious. Next, I could see the ventilator fighting hard to keep Joe’s carbon dioxide levels just right. The bank of flashing monitors included a characteristic wavy line with two distinct peaks representing the pressure inside Joe’s head.

., Bell, M., Cook, T. M., Grocott, M. P. W. & Moonesinghe, S. R. Patient reported outcome of adult perioperative anaesthesia in the United Kingdom: a cross-sectional observational study. British Journal of Anaesthesia 117, 758–766r (2016). ‘The book Blink by my hero, Malcolm Gladwell . . .’ Gladwell, M. Blink (Hachette UK, 2007). ‘(This was based on the work of Nobel Prize winner Daniel Kahneman and his late colleague Amos Tversky.)’ Kahneman, D. & Tversky, A. On the reality of cognitive illusions. Psychol Rev 103, 582–91– discussion 592–6 (1996). ‘Later, as a fighter pilot in the Second World War, he came close to death after landing his Gloster Gladiator biplane hard in the Egyptian desert and breaking his nose, fracturing his skull and being knocked unconscious.’ Storyteller: The Life of Roald Dahl, Donald Sturrock (William Collins, 2016).

Crew resource management (CRM) empowers junior staff to question the decisions made by senior members of the team, flattening hierarchy and thereby improving safety. CRM can help teams come together in the fog of a disaster and work together effectively and safely. During emergencies in critical care, I now take a step backwards rather than forwards to get an overview of the situation, assign roles and act on good ideas provided by others. The final transformative strand was built on the work of Nobel Prize-winning Daniel Kahneman in his life-affirming book, Thinking, Fast and Slow. Recognising that medical error is effectively a manifestation of ingrained human heuristics has allowed commonly described cognitive errors to be anticipated in healthcare. Every day, I see evidence of anchoring bias, where an incorrect diagnostic label is permanently attached to a patient after being applied earlier by another doctor. I am aware I often test patients for rare diagnoses in the days after I care for another patient with that very diagnosis.


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

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

.: Office of Management and Budget, 1993), table 1.1. a move for which his defenders claimed: Bruce Ackerman, “Like the Emancipation Proclamation, Obama’s Order Forces Democracy,” Los Angeles Times, November 21, 2014. New York Times columnist Joe Nocera: Joe Nocera, “Tea Party’s War on America,” New York Times, August 2, 2011. 1 × 2 × 3 × 4: Amos Tversky and Daniel Kahneman, “Judgment Under Uncertainty: Heuristics and Biases,” in Judgment Under Uncertainty: Heuristics and Biases, edited by Daniel Kahneman, Paul Slovic, and Amos Tversky (Cambridge, England: Cambridge University Press, 1982), 15. Nudge: The discussion of Nudge draws on the following sources: Christopher Caldwell, “The Perils of Shaping Choice,” Financial Times, April 4, 2008. Christopher Caldwell, “Coaxers and Coercers on Common Ground,” Financial Times, March 1, 2013.

Although Obama resisted this batty construal, there was an impatience with democracy in the air. Nudge and behavioral economics The fallibility of human decision-making had lately preoccupied social scientists. They were out to show that Homo economicus, the reliably rational calculator of his own advantage who inhabits the works of Adam Smith and Alfred Marshall, did not exist. In 2002 the Israeli psychologist Daniel Kahneman of Princeton had won the Nobel Prize in economics for work done with his late compatriot Amos Tversky of Stanford. Their work in so-called behavioral economics described people’s tendency to mis-predict and mis-assess. Human reason, it turns out, can cut its way through problems only if the choices are laid out in the proper way. When you ask people what the product of the first eight integers is, much depends on whether you express the multiplication in the form 1 × 2 × 3 × 4 × 5 × 6 × 7 × 8 or in the form 8 × 7 × 6 × 5 × 4 × 3 × 2 × 1 Given five seconds to make an estimate, the average person thinks the product of the first string is 512 and of the second 2,250.

Hobsbawm, E. J. The Age of Extremes: A History of the World, 1914–1991. New York: Pantheon, 1994. ———. Primitive Rebels. Manchester: Manchester University Press, 1959. Howe, Irving. Selected Writings, 1950–1990. San Diego: Harcourt Brace Jovanovich, 1990. Inglehart, Ronald. Culture Shift in Advanced Industrial Society. Princeton: Princeton University Press, 1990. Kahneman, Daniel, Paul Slovic, and Amos Tversky, eds. Judgment Under Uncertainty: Heuristics and Biases. Cambridge, England: Cambridge University Press, 1982. Kalven, Harry, Jr. The Negro and the First Amendment. Columbus: Ohio State University Press, 1965. Kaplan, Roberta, with Lisa Dickey. Then Comes Marriage: How Two Women Fought for and Won Equal Dignity for All. New York: Norton, 2015. Kazin, Michael. The Populist Persuasion: An American History.


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How Doctors Think by Jerome Groopman

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

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

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

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


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Thinking in Bets by Annie Duke

banking crisis, Bernie Madoff, Cass Sunstein, cognitive bias, cognitive dissonance, Daniel Kahneman / Amos Tversky, delayed gratification, Donald Trump, en.wikipedia.org, endowment effect, Estimating the Reproducibility of Psychological Science, Filter Bubble, hindsight bias, Jean Tirole, John Nash: game theory, John von Neumann, loss aversion, market design, mutually assured destruction, Nate Silver, p-value, phenotype, prediction markets, Richard Feynman, ride hailing / ride sharing, Stanford marshmallow experiment, Stephen Hawking, Steven Pinker, the scientific method, The Signal and the Noise by Nate Silver, urban planning, Walter Mischel, Yogi Berra, zero-sum game

If you applied to NASA’s astronaut program or the NBC page program, both of which have drawn thousands of applicants for a handful of positions, things will go your way a minority of the time, but you didn’t necessarily do anything wrong. Don’t fall in love or even date anybody if you want only positive results. The world is structured to give us lots of opportunities to feel bad about being wrong if we want to measure ourselves by outcomes. Don’t fall for it! Second, being wrong hurts us more than being right feels good. We know from Daniel Kahneman and Amos Tversky’s work on loss aversion, part of prospect theory (which won Kahneman the Nobel Prize in Economics in 2002), that losses in general feel about two times as bad as wins feel good. So winning $100 at blackjack feels as good to us as losing $50 feels bad to us. Because being right feels like winning and being wrong feels like losing, that means we need two favorable results for every one unfavorable result just to break even emotionally.

“‘They Saw a Protest’: Cognitive Illiberalism and the Speech-Conduct Distinction.” Stanford Law Review 64 (2012): 851–906. Kahan, Dan, Ellen Peters, Erica Dawson, and Paul Slovic. “Motivated Numeracy and Enlightened Self-Government.” Behavioural Public Policy 1, no. 1 (May 2017): 54–86. Kahneman, Daniel. Thinking, Fast and Slow. New York: Farrar, Straus and Giroux, 2011. Kahneman, Daniel, and Amos Tversky. “Prospect Theory: An Analysis of Decision Under Risk.” Econometrica: Journal of the Econometric Society 47, no. 2 (March 1979): 263–91. Katyal, Neil. “Washington Needs More Dissent Channels.” New York Times, July 1, 2016. https://www.nytimes.com/2016/07/02/opinion/washington-needs-more-dissent-channels.html. Katz, David, and Stephanie Meller. “Can We Say What Diet Is Best for Health?”

When we work backward from results to figure out why those things happened, we are susceptible to a variety of cognitive traps, like assuming causation when there is only a correlation, or cherry-picking data to confirm the narrative we prefer. We will pound a lot of square pegs into round holes to maintain the illusion of a tight relationship between our outcomes and our decisions. Different brain functions compete to control our decisions. Nobel laureate and psychology professor Daniel Kahneman, in his 2011 best-selling Thinking, Fast and Slow, popularized the labels of “System 1” and “System 2.” He characterized System 1 as “fast thinking.” System 1 is what causes you to hit the brakes the instant someone jumps into the street in front of your car. It encompasses reflex, instinct, intuition, impulse, and automatic processing. System 2, “slow thinking,” is how we choose, concentrate, and expend mental energy.


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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

Opitz, Bruna Martins, Michiko Sakaki, and Mara Mather, “Thinking About a Limited Future Enhances the Positivity of Younger and Older Adults’ Recall: Support for Socioemotional Selectivity Theory,” Memory and Cognition 44, no. 6 (2016): 869–82; Mara Mather, “The Affective Neuroscience of Aging,” Annual Review of Psychology 67 (2016): 213–38. 31. Daniel Kahneman, “Experienced Utility and Objective Happiness: A Moment-Based Approach,” in Choices, Values, and Frames, eds. Daniel Kahneman and Amos Tversky (New York: Russell Sage Foundation, 2000); Daniel Kahneman, “Evaluation by Moments: Past and Future,” in ibid.; Bruna Martins, Gal Sheppes, James J. Gross, and Mara Mather, “Age Differences in Emotion Regulation Choice: Older Adults Use Distraction Less Than Younger Adults in High-Intensity Positive Contexts,” Journals of Gerontology Series B: Psychological Sciences and Social Sciences (2016): gbw028. 9 CONSCIOUSNESS 1.

The detail is there, and excruciatingly painful feelings can certainly be produced from it. But perhaps the not so good memories do not gain strength with time in contrast to the good memories that replay better than on past recalls. It would be a case not of suppressing details of bad memories but of lingering less over them, thus diminishing their negativity. The upshot is a highly adaptive increase in well-being.30 The peak-end effect described by Daniel Kahneman and Amos Tversky could contribute as well. We would be prone to creating strong memories for the more rewarding aspects of a past scene and obscure the rest. Memory is imperfect.31 Not everyone reports this sort of affectively positive reshaping of remembrances. Some people consider that their recollections are precisely as they should be, neither better nor worse. Predictably, the pessimists among us report a worsening.

Grey Walter, “An Imitation of Life,” Scientific American 182, no. 5 (1950): 42–45. 12 ON THE HUMAN CONDITION NOW 1. Epicurus and Bertrand Russell would have been pleased to know that their philosophical concerns for human happiness have not been forgotten. Epicurus, The Epicurus Reader, eds. B. Inwood and L. P. Gerson (Indianapolis: Hackett, 1994); Bertrand Russell, The Conquest of Happiness (New York: Liveright, 1930); Daniel Kahneman, “Objective Happiness,” in Well-Being: Foundations of Hedonic Psychology, eds. Daniel Kahneman, Edward Diener, and Norbert Schwarz (New York: Russell Sage Foundation, 1999); Amartya Sen, “The Economics of Happiness and Capability,” in Capabilities and Happiness, eds. Luigino Bruni, Flavio Comim, and Maurizio Pugno (New York: Oxford University Press, 2008); Richard Davidson and Brianna S. Shuyler, “Neuroscience of Happiness,” in World Happiness Report 2015, eds.


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

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

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

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


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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

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

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

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


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

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

“decentralization with coordinated control”: Alfred P. Sloan Jr., My Years with General Motors (New York: Doubleday, 1990), 129, quoted in Garvin and Levesque, “Executive Decision Making at General Motors.” a range of fundamental cognitive limitations: Amos Tversky and Daniel Kahneman, “Judgment Under Uncertainty: Heuristics and Biases,” Science 185, no. 4157 (September 27, 1974), 1124–1131. In 2002, Kahneman earned the Nobel Prize in Economics for the Tversky-Kahneman research; Tversky died in 1996 and therefore did not share in the honor. See also Daniel Kahneman, Thinking, Fast and Slow (New York: Farrar, Straus and Giroux, 2011); on how Kahneman and Tversky achieved their breakthrough insights, see Michael Lewis, The Undoing Project: A Friendship That Changed Our Minds (New York: W. W. Norton, 2016).

It has gained significant ground relative to the market as the coordination mechanism of choice. But much of the efficiency gains have now been absorbed, and to reap further benefits firms will have to focus on improving information processing among a firm’s top decision makers. There, however, firms face a far more difficult challenge: constraints in human cognition. As psychologists Daniel Kahneman and Amos Tversky pointed out in their groundbreaking studies (which fueled the creation of a new academic field, behavioral economics), humans are plagued by a range of fundamental cognitive limitations that impair our general ability to decide well. We have seen this in the context of price, but the constraints are far more universal. For example, we naturally evaluate new information by comparing it to information that we can easily bring to mind.

McNamara and the Evolution of Modern Management,” Harvard Business Review, December 2010, https://hbr.org/2010/12/robert-s-mcnamara-and-the-evolution-of-modern-management. simplifying data to make it more digestible: Mayer-Schönberger and Cukier, Big Data, 164–165, 168. tools to shape the flow of information: Ludwig Siegele and Joachim Zepelin, Matrix der Welt: SAP und der neue globale Kapitalismus (Frankfurt: Campus Verlag, 2009). the “noise” they create in the organization: Daniel Kahneman, Andrew M. Rosenfield, Linnea Gandhi, and Tom Blaser, “Noise: How to Overcome the High, Hidden Cost of Inconsistent Decision Making,” Harvard Business Review (October 2016), https://hbr.org/2016/10/noise. Checklists in aircraft: Brigette M. Hales and Peter J. Pronovost, “The Checklist—a Tool for Error Management and Performance,” Journal of Critical Care 21 (2006), 231–235. checklist in a hospital intensive care unit: Atul Gawande, The Checklist Manifesto: How to Get Things Right (New York: Metropolitan Books, 2009).


Innovation and Its Enemies by Calestous Juma

3D printing, additive manufacturing, agricultural Revolution, Asilomar, Asilomar Conference on Recombinant DNA, autonomous vehicles, big-box store, business cycle, Cass Sunstein, clean water, collective bargaining, colonial rule, computer age, creative destruction, Daniel Kahneman / Amos Tversky, deskilling, disruptive innovation, energy transition, Erik Brynjolfsson, financial innovation, global value chain, Honoré de Balzac, illegal immigration, Intergovernmental Panel on Climate Change (IPCC), Internet of things, invention of movable type, invention of the printing press, Joseph Schumpeter, knowledge economy, loss aversion, Marc Andreessen, means of production, Menlo Park, mobile money, New Urbanism, Nicholas Carr, pensions crisis, phenotype, Ray Kurzweil, refrigerator car, Second Machine Age, self-driving car, smart grid, smart meter, stem cell, Steve Jobs, technological singularity, The Future of Employment, Thomas Kuhn: the structure of scientific revolutions, Travis Kalanick

Sheth, “Psychology of Innovation Resistance.” 91. Daniel Kahneman and Amos Tversky, “Prospect Theory: An Analysis of Decision under Risk,” Econometrica 47, no. 2 (1979): 263–292. 92. For a more detailed explanation, see Daniel Kahneman and Amos Tversky, “Choices, Frames, and Values,” American Psychologist 39, no. 4 (1984): 341–350; and Daniel Kahneman, Thinking, Fast and Slow (New York: Farrar, Straus and Giroux, 2011). 93. Bazerman and Moore, Judgment. 94. William Samuelson and Richard Zeckhauser, “Status Quo Bias in Decision Making,” Journal of Risk and Uncertainty 1 (1988): 7–59. 95. Bazerman and Moore, Judgment. 96. Ilans Ritov and Jonathan Baron, “Reluctance to Vaccinate: Omission Bias and Ambiguity,” Journal of Behavioral Decision Making 3 (1990): 263–277. 97. Ritov and Baron, “Reluctance to Vaccinate”; Daniel Kahneman and Dale T.

See Center for Veterinary Medicine, “AquAdvantage Salmon: Environmental Assessment,” FDA, November 12, 2015, http://www.fda.gov/downloads/AnimalVeterinary/DevelopmentApprovalProcess/GeneticEngineering/GeneticallyEngineeredAnimals/UCM466218.pdf. 26. Van Eenennaam, Muir, and Hallermann, Unaccountable Regulatory Delay, 3. 27. Max H. Bazerman and Don Moore, Judgment in Managerial Decision Making (New York: Wiley, 2008). 28. Daniel Kahneman and Amos Tversky, “Prospect Theory: An Analysis of Decision under Risk,” Econometrica 47, no. 2 (1979): 263–292. 29. Alison L. van Eenennaam, Eric M. Hallerman, and William M. Muir, The Science and Regulation of Food from Genetically Engineered Animals (Washington, DC: Council for Agricultural Science and Technology, 2011). 30. Van Eenennaam, Muir, and Hallermann, Unaccountable Regulatory Delay. 31.


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

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

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

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

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


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

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

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

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


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The Scandal of Money by George Gilder

Affordable Care Act / Obamacare, bank run, Bernie Sanders, bitcoin, blockchain, borderless world, Bretton Woods, capital controls, Capital in the Twenty-First Century by Thomas Piketty, Carmen Reinhart, central bank independence, Claude Shannon: information theory, Clayton Christensen, cloud computing, corporate governance, cryptocurrency, currency manipulation / currency intervention, Daniel Kahneman / Amos Tversky, Deng Xiaoping, disintermediation, Donald Trump, fiat currency, financial innovation, Fractional reserve banking, full employment, George Gilder, glass ceiling, Home mortgage interest deduction, index fund, indoor plumbing, industrial robot, inflation targeting, informal economy, Innovator's Dilemma, Internet of things, invisible hand, Isaac Newton, Jeff Bezos, John von Neumann, Joseph Schumpeter, Kenneth Rogoff, knowledge economy, Law of Accelerating Returns, Marc Andreessen, Mark Zuckerberg, Menlo Park, Metcalfe’s law, money: store of value / unit of account / medium of exchange, mortgage tax deduction, obamacare, Paul Samuelson, Peter Thiel, Ponzi scheme, price stability, Productivity paradox, purchasing power parity, quantitative easing, quantitative trading / quantitative finance, Ray Kurzweil, reserve currency, road to serfdom, Robert Gordon, Robert Metcalfe, Ronald Reagan, Sand Hill Road, Satoshi Nakamoto, Search for Extraterrestrial Intelligence, secular stagnation, seigniorage, Silicon Valley, smart grid, South China Sea, special drawing rights, The Great Moderation, The Rise and Fall of American Growth, The Wealth of Nations by Adam Smith, Tim Cook: Apple, time value of money, too big to fail, transaction costs, trickle-down economics, Turing machine, winner-take-all economy, yield curve, zero-sum game

Most alert to the problem, the Austrian school of economics, led by Friedrich Hayek and Ludwig von Mises, laboriously makes room for human creativity and entrepreneurship, “opportunity scouts” and arbitrageurs.5 Then they explain it all away as a function of “spontaneous order,” apparently restricting human beings to finding price differences and “assembling or reassembling chemical elements” in an effort to restore “equilibrium.” We are back again to the great machine purring away as deterministically as the stars and planets of Newton’s galaxy. In recent years, some pioneers of what is called behavioral economics—led by the psychologists Daniel Kahneman and Amos Tversky—have caused a stir by challenging our faith in Homo economicus.6 Kahneman won a Nobel Prize. But astonishingly enough, the behavioralists question the concept only to diminish it further, by denying the rationality that makes the machine operational and its outcomes just. The putatively rational economic agents—who’da thunk it?—turn out to harbor “biases” and habitual modes of thought, “anchoring” on previous inputs and prices, over-projecting from past experience into the future, overreacting to losses, succumbing to misleading contextual cues.

Skousen superbly covers the canonical sources of Austrian and Chicago economic thought. See also Robert P. Murphy and Donald J. Boudreaux, Choice: Cooperation, Enterprise and Human Action (Oakland, CA: Independent Institute, 2015). For the definitive texts, see Ludwig von Mises, Human Action, and Friedrich Hayek, The Road to Serfdom, both available in many editions. 6.Daniel Kahneman, Thinking, Fast and Slow (New York, NY: Farrar, Straus and Giroux, 2011). The Israeli cognitive psychologist Amos Tversky was his collaborator. CHAPTER 1: THE DREAM AND THE DOLLAR 1.Louis Simpson, “In California,” in The Owner of the House: New Collected Poems, 1940–2001 (Rochester, NY: BOA Editions, 2003), 173. 2.“There was virtually no growth before 1750, and thus there is no guarantee that growth will continue indefinitely. Rather, the paper suggests that the rapid progress made over the past 250 years could well turn out to be a unique episode in human history.”


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

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

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

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


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

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

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

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

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


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

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

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

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

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


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SuperFreakonomics by Steven D. Levitt, Stephen J. Dubner

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

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

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

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


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Adapt: Why Success Always Starts With Failure by Tim Harford

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

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

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


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

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

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

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

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


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

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

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

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

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


Deep Value by Tobias E. Carlisle

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

Like the lay investor, they too commit the investment sin of putting too much weight on the recent past for the particular stock under examination, rather than a rational prior, which is the probability of returns to glamorous, high-growth story stocks. This is a common judgment error not just in the stock market, but also in many situations requiring predictions about uncertain future states. It is known as “neglect of the base rate,” and it was first examined by two pioneers in behavioral finance research, Daniel Kahneman and Amos Tversky, who gave it a prominent place in their groundbreaking paper, “Judgment under Uncertainty: Heuristics and Biases” (1974).42 Kahneman and Tversky found that we make decisions about uncertain future events based on three heuristics—short cuts or simple rules of thumb—that help us break down complex cognitive tasks into simpler operations. Each leads us to make poor decisions about uncertain events because it leads us to consider irrelevant evidence, and in so doing diverts us from considering the underlying probabilities about the events.

(New York: HarperCollins) 2009. 40. John. C. Bogle. “Statement of John C. Bogle to the United States Senate Governmental Affairs Subcommittee,” November 3, 2003. Available at http:// www.vanguard.com/bogle_site/sp20031103.html. 41. J. Lakonishok, A. Shleifer, and R.W. Vishny.“Contrarian Investments, Extrapolation, and Risk.” Journal of Finance, Vol. XLIX, No. 5, (1994) pp. 1541–1578. 42. Amos Tversky and Daniel Kahneman. “Judgment under Uncertainty: Heuristics and Biases.”Science,New Series,Vol.185,No.4157.(Sep.27,1974),pp.1124–1131. http://www.jstor.org/pss/1738360. 43. Leonard Mlodinow. The Drunkard’s Walk: How Randomness Rules Our Lives. (New York: Pantheon Books) Reprint edition, 2009. 44. John B. Williams. The Theory of Investment Value. (Fraser Publishing Co.) 1997. 45. Roy Batchelor. “Bias in Macroeconomic Forecasts,” International Journal of Forecasting 23 2, 189–203, April–June 2007. 46.

Jay Ritter. “Economic Growth and Equity Returns.” Working Paper, University of Florida, November 2004. 18. Ibid. 19. Warren Buffett. “Chairman’s Letter.” Berkshire Hathaway, Inc. Annual Report, 1985. 20. Sebastien Brant. The Ship of Fools. Translated by Alexander Barclay. (Edinburgh: William Paterson) 1874. Available at http://www.gutenberg.org/ files/20179/20179-h/images/t311.png. 21. Daniel Kahneman. “Daniel Kahneman—Autobiographical.” The Nobel Prizes 2002, Editor Tore Frängsmyr, Nobel Foundation, Stockholm, 2003. Available at http://www.nobelprize.org/nobel_prizes/economic-sciences/laureates/2002/ kahneman-bio.html. 22. J. Lakonishok, A. Shleifer, and R.W. Vishny. “Contrarian Investments, Extrapolation, and Risk.” Journal of Finance, Vol. XLIX, No. 5, (1994) pp. 1541–1578. 23. Suggested by Value vs.


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

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

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

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

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


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

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

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

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

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


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Willful: How We Choose What We Do by Richard Robb

activist fund / activist shareholder / activist investor, Alvin Roth, Asian financial crisis, asset-backed security, Bernie Madoff, capital asset pricing model, cognitive bias, collapse of Lehman Brothers, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, delayed gratification, diversification, diversified portfolio, effective altruism, endowment effect, Eratosthenes, experimental subject, family office, George Akerlof, index fund, information asymmetry, job satisfaction, John Maynard Keynes: Economic Possibilities for our Grandchildren, lake wobegon effect, loss aversion, market bubble, market clearing, money market fund, Pareto efficiency, Paul Samuelson, Peter Singer: altruism, principal–agent problem, profit maximization, profit motive, Richard Thaler, Silicon Valley, sovereign wealth fund, survivorship bias, the scientific method, The Wealth of Nations by Adam Smith, Thomas Malthus, Thorstein Veblen, transaction costs, ultimatum game

Huizinga frames action as a continuous flow rather than a sequence of discrete moments. Instead of adhering to plans that are dictated by preferences, the Homo ludens chooses how to respond to new scenarios as they arise and which challenges to tackle. These choices and the ensuing struggle are for-itself. This depiction of choice through time shares elements with prospect theory, an influential thrust of behavioral economics. In 1979, Daniel Kahneman and Amos Tversky proposed this psychological account of various anomalies such as the tendency to become more risk averse when confronting small losses rather than small gains or to take inordinate risks to earn back previous losses. According to prospect theory, a person facing choice under uncertainty begins by computing a base-case outcome or reference point, then characterizes each outcome as a gain or loss relative to that reference point.

Are we drawn to movies in which only good fortune befalls the protagonist? Of course not. Enjoying a dramatic plot with a buildup of tension is no more paradoxical than the paradox of choice. The second puzzle is called the “disjunction effect.” It occurs when someone can’t act until he determines his motive, even if all possible motives justify the same action. It is supposed to represent a deviation from rationality. Amos Tversky and Eldar Shafir coined “disjunction effect” after conducting the following experiment: undergraduates are told to imagine that they have just taken a grueling qualifying exam. They will learn the next day, before the winter holiday, whether they passed or failed. They can buy a five-day vacation to Hawaii at an exceptionally low price today, pay a small nonrefundable fee for the option of buying the trip in two days when they know the exam results, or pass up the opportunity altogether.

Hume, David. Treatise of Human Nature. 2nd ed. Vol. 2: Of the Passions. Oxford, UK: Clarendon Press, 1896. Iyengar, Sheena S., and Mark R. Lepper. “When Choice Is Demotivating: Can One Desire Too Much of a Good Thing?” Journal of Personality and Social Psychology 79, no. 6 (2000): 995–1006. Kahneman, Daniel. Thinking, Fast and Slow. New York: Farrar, Straus and Giroux, 2011. Kahneman, Daniel, and Amos Tversky. “Prospect Theory: An Analysis of Decision under Risk.” Econometrica 47, no. 2 (1979): 263–291. Karabarbounis, Loukas. “The Labor Wedge: MRS vs. MPN.” Review of Economic Dynamics 17, no. 2 (2014): 206–223. Kestenbaum, David. “Keynes Predicted We Would Be Working 15-Hour Weeks. Why Was He So Wrong?” NPR Planet Money. Podcast audio, August 13, 2015. http://www.npr.org/2015/08/13/432122637/keynes-predicted-we-would-be-working-15-hour-weeks-why-was-he-so-wrong (accessed February 2, 2019).


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

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

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

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

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


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

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

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

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


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

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

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

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

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


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

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

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

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

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


pages: 580 words: 168,476

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

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

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

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

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


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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

Kahneman won the Nobel Prize for work done with Tversky, but Tversky passed away before it was awarded. Unfortunately, the Nobel is not awarded posthumously. At his Nobel acceptance speech, Kahneman’s first words were, “The work on which the award was given… was done jointly with Amos Tversky during a long period of unusually close collaboration. He should have been here.” Prize Lecture by Daniel Kahneman, Stockholm University, December 8, 2002, http://www.nobelprize.org/mediaplayer/?id=531. 203. “Inflation Calculator.” 204. Amos Tversky and Daniel Kahneman, “The Framing of Decisions and the Psychology of Choice,” Science 211, no. 4481 (January 30, 1981): 453–458, http://psych.hanover.edu/classes/cognition/papers/tversky81.pdf. 205. Stephen Macknik and Susana Martinez-Conde, Sleights of Mind: What the Neuroscience of Magic Reveals About Our Everyday Deceptions (New York: Henry Holt, 2010), 76–77. 206.

Sage advice, but hard to realize. We believe we know ourselves, and that certainty is part of the problem. In his book Thinking, Fast and Slow, Daniel Kahneman, a Nobel Prize–winning professor emeritus of Princeton University, describes us as having two brains. One brain is slow, thoughtful, reflective, and data driven, and the other is fast, intuitive, and impulse driven. It’s the second brain we rely on most, which is why even when we think we’re being rational, we’re probably not. For example, how much is $5 worth to you? Would you be willing to leave a store and drive twenty minutes to save that much? In 1981, Kahneman and his colleague, Amos Tversky,202 wondered if we were consistent in how we valued money and time. They asked 181 people one of the following questions: Imagine that you are about to buy a jacket for $125 and a calculator for $15.


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

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

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

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

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


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Possible Minds: Twenty-Five Ways of Looking at AI by John Brockman

AI winter, airport security, Alan Turing: On Computable Numbers, with an Application to the Entscheidungsproblem, artificial general intelligence, Asilomar, autonomous vehicles, basic income, Benoit Mandelbrot, Bill Joy: nanobots, Buckminster Fuller, cellular automata, Claude Shannon: information theory, Daniel Kahneman / Amos Tversky, Danny Hillis, David Graeber, easy for humans, difficult for computers, Elon Musk, Eratosthenes, Ernest Rutherford, finite state, friendly AI, future of work, Geoffrey West, Santa Fe Institute, gig economy, income inequality, industrial robot, information retrieval, invention of writing, James Watt: steam engine, Johannes Kepler, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Maynard Keynes: technological unemployment, John von Neumann, Kevin Kelly, Kickstarter, Laplace demon, Loebner Prize, market fundamentalism, Marshall McLuhan, Menlo Park, Norbert Wiener, optical character recognition, pattern recognition, personalized medicine, Picturephone, profit maximization, profit motive, RAND corporation, random walk, Ray Kurzweil, Richard Feynman, Rodney Brooks, self-driving car, sexual politics, Silicon Valley, Skype, social graph, speech recognition, statistical model, Stephen Hawking, Steven Pinker, Stewart Brand, strong AI, superintelligent machines, supervolcano, technological singularity, technoutopianism, telemarketer, telerobotics, the scientific method, theory of mind, Turing machine, Turing test, universal basic income, Upton Sinclair, Von Neumann architecture, Whole Earth Catalog, Y2K, zero-sum game

For the same reason, rationality is the standard assumption in inverse-reinforcement-learning models that try to make inferences from human behavior—perhaps with the concession that humans are not perfectly rational agents and sometimes randomly choose to act in ways unaligned with or even opposed to their best interests. The problem with rationality as a basis for modeling human cognition is that it is not accurate. In the domain of decision making, an extensive literature—spearheaded by the work of cognitive psychologists Daniel Kahneman and Amos Tversky—has documented the ways in which people deviate from the prescriptions of rational models. Kahneman and Tversky proposed that in many situations people instead follow simple heuristics that allow them to reach good solutions at low cognitive cost but sometimes result in errors. To take one of their examples, if you ask somebody to evaluate the probability of an event, they might rely on how easy it is to generate an example of such an event from memory, consider whether they can come up with a causal story for that event’s occurring, or assess how similar the event is to their expectations.

If we all have those tools to some extent, shouldn’t we all be able to benefit? These scenarios echo Kurt Vonnegut’s 1961 short story “Harrison Bergeron,” in which exceptional aptitude is suppressed in deference to the mediocre lowest common denominator of society. Thought experiments like John Searle’s Chinese Room and Isaac Asimov’s Three Laws of Robotics all appeal to the sorts of intuitions plaguing human brains that Daniel Kahneman, Amos Tversky, and others have demonstrated. The Chinese Room experiment posits that a mind composed of mechanical and Homo sapiens parts cannot be conscious, no matter how competent at intelligent human (Chinese) conversation, unless a human can identify the source of the consciousness and “feel” it. Enforced preference for Asimov’s First and Second Laws favor human minds over any other mind meekly present in his Third Law, of self-preservation.

Tom once remarked to me that “one of the mysteries of human intelligence is that we’re able to do so much with so little.” Like machines, human beings use algorithms to make decisions or solve problems; the remarkable difference lies in the human brain’s overall level of success despite the comparative limits on computational resources. The efficacy of human algorithms springs from what AI researchers refer to as “bounded optimality.” As psychologist Daniel Kahneman has notably pointed out, human beings are rational only up to a point. If you were perfectly rational, you would risk dropping dead before making an important decision—whom to hire, whom to marry, and so on—depending on the number of options available for your review. “With all of the successes of AI over the last few years, we’ve got good models of things like images and text, but what we’re missing are good models of people,” Tom says.


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

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

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

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


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

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

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

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


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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

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

Currently, about two-thirds of the Dow Industrial stocks pay dividends in the first half of the month, which means that the difference between the first- and second-half returns is greater than reported here. Chapter 22 1. David Dreman, Contrarian Investment Strategies: The Next Generation, New York: Simon & Schuster, 1998. 2. Frank J. Williams, If You Must Speculate, Learn the Rules, Burlington, VT: Freiser Press, 1930. 3. Daniel Kahneman and Amos Tversky, “Prospect Theory: An Analysis of Decision Under Risk,” Econometrica, vol. 47, no. 2 (March 1979). 4. Robert Shiller, “Stock Prices and Social Dynamics,” Brookings Papers on Economic Activity, Washington, DC: Brookings Institution, 1984. 5. Robert Shiller, “Do Stock Prices Move Too Much to Be Justified by Subsequent Movements in Dividends?” American Economic Review, vol. 71, no. 3 (1981), pp. 421-436.

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. See Tom Chang, David Solomon, and Mark Westerfield, “Looking for Someone to Blame: Delegation, Cognitive Dissonance, and the Disposition Effect,” May 2013. 23. Leroy Gross, The Art of Selling Intangibles, New York: New York Institute of Finance, 1982. 24. Amos Tversky and Daniel Kahneman, “Judgment Under Uncertainty: Heuristics and Biases,” Science, vol. 185 (1974), pp. 1124-1131. 25. Terrance Odean, “Are Investors Reluctant to Realize Their Losses?” Journal of Finance, vol. 53, no. 5 (October 1998), p. 1786. 26. Hersh Shefrin and Richard Thaler, “An Economic Theory of Self-Control,” Journal of Political Economy, vol. 89, no. 21 (1981), pp. 392-406. 27. See Paul Sloan, “Can’t Stop Checking Your Stock Quotes,” U.S.


Engineering Security by Peter Gutmann

active measures, algorithmic trading, Amazon Web Services, Asperger Syndrome, bank run, barriers to entry, bitcoin, Brian Krebs, business process, call centre, card file, cloud computing, cognitive bias, cognitive dissonance, combinatorial explosion, Credit Default Swap, crowdsourcing, cryptocurrency, Daniel Kahneman / Amos Tversky, Debian, domain-specific language, Donald Davies, Donald Knuth, double helix, en.wikipedia.org, endowment effect, fault tolerance, Firefox, fundamental attribution error, George Akerlof, glass ceiling, GnuPG, Google Chrome, iterative process, Jacob Appelbaum, Jane Jacobs, Jeff Bezos, John Conway, John Markoff, John von Neumann, Kickstarter, lake wobegon effect, Laplace demon, linear programming, litecoin, load shedding, MITM: man-in-the-middle, Network effects, Parkinson's law, pattern recognition, peer-to-peer, Pierre-Simon Laplace, place-making, post-materialism, QR code, race to the bottom, random walk, recommendation engine, RFID, risk tolerance, Robert Metcalfe, Ruby on Rails, Sapir-Whorf hypothesis, Satoshi Nakamoto, security theater, semantic web, Skype, slashdot, smart meter, social intelligence, speech recognition, statistical model, Steve Jobs, Steven Pinker, Stuxnet, telemarketer, text mining, the built environment, The Death and Life of Great American Cities, The Market for Lemons, the payments system, Therac-25, too big to fail, Turing complete, Turing machine, Turing test, web application, web of trust, x509 certificate, Y2K, zero day, Zimmermann PGP

p=12. [153] “Re: [cryptography] not a Paypal phish using EV certificate”, Andy Steingruebl, posting to the cryptography@randombit.net mailing list, messageID CAMm53wRuf_7jaayz2VS1KbqWdBxQ7kQz0yfJaAW+4KrO28DLyA@mail.gmail.com, 13 August 2013. [154] “Security Watch: Passwords and Credit Cards, Part 2”, Jesper Johansson, Microsoft TechNet Magazine, August 2008, http://technet.microsoft.com/enus/magazine/2008.08.securitywatch.aspx. [155] “Banks phishes its own customers”, Peter Gutmann, posting to the cryptography@metzdowd.com mailing list, message-ID E1MB80g-0001a31Y@wintermute01.cs.auckland.ac.nz, 2 June 2009. [156] “Judgement under uncertainty: Heuristics and biases”, Amos Tversky and Daniel Kahneman, Science, Vol.185, Issue 4157 (27 September 1974), p.1124. [157] “Judgment under Uncertainty: Heuristics and Biases”, Daniel Kahneman, Paul Slovic and Amos Tversky, Cambridge University Press, 1982. [158] “The Logic of Scientific Discovery”, Karl Popper, Basic Books, 1959. [159] “Critical Thinking Skills in Tactical Decision Making: A Model and A Training Strategy”, Marvin Cohen, Jared Freeman and Bryan Thompson, in References [160] [161] [162] [163] [164] [165] [166] [167] [168] [169] [170] [171] [172] [173] [174] [175] [176] [177] [178] [179] [180] 213 “Making Decisions Under Stress: Implications for Individual and Team Training”, American Psychological Association (APA), 1998, p.155.

“The mindlessness of ostensibly thoughtful action: The role of ‘placebic’ information in interpersonal interaction”, Ellen Langer, Arthur Blank and Benzion Chanowitz, Journal of Personality and Social Psychology, Vol.36, No.6 (June 1978), p.635. “The framing of decisions and the psychology of choice”, Amos Tversky and Daniel Kahneman, Science, Vol.211, No.4481 (30 January 1981), p.453. “Gain-Loss Frames and Cooperation in Two-Person Social Dilemmas: A Transformational Analysis”, Carsten de Dreu and Christopher McCusker, Journal of Personality and Social Psychology, Vol.72, No.5 (1997), p.1093. “Framing of decisions and selection of alternatives in health care”, Dawn Wilson, Robert Kaplan and Lawrence Schneiderman, Social Behaviour, No.2 (1987). p.51. “Prospect Theory: An Analysis of Decision under Risk”, Daniel Kahneman and Amos Tversky, Econometrica, Vol.47, No.2 (March 1979), p.263. “Against the Gods: The Remarkable Story of Risk”, Peter Bernstein, John Wiley and Sons, 1998.

The article that this talk is derived from was published as “Computer Security in the Real World”, Butler Lampson, IEEE Computer, Vol.37, No.6 (June 2004), p.37, although this version doesn't contain the Voltaire quote. “Information and Efficiency: Another Viewpoint”, Harold Demsetz, Journal of Law and Economics, Vol.12, No.1 (April 1969), p.1. 96 Problems [59] [60] [61] [62] [63] [64] [65] [66] [67] [68] [69] [70] [71] [72] “Prospect Theory: An Analysis of Decision under Risk”, Daniel Kahneman and Amos Tversky, Econometrica, Vol.47, No.2 (March 1979), p.263. “A Funny Thing Happened on the Way to the Market”, Sean Smith, IEEE Security and Privacy, Vol.1, No.6 (November/December 2003), p.74. “Zero as a Special Price: The True Value of Free Products”, Kristina Shampanier, Nina Mazar and Dan Ariely, Marketing Science, Vol.26, No.6 (November/December 2007), p.742. “Predictably Irrational”, Dan Ariely, Harper Collins, 2008.


pages: 670 words: 194,502

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

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

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

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

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


pages: 829 words: 186,976

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

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

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

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

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


pages: 384 words: 118,572

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

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

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

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

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


pages: 202 words: 62,199

Essentialism: The Disciplined Pursuit of Less by Greg McKeown

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

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

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

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


pages: 807 words: 154,435

Radical Uncertainty: Decision-Making for an Unknowable Future by Mervyn King, John Kay

"Robert Solow", Airbus A320, Albert Einstein, Albert Michelson, algorithmic trading, Antoine Gombaud: Chevalier de Méré, Arthur Eddington, autonomous vehicles, availability heuristic, banking crisis, Barry Marshall: ulcers, battle of ideas, Benoit Mandelbrot, bitcoin, Black Swan, Bonfire of the Vanities, Brownian motion, business cycle, business process, capital asset pricing model, central bank independence, collapse of Lehman Brothers, correlation does not imply causation, credit crunch, cryptocurrency, cuban missile crisis, Daniel Kahneman / Amos Tversky, David Ricardo: comparative advantage, demographic transition, discounted cash flows, disruptive innovation, diversification, diversified portfolio, Donald Trump, easy for humans, difficult for computers, Edmond Halley, Edward Lloyd's coffeehouse, Edward Thorp, Elon Musk, Ethereum, Eugene Fama: efficient market hypothesis, experimental economics, experimental subject, fear of failure, feminist movement, financial deregulation, George Akerlof, germ theory of disease, Hans Rosling, Ignaz Semmelweis: hand washing, income per capita, incomplete markets, inflation targeting, information asymmetry, invention of the wheel, invisible hand, Jeff Bezos, Johannes Kepler, John Maynard Keynes: Economic Possibilities for our Grandchildren, John Snow's cholera map, John von Neumann, Kenneth Arrow, Long Term Capital Management, loss aversion, Louis Pasteur, mandelbrot fractal, market bubble, market fundamentalism, Moneyball by Michael Lewis explains big data, Nash equilibrium, Nate Silver, new economy, Nick Leeson, Northern Rock, oil shock, Paul Samuelson, peak oil, Peter Thiel, Philip Mirowski, Pierre-Simon Laplace, popular electronics, price mechanism, probability theory / Blaise Pascal / Pierre de Fermat, quantitative trading / quantitative finance, railway mania, RAND corporation, rent-seeking, Richard Feynman, Richard Thaler, risk tolerance, risk-adjusted returns, Robert Shiller, Robert Shiller, Ronald Coase, sealed-bid auction, shareholder value, Silicon Valley, Simon Kuznets, Socratic dialogue, South Sea Bubble, spectrum auction, Steve Ballmer, Steve Jobs, Steve Wozniak, Tacoma Narrows Bridge, Thales and the olive presses, Thales of Miletus, The Chicago School, the map is not the territory, The Market for Lemons, The Nature of the Firm, The Signal and the Noise by Nate Silver, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, Thomas Bayes, Thomas Davenport, Thomas Malthus, Toyota Production System, transaction costs, ultimatum game, urban planning, value at risk, World Values Survey, Yom Kippur War, zero-sum game

The everyday meaning of risk refers to an adverse event which jeopardises the realistic expectations of the individual household or institution. And so the meaning of risk is a product of the plans and expectations of that household or institution. Risk is necessarily particular. It does not mean the same thing to J. P. Morgan as it does to a paraglider or mountain climber, or to a household saving for retirement or the children’s education. In 1979, Daniel Kahneman and Amos Tversky, the two Israeli psychologists working in America who were popularised in Michael Lewis’s bestseller The Undoing Project , offered ‘prospect theory’ as an alternative account of behaviour under uncertainty to the conventional ‘rational’ view based on the Friedman– Savage axioms. Uncertainty was ‘coded’ relative to some reference point around which gains were valued less than losses of similar amount were resented.

and the wise sovereign would sensibly seek not another economic model, but another adviser on economic issues. It is not necessary to have an alternative tool available to know that the plumber who arrives armed only with a screwdriver is not the tradesman we need. In Michael Lewis’s book The Undoing Project , a revealing passage describes the transformation of Amos Tversky’s thinking after he gave a seminar in the course run by Daniel Kahneman. 19 Before that, Lewis describes Tversky’s thinking as ‘Until you could replace a theory with a better theory – a theory that better predicted what actually happened – you didn’t chuck a theory out.’ After the seminar, ‘he treated theories that he had more or less accepted as sound and plausible as objects of suspicion’. He embraced ‘a state of mind unusual for him: doubt’.

And our knowledge of the world would lead us to think it more likely that Lenin met Rosa Luxemburg (the leader of the German communist revolution of 1918) than that he met James Joyce (if you are interested, Lenin and Luxemburg did meet when Lenin and his wife changed trains in Berlin in 1908). 8 Philadelphia is not the capital of Pennsylvania, and anyone who offers odds on the answer to such a question is a knave (and anyone who accepts them a fool). You will wind up with an earful of cider. The ‘Linda problem’ is one of the most frequently reported experiments in behavioural economics. In his bestseller Thinking, Fast and Slow , Daniel Kahneman describes it thus: ‘Linda is thirty-one years old, single, outspoken, and very bright. She majored in philosophy. As a student, she was deeply concerned with issues of discrimination and social justice, and also participated in anti-nuclear demonstrations. Which of the following is more likely? “Linda is a bank teller” or “Linda is a bank teller and is active in the feminist movement”.’ 9 The most common answer (given by 85% to 90% of undergraduates in major universities) 10 is that Linda is more likely to be a feminist bank teller than a bank teller.


pages: 250 words: 88,762

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

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

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

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


pages: 345 words: 87,745

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

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

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

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


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

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

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

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


pages: 190 words: 53,409

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

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

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

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

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


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

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

The world is fraught with uncertainties, many of which people have no control over. These vagaries make them unhappy, but perhaps not as unhappy as making an active choice that ends up, purely as a result of bad luck, making them worse off than if they had done nothing. The status quo, the outcome of letting things be, serves as a natural benchmark. Any loss relative to that benchmark is particularly painful. This concept was named loss aversion by Daniel Kahneman and Amos Tversky, two psychologists who have been incredibly influential in economics. (Kahneman won the Nobel Prize in economics in 2002 and Tversky would probably have as well, but for his untimely demise.) Since their original work, a vast literature has demonstrated the existence of loss aversion and its ability to explain many apparently strange behaviors. For example, most people pay a huge premium on their home insurance plans to get a low deductible.67 This allows them to avoid that painful moment when, after some accident has damaged their house, they have to pay a large sum out of pocket (the high deductible).

Khandelwal, and Adam Osman, “Exporting and Firm Performance: Evidence from a Randomized Experiment,” Quarterly Journal of Economics 132, no. 2 (2017): 551–615. 33 “Rankings by Country of Average Monthly Net Salary (After Tax) (Salaries and Financing),” Numbeo, accessed March 18, 2019, https://www.numbeo.com/cost-of-living/country_price_rankings?itemId=105. 34 Abhijit V. Banerjee and Esther Duflo, “Reputation Effects and the Limits of Contracting: A Study of the Indian Software Industry,” Quarterly Journal of Economics 115, no. 3 (2000): 989–1017. 35 Amos Tversky and Daniel Kahneman, “The Framing of Decisions and Psychology of Choice,” Science 211 (1981): 453–58. 36 Jean Tirole, “A Theory of Collective Reputations (with Applications to the Persistence of Corruption and to Firm Quality),” Review of Economic Studies 63, no. 1 (1996): 1–22. 37 Rocco Machiavello and Ameet Morjaria, “The Value of Relationships: Evidence from Supply Shock to Kenyan Rose Exports,” American Economic Review 105, no. 9 (2015): 2911–45. 38 Wang Xiaodong, “Govt Issues Guidance for Quality of Products,” China Daily, updated September 14, 2017, accessed March 29, 2019, http://www.chinadaily.com.cn/china/2017-09/14/content_31975019.htm. 39 Gujanita Kalita, “The Emergence of Tirupur as the Export Hub of Knitted Garments in India: A Case Study,” ICRIER, accessed April 21, 2019, https://www.econ-jobs.com/research/52329-The-Emergence-of-Tirupur-as-the-Export-Hub-of-Knitted-Garments-in-India-A-Case-Study.pdf. 40 L.

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


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

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

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

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


Super Thinking: The Big Book of Mental Models by Gabriel Weinberg, Lauren McCann

affirmative action, Affordable Care Act / Obamacare, Airbnb, Albert Einstein, anti-pattern, Anton Chekhov, autonomous vehicles, bank run, barriers to entry, Bayesian statistics, Bernie Madoff, Bernie Sanders, Black Swan, Broken windows theory, business process, butterfly effect, Cal Newport, Clayton Christensen, cognitive dissonance, commoditize, correlation does not imply causation, crowdsourcing, Daniel Kahneman / Amos Tversky, David Attenborough, delayed gratification, deliberate practice, discounted cash flows, disruptive innovation, Donald Trump, Douglas Hofstadter, Edward Lorenz: Chaos theory, Edward Snowden, effective altruism, Elon Musk, en.wikipedia.org, experimental subject, fear of failure, feminist movement, Filter Bubble, framing effect, friendly fire, fundamental attribution error, Gödel, Escher, Bach, hindsight bias, housing crisis, Ignaz Semmelweis: hand washing, illegal immigration, income inequality, information asymmetry, Isaac Newton, Jeff Bezos, John Nash: game theory, lateral thinking, loss aversion, Louis Pasteur, Lyft, mail merge, Mark Zuckerberg, meta analysis, meta-analysis, Metcalfe’s law, Milgram experiment, minimum viable product, moral hazard, mutually assured destruction, Nash equilibrium, Network effects, nuclear winter, offshore financial centre, p-value, Parkinson's law, Paul Graham, peak oil, Peter Thiel, phenotype, Pierre-Simon Laplace, placebo effect, Potemkin village, prediction markets, premature optimization, price anchoring, principal–agent problem, publication bias, recommendation engine, remote working, replication crisis, Richard Feynman, Richard Feynman: Challenger O-ring, Richard Thaler, ride hailing / ride sharing, Robert Metcalfe, Ronald Coase, Ronald Reagan, school choice, Schrödinger's Cat, selection bias, Shai Danziger, side project, Silicon Valley, Silicon Valley startup, speech recognition, statistical model, Steve Jobs, Steve Wozniak, Steven Pinker, survivorship bias, The Present Situation in Quantum Mechanics, the scientific method, The Wisdom of Crowds, Thomas Kuhn: the structure of scientific revolutions, transaction costs, uber lyft, ultimatum game, uranium enrichment, urban planning, Vilfredo Pareto, wikimedia commons

However, there is no reason to jump immediately to the complex explanation when you have simpler alternatives to explore first. If you don’t simplify your assumptions, you can fall into a couple of traps, described in our next mental models. First, most people are, unfortunately, hardwired to latch onto unnecessary assumptions, a predilection called the conjunction fallacy, studied by Amos Tversky and Daniel Kahneman, who provided this example in the October 1983 Psychological Review: Linda is 31 years old, single, outspoken, and very bright. She majored in philosophy. As a student, she was deeply concerned with issues of discrimination and social justice, and also participated in anti-nuclear demonstrations. Which is more probable? 1. Linda is a bank teller. 2. Linda is a bank teller and is active in the feminist movement.

You may stay in a house despite wanting to move, because you are waiting until its selling price exceeds your purchase price. These purchase prices are arbitrary numbers, independent of the current value of the assets, but they are meaningful to you because they represent losses or gains. Similarly, you may avoid killing a project because that would mean admitting the loss of your efforts up to that point. Daniel Kahneman and Amos Tversky’s work on this topic, detailed in the October 1992 issue of the Journal of Risk and Uncertainty, demonstrated that across many risky situations, such as winning or losing money based on a coin toss, people tend to want the potential payoff to be around double the potential loss before they are willing to take the gamble. That is, people want to have a fifty-fifty chance of winning one hundred dollars if they have to put fifty dollars on the line.

As Charlie Munger says, “I never allow myself to have an opinion on anything that I don’t know the other side’s argument better than they do.” DON’T TRUST YOUR GUT You make most of your everyday decisions using your intuition, with your subconscious automatically intuiting what to do from instinct or encoded knowledge. It’s your common or sixth sense, your gut feeling, drawing on your past experiences and natural programming to react to circumstances. In his book Thinking, Fast and Slow, economics Nobel laureate Daniel Kahneman makes a distinction between this intuitive fast thinking and the more deliberate, logical thinking you do when you slow down and question your intuitive assumptions. He argues that when you do something frequently, it gradually gets encoded in your brain until at some point your intuition, via your fast thinking, takes over most of the time and you can do the task mindlessly: driving on the highway, doing simple arithmetic, saying your name.


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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

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

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

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


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Descartes' Error: Emotion, Reason and the Human Brain by António R. Damásio

Albert Einstein, Benoit Mandelbrot, Daniel Kahneman / Amos Tversky, discovery of DNA, experimental subject, longitudinal study, mandelbrot fractal, placebo effect, Richard Feynman, social intelligence, theory of mind

But first, get a lot of paper and a pencil sharpener, and a large desk, and do not expect anybody to wait until you are finished. It is also important to note that the flaws of the common-sense view are not confined to the issue of limited memory capacity. Even with paper and pencil to hold the necessary knowledge in place, the reasoning strategies themselves are fraught with weaknesses, as Amos Tversky and Daniel Kahneman have demonstrated.4 One of those important weaknesses may well be humans’ devastating ignorance and defective use of probability theory and statistics, as Stuart Sutherland has suggested.5 Nonetheless, our brains can often decide well, in seconds, or minutes, depending on the time frame we set as appropriate for the goal we want to achieve, and if they can do so, they must do the marvelous job with more than just pure reason.

But although ages of evolution and dedicated neural systems may confer some independence to each of these reasoning/decision-making “modules,” I suspect they are all interdependent. When we witness signs of creativity in contemporary humans, we are probably witnessing the integrated operation of sundry combinations of these devices. THE HELP OF EMOTION, FOR BETTER AND FOR WORSE The work of Amos Tversky and Daniel Kahneman demonstrates that the objective reasoning we employ in day-to-day decisions is far less effective than it seems and than it ought to be.16 To put it simply, our reasoning strategies are defective and Stuart Sutherland strikes an important chord when he talks about irrationality as an “enemy within.”17 But even if our reasoning strategies were perfectly tuned, it appears, they would not cope well with the uncertainty and complexity of personal and social problems.


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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

But it also has a weakness: you can stop using it whenever you like. Punishments are effective when they’re genuinely unpleasant, but some people might stop using a device that makes them feel bad. The trick for those people is to find a method that isn’t aversive. I was wrapping up my PhD at Princeton University in 2008, when Nobel prizewinner Daniel Kahneman invited me to his office. “You can tell me about your research,” he said. I was excited. Kahneman and his colleague Amos Tversky had pioneered the field of judgment and decision making, and now, forty years later, I was a young researcher in the same field. I told Kahneman that I wanted to invent a tiny alarm clock that followed each of us around and rang whenever we were about to make an important decision. He and Tversky had spent decades studying laziness in decision making, so he understood what I was getting at.

Schelling, “Self-Command in Practice, in Policy, and in a Theory of Rational Choice, American Economic Review 74, no. 2 (1984): 1–11; Jan Kubanek, Lawrence H. Snyder, and Richard A. Abrams, “Reward and Punishment Act as Distinct Factors in Guiding Behavior,” Cognition 139 (June 2015): 154–67; Ronald G. Fryer, Steven D. Levitt, John List, and Sally Sadoff, “Enhancing the Efficacy of Teacher Incentives Through Loss Aversion: A Field Experiment,” Working Paper 18237, National Bureau of Economic Research, Cambridge, MA, 2012; Daniel Kahneman and Amos Tversky, “Prospect Theory: An Analysis of Decision under Risk,” Econometrica 47, no. 2 (March 1979): 263–92. Don’t Waste Your Money game: Paul Simpson, Assessing and Treating Compulsive Internet Use (Brentwood, TN: Cross Country Education, 2013). Relational spending: Elizabeth Dunn and Michael Norton, Happy Money: The Science of Happier Spending (New York: Simon & Schuster, 2013). Benjamin Grosser, a: The Facebook Demetricator site: bengrosser.com/projects/facebook-demetricator/.


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

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

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

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


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The People vs Tech: How the Internet Is Killing Democracy (And How We Save It) by Jamie Bartlett

Ada Lovelace, Airbnb, Amazon Mechanical Turk, Andrew Keen, autonomous vehicles, barriers to entry, basic income, Bernie Sanders, bitcoin, blockchain, Boris Johnson, central bank independence, Chelsea Manning, cloud computing, computer vision, creative destruction, cryptocurrency, Daniel Kahneman / Amos Tversky, Dominic Cummings, Donald Trump, Edward Snowden, Elon Musk, Filter Bubble, future of work, gig economy, global village, Google bus, hive mind, Howard Rheingold, information retrieval, Internet of things, Jeff Bezos, job automation, John Maynard Keynes: technological unemployment, Julian Assange, manufacturing employment, Mark Zuckerberg, Marshall McLuhan, Menlo Park, meta analysis, meta-analysis, mittelstand, move fast and break things, move fast and break things, Network effects, Nicholas Carr, off grid, Panopticon Jeremy Bentham, payday loans, Peter Thiel, prediction markets, QR code, ransomware, Ray Kurzweil, recommendation engine, Renaissance Technologies, ride hailing / ride sharing, Robert Mercer, Ross Ulbricht, Sam Altman, Satoshi Nakamoto, Second Machine Age, sharing economy, Silicon Valley, Silicon Valley ideology, Silicon Valley startup, smart cities, smart contracts, smart meter, Snapchat, Stanford prison experiment, Steve Jobs, Steven Levy, strong AI, TaskRabbit, technological singularity, technoutopianism, Ted Kaczynski, the medium is the message, the scientific method, The Spirit Level, The Wealth of Nations by Adam Smith, The Wisdom of Crowds, theory of mind, too big to fail, ultimatum game, universal basic income, WikiLeaks, World Values Survey, Y Combinator

If literate man was rational, said McLuhan, then electronic man would be more emotional, aural and tactile. McLuhan’s prescient 50-year-old ‘probes’ (he called his ideas probes) into how technology would change behaviour are still significantly more insightful than almost every ‘thought-provoking’ TED Talk. But McLuhan wasn’t a scientist. He didn’t conduct studies or test theories. Fortunately Daniel Kahneman, the academic most associated with examining bias in human decision-making, did. Through decades of empirical research with long-time collaborator Amos Tversky, he pioneered the study of how we take decisions – and especially irrational ones. I won’t recite the Stanford Prison Experiments or the Ultimatum Game, but Kahneman’s main point was that there are two basic systems that govern human behaviour. ‘System one’ thinking is fast, instinctive and emotional. It’s the reptilian brain, running on instinct.

Chapter 2: The Global Village 1 Marshall McLuhan, The Gutenberg Galaxy: The Making of Typographic Man (University of Toronto Press, 1962). 2 Eric Norden, ‘The Playboy Interview: Marshall McLuhan’, Playboy, March 1969. 3 James Madison, ‘Federalist No. 10 – The Utility of the Union as a Safeguard Against Domestic Faction and Insurrection’, 23 November 1787. 4 Thomas Hawk, ‘How to unleash the wisdom of crowds’, www.theconversation.com, 9 February 2016. 5 See especially the following authors: Zeynep Tufekci, Eli Pariser and Evgeny Morozov. On ‘post-truth’, see books by Matthew D’Ancona, James Ball and Evan Davies. 6 Bruce Drake, ‘Six new findings about Millennials’, www.pewresearch.org, 7 March 2014. A survey repeatedly found that millennials have fewer institutional attachments than their parents, are more politically independent, but do ‘connect’ to personalised networks. 7 Daniel Kahneman, Thinking, Fast and Slow (Farrar, Straus and Giroux, 2011). S. Messing and S.J. Westwood (2014), ‘Selective exposure in the age of social media: Endorsements trump partisan source affiliation when selecting news online’. Communication Research, 41(8), 1042–1063. E. Bakshy, S. Messing and L.A. Adamic (2015), ‘Exposure to ideologically diverse news and opinion on Facebook’, Science, 348 (6239), 1130–1132. 8 Jonathan Taplin, Move Fast and Break Things (Macmillan, 2017). 9 Lee Drutman, ‘We need political parties.


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Rapt: Attention and the Focused Life by Winifred Gallagher

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

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

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

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


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Prediction Machines: The Simple Economics of Artificial Intelligence by Ajay Agrawal, Joshua Gans, Avi Goldfarb

"Robert Solow", Ada Lovelace, AI winter, Air France Flight 447, Airbus A320, artificial general intelligence, autonomous vehicles, basic income, Bayesian statistics, Black Swan, blockchain, call centre, Capital in the Twenty-First Century by Thomas Piketty, Captain Sullenberger Hudson, collateralized debt obligation, computer age, creative destruction, Daniel Kahneman / Amos Tversky, data acquisition, data is the new oil, deskilling, disruptive innovation, Elon Musk, en.wikipedia.org, Erik Brynjolfsson, everywhere but in the productivity statistics, Google Glasses, high net worth, ImageNet competition, income inequality, information retrieval, inventory management, invisible hand, job automation, John Markoff, Joseph Schumpeter, Kevin Kelly, Lyft, Minecraft, Mitch Kapor, Moneyball by Michael Lewis explains big data, Nate Silver, new economy, On the Economy of Machinery and Manufactures, pattern recognition, performance metric, profit maximization, QWERTY keyboard, race to the bottom, randomized controlled trial, Ray Kurzweil, ride hailing / ride sharing, Second Machine Age, self-driving car, shareholder value, Silicon Valley, statistical model, Stephen Hawking, Steve Jobs, Steven Levy, strong AI, The Future of Employment, The Signal and the Noise by Nate Silver, Tim Cook: Apple, Turing test, Uber and Lyft, uber lyft, US Airways Flight 1549, Vernor Vinge, Watson beat the top human players on Jeopardy!, William Langewiesche, Y Combinator, zero-sum game

If you randomize 60/40, as most participants do, your prediction ends up being correct 52 percent of the time, only slightly better than if you had not bothered to assess relative frequencies of Xs and Os and instead just guessed one or the other (50/50).1 What such experiments tell us is that humans are poor statisticians, even in situations when they are not too bad at assessing probabilities. No prediction machine would make an error like this. But perhaps humans don’t take such tasks seriously, since they may feel as if they are playing a game. Would they make similar errors if the consequences are decidedly not game-like? The answer—demonstrated over many experiments by psychologists Daniel Kahneman and Amos Tversky—is decidedly yes.2 When they told people to consider two hospitals—one with forty-five births per day and another with fifteen births per day—and asked which hospital would have more days when 60 percent or more of the babies born are boys, very few gave the correct answer—the smaller hospital. The smaller hospital is correct because the larger the number of events (in this case, births), the likelier each daily outcome will be close to the average (in this case, 50 percent).

Google has argued that Bing is big enough to reap the benefits of scale in search. Chapter 6 1. Sixty percent of the time you choose X and are correct 60 percent of the time, while 40 percent of the time you choose O and are correct only 40 percent of the time. On average, this is 0.6^2 + 0.4^2 = 0.52. 2. Amost Tversky and Daniel Kahneman, “Judgment under Uncertainty: Heuristics and Biases,” Science 185, no. 4157 (1974): 1124–1131, https://people.hss.caltech.edu/~camerer/Ec101/JudgementUncertainty.pdf. 3. See Daniel Kahneman, Thinking, Fast and Slow (New York: Farrar, Strauss and Giroux, 2011); and Dan Ariely, Predictably Irrational (New York: HarperCollins, 2009). 4. Michael Lewis, Moneyball (New York: Norton, 2003). 5. Of course, while Moneyball was based on the use of traditional statistics, it should be no surprise that teams are now looking to machine-learning methods to perform that function, gathering far more data in the process.

Tesla CEO Elon Musk has been one of the most consistent, high-profile, and experienced individuals sounding alarm bells: “I have exposure to the very cutting-edge AI, and I think people should be really concerned about it … I keep sounding the alarm bell, but until people see robots going down the street killing people, they don’t know how to react, because it seems so ethereal.”1 Another learned expert with an opinion on this is renowned psychologist and Nobel laureate Daniel Kahneman. Among non-academics, he may be best known for his 2011 book, Thinking, Fast and Slow. In 2017, at a conference we organized in Toronto on the economics of artificial intelligence, he explained why he thinks AIs will be wiser than humans: A well-known novelist wrote me some time ago that he’s planning a novel. The novel is about a love triangle between two humans and a robot and what he wanted to know is how the robot would be different from the people.


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

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

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

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

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


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Traffic: Why We Drive the Way We Do (And What It Says About Us) by Tom Vanderbilt

Albert Einstein, autonomous vehicles, availability heuristic, Berlin Wall, call centre, cellular automata, Cesare Marchetti: Marchetti’s constant, cognitive dissonance, computer vision, congestion charging, Daniel Kahneman / Amos Tversky, DARPA: Urban Challenge, endowment effect, extreme commuting, fundamental attribution error, Google Earth, hedonic treadmill, hindsight bias, hive mind, if you build it, they will come, impulse control, income inequality, Induced demand, invisible hand, Isaac Newton, Jane Jacobs, John Nash: game theory, Kenneth Arrow, lake wobegon effect, loss aversion, megacity, Milgram experiment, Nash equilibrium, Sam Peltzman, Silicon Valley, statistical model, the built environment, The Death and Life of Great American Cities, traffic fines, ultimatum game, urban planning, urban sprawl, women in the workforce, working poor

looking in the rearview mirror: The forward and rearview percentages are drawn from M. A. Brackstone and B. J. Waterson, “Are We Looking Where We Are Going? An Exploratory Examination of Eye Movement in High Speed Driving.” Paper 04-2602, Proceedings of the 83rd Annual Meeting of the Transportation Research Board (Washington D.C., January 2004). “loss aversion”: The notion of loss aversion was first hypothesized by Daniel Kahneman and Amos Tversky, “Prospect Theory: An Analysis of Decision Under Risk,” Econometrica, vol. 47 (1979), pp. 263–91. sensitive to loss: See Sabrina M. Tom, Craig R. Fox, Christopher Trepel, and Russell A. Poldrack, “The Neural Basis of Loss Aversion in Decision-Making Under Risk,” Science, vol. 315, no. 5811 (26 January 2007), pp. 515–18. See also William J. Gehring and Adrian R. Willoughby, “The Medial Frontal Cortex and the Rapid Processing of Monetary Gains and Losses,” Science, vol. 295, no. 5563 (2002), pp. 2279–82.

Kobza, “A Probabilistic Approach to Evaluate Strategies for Selecting a Parking Space,” Transportation Science, vol. 32, no. 1 (January 1998), pp. 30–42. to walk somewhere: Travel Behaviour Research Baseline Survey 2004: Sustainable Travel Demonstration Towns (SUSTRANS and Socialdata, 2004). Retrieved from http://www.sustrans.org.uk/webfiles/travelsmart/STDT%20Research%20FINAL.pdf. was at work: The “availability heuristic” is credited to Daniel Kahneman and Amos Tversky. (Heuristic is a sophisticated-sounding word that really just means “mental shortcut.”) When people are asked to imagine how often something happens, they tend to overestimate the probability of things that can be more easily recalled from memory—that is, that are “available”—or that loom more vividly in the imagination. mixed conclusions on this: See, for example, R. G. Golledge, K.

In other words, we’re much more aware of what is passing us than what we have passed. The fact that we spend more time seeing losses than gains while driving in congestion plays perfectly into a well-known psychological theory called “loss aversion.” Any number of experiments have shown that humans register losses more powerfully than gains. Our brains even seem rigged to be more sensitive to loss. In what psychologist Daniel Kahneman has called the “endowment affect,” once people have been given something, they are instantly more hesitant to give it up. Do you remember the childlike glee you felt the last time you found a parking spot at the mall on a crowded day? You may have left the spot with a certain reluctance, particularly if someone else was waiting for it. Studies have shown that people take longer to leave a parking spot when another driver is waiting, even though they predict they will not.


Investment: A History by Norton Reamer, Jesse Downing

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

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

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

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


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

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

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

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

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


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

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

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

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

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

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

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

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


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The Wisdom of Frugality: Why Less Is More - More or Less by Emrys Westacott

Airbnb, back-to-the-land, Bertrand Russell: In Praise of Idleness, Bonfire of the Vanities, carbon footprint, clean water, Community Supported Agriculture, corporate raider, Daniel Kahneman / Amos Tversky, dark matter, Diane Coyle, discovery of DNA, Downton Abbey, dumpster diving, financial independence, full employment, greed is good, happiness index / gross national happiness, haute cuisine, hedonic treadmill, income inequality, invisible hand, Isaac Newton, loss aversion, McMansion, means of production, move fast and break things, move fast and break things, negative equity, New Urbanism, paradox of thrift, Ralph Waldo Emerson, Thales and the olive presses, Thales of Miletus, the market place, The Spirit Level, Thorstein Veblen, Upton Sinclair, Veblen good, Zipcar

He makes the rational and the spirited parts sit on the ground beneath appetite, one on either side, reducing them to slaves. He won’t allow the first to reason about or examine anything except how a little money can be made into great wealth. And he won’t allow the second to value or admire anything but wealth and wealthy people or to have any ambition other than the acquisition of wealth or whatever might contribute to getting it.8 The “sunk cost” fallacy: Research by psychologists Daniel Kahneman and Amos Tversky in the 1970s led them to conclude that for most human beings a concern to avoid losses is a more powerful motivator than the desire to realize gains. Many other psychologists have followed in their footsteps and investigated the phenomenon of loss aversion. A study by Hal Arkes and Catherine Blumer is representative and revealing. Participants in their study were asked to imagine that they had bought two nonrefundable tickets, a $100 ticket for a skiing trip to Michigan, and a $50 ticket for a skiing trip to Wisconsin.

Richard Wilkinson and Kate Pickett, The Spirit Level: Why More Equal Societies Almost Always Do Better (London: Bloomsbury, 2009); Joseph Stiglitz, The Price of Inequality: How Today’s Divided Society Endangers Our Future (New York: Norton, 2013). It should be noted that Wilkinson and Pickett’s methodology, evidence, and conclusions have been challenged. See, for instance, Peter Saunders, “Beware False Prophets: Equality, the Good Society and the Spirit Level,” Policy Exchange, July 8, 2010. 22. Daniel Kahneman and Angus Deaton, “High Income Improves Evaluation of Life but Not Emotional Well-Being, Proceedings of the National Academy of Sciences of the United States of America, August 4, 2010. 23. See Daniel Kahneman, Thinking Fast and Slow (New York: Farrar, Straus and Giroux, 2011), p. 396. 24. Skidelsky and Skidelsky, How Much Is Enough?, p. 75. 25. Plato, Republic, 4.442a. 26. Nietzsche, The Gay Science, bk. 1, 14. 27. See Kathleen D. Vohs, Nicole L. Mead, and Miranda R. Goode, “The Psychological Consequences of Money,” Science 314, no. 5802 (November 2006): 1154–56. 28.

In the United States in 2012, this point was reckoned to be around $75,000 in high-cost areas, according to a study using Gallup Poll data drawn from over 450,000 respondents.22 The existence of a satiation point is in some ways surprising. After all, a much higher income than $75,000 would enable one to travel to exotic places, buy expensive concert tickets, try out fancy restaurants, and in general treat oneself to a few more luxuries. And it seems reasonable to suppose that increasing the number and quality of pleasurable experiences would make one happier. So why does this seem not to occur? Daniel Kahneman suggests one partial explanation that harks back to points made earlier about the simple life: as people become richer, their ability to savor small, simple, everyday pleasures is reduced.23 A study in which subjects seemed to derive less pleasure from eating chocolate after they had been primed with wealth-related ideas possibly lends support to this hypothesis. The finding that once we have attained a moderate level of affluence additional wealth does not make us much happier seems to be well established.


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

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

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

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

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


pages: 226 words: 59,080

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

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

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

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


pages: 393 words: 115,263

Planet Ponzi by Mitch Feierstein

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

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

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


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Strategy: A History by Lawrence Freedman

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

See also “Information Processing Models of Cognition,” Annual Review of Psychology 30, no. 3 (February 1979): 363–396. Herbert A. Simon and William G. Chase, “Skill in Chess,” American Scientist 61, no. 4 (July 1973): 394–403. 12. Amos Tversky and Daniel Kahneman, “Judgment Under Uncertainty: Heuristics and Biases,” Science 185, no. 4157 (September 1974): 1124. See also Daniel Kahneman, “A Perspective on Judgment and Choice: Mapping Bounded Rationality,” American Psychologist 56, no. 9 (September 2003): 697–720. 13. “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.

Rather than perform exhaustive searches to get the best solution, they searched until they found one that was satisfactory, a process he described as “satisficing.”11 Social norms were adopted, even when inconvenient, to avoid unwanted conflicts. When the empirical work demonstrated strong and consistent patterns of behavior this might reflect the rational pursuit of egotistical goals, but alternatively these patterns might reflect the influence of powerful conventions that inclined people to follow the pack. Building upon Simon’s work, Amos Tversky and Daniel Kahneman introduced further insights from psychology into economics. To gain credibility, they used sufficient mathematics to demonstrate the seriousness of their methodology and so were able to create a new field of behavioral economics. They demonstrated how individuals used shortcuts to cope with complex situations, relying on processes that were “good enough” and interpreted information superficially using “rules of thumb.”

The designations System 1 and System 2 come from Keith Stanovich and Richard West, “Individual Differences in Reasoning: Implications for the Rationality Debate,” Behavioral and Brain Sciences 23 (2000): 645–665. Daniel Kahneman has popularized the terms in his Thinking Fast and Slow (London: Penguin Books, 2011). J. St. B. T. Evans, “In Two Minds: Dual-Process Accounts of Reasoning,” Trends in Cognition Science 7, no. 10 (October 2003): 454–459; “Dual-Processing Accounts of Reasoning, Judgment and Social Cognition,” The Annual Review of Psychology 59 (January 2008): 255–278. 43. Andreas Glöckner and Cilia Witteman, “Beyond Dual-Process Models: A Categorisation of Processes Underlying Intuitive Judgement and Decision Making,” Thinking & Reasoning 16, no. 1 (2009): 1–25. 44. Daniel Kahneman, Thinking Fast and Slow, 42. 45. Alan G. Sanfey et al., “Social Decision-Making,” 598–602. 46. Colin F. Camerer and Robin M.


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Whiteshift: Populism, Immigration and the Future of White Majorities by Eric Kaufmann

4chan, affirmative action, Amazon Mechanical Turk, anti-communist, anti-globalists, augmented reality, battle of ideas, Berlin Wall, Bernie Sanders, Boris Johnson, British Empire, centre right, Chelsea Manning, cognitive dissonance, complexity theory, corporate governance, correlation does not imply causation, crowdsourcing, Daniel Kahneman / Amos Tversky, David Brooks, deindustrialization, demographic transition, Donald Trump, Elon Musk, en.wikipedia.org, facts on the ground, failed state, Fall of the Berlin Wall, first-past-the-post, Francis Fukuyama: the end of history, Haight Ashbury, illegal immigration, immigration reform, imperial preference, income inequality, knowledge economy, knowledge worker, liberal capitalism, longitudinal study, Lyft, mass immigration, meta analysis, meta-analysis, moral panic, Nate Silver, New Urbanism, Norman Mailer, open borders, phenotype, postnationalism / post nation state, Ralph Waldo Emerson, Republic of Letters, Ronald Reagan, Scientific racism, Silicon Valley, statistical model, Steven Pinker, the built environment, the scientific method, The Wisdom of Crowds, transcontinental railway, twin studies, uber lyft, upwardly mobile, urban sprawl, Washington Consensus, white flight, working-age population, World Values Survey, young professional

Most offer what social scientists dub ‘overdetermined’ arguments, throwing a kitchen sink of explanations at the problem (economic stagnation, racism, distrust in politicians) without using data to distinguish which ones matter and which don’t. The manager of the Oakland A’s baseball team, Billy Beane, in Michael Lewis’s Moneyball showed that large-scale datasets could reveal truths that scouts acting on gut instinct failed to see.5 On-base percentage mattered more than how athletic a batter looked or how many big hits he had. The scouts, like all of us, think in terms of vivid images, which lead us to make what Daniel Kahneman and Amos Tversky term ‘fast-thinking’ decisions.6 These can be misleading. In approaching populism, many have been seduced by stories of ‘left-behind’ working-class whites, the opioid crisis and rusting factories, so we’ve had numerous media ‘safaris’ into Trumpland which tend to simply confirm reporters’ biases.7 Journalists have been mesmerized by election maps. Looking at fine-grained surveys of individual voters produces a different picture, in which values count far more than economics or geography.

These researchers discovered a steady increase in non-Hispanic white suicide rates linked to an opioid epidemic among working-class white Americans.107 Other authors favoured J. D. Vance’s autobiographical and evocative Hillbilly Elegy, about growing up in backwoods poverty in Appalachia. Some tramped the byways of rustbelt Ohio or reported from struggling post-industrial towns to suggest that economic misery explained Trump’s success. None performed any sophisticated individual-level data analysis. Daniel Kahneman and Amos Tversky emphasize that our brains are wired to work with vivid images such as a coal miner in a down-at-the-heel West Virginia town.108 Like Billy Beane in Michael Lewis’s Moneyball, we are better off ignoring gut feel and looking at the individual-level data. It’s much harder for us to digest the fact that the psychological differences between two Appalachian miners matter more for the Trump vote than the social distance between Youngstown, Ohio, and the northern Virginia suburbs.

National-level attitudes are often linked to views on the death penalty, trust, crime, political correctness and, more recently, the European Union. They tap into both authoritarianism – the desire for order and stability – and conservatism, a preference for continuity with the past. Perceptions of the nation are imagined through the media as well as by travelling around the country or hearing travel tales related by friends and relatives. Given people’s tendency to ‘fast think’ through what Amos Tversky and Daniel Kahneman term ‘system 1’ cognition, vivid images and stories will tend to carry more weight than representative data and rational ‘system 2’ deliberation.54 The media has an important role in reinforcing perceptions, but isn’t the only influence on whether people imagine threats to the nation. Bottom-up, peer-to-peer transmission of emotional stories also matters. This can drive perceptions, creating fertile soil for the media.


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Smarter Investing by Tim Hale

Albert Einstein, asset allocation, buy and hold, buy low sell high, capital asset pricing model, collapse of Lehman Brothers, corporate governance, credit crunch, Daniel Kahneman / Amos Tversky, diversification, diversified portfolio, Donald Trump, equity premium, Eugene Fama: efficient market hypothesis, eurozone crisis, fiat currency, financial independence, financial innovation, fixed income, full employment, implied volatility, index fund, information asymmetry, Isaac Newton, John Meriwether, Long Term Capital Management, Northern Rock, passive investing, Ponzi scheme, purchasing power parity, quantitative easing, random walk, risk tolerance, risk-adjusted returns, risk/return, Robert Shiller, Robert Shiller, South Sea Bubble, technology bubble, the rule of 72, time value of money, transaction costs, Vanguard fund, women in the workforce, zero-sum game

Hindsight delusion, combined with overconfidence and susceptibility to seeing trends where none exist is a recipe for wealth destruction. Lesson: Do not believe that you have predictive powers – you do not, I assure you. I will throw my anchor out here thanks The human mind really likes to use ‘anchors’ when forming opinions, which in many cases leads to extraordinarily inaccurate estimates of outcomes. As an example, experiments undertaken by two of the most respected behavioural economists, Amos Tversky and Daniel Kahneman, used a wheel-of-fortune with the numbers 1 to 100 on it. Before asking their subjects a number of difficult questions, such as how many African nations are in the United Nations, they span the wheel. They first asked if the number was higher or lower than the number on the wheel, and then asked for the participants’ guesses. When the wheel stopped on 10 the median guess was 25, but when it stopped on 65 the median number was 45.

Likewise, to understand human nature we need to look at it in the context of our evolutionary past and the evolutionary process itself. Evolution occurs by a process of natural selection where the favorable heritable traits exhibited by an individual (defined by its genes) become more common in successive generations of a population. Physiological responses that made us run from shadows, avoid pain, devour sources of plenty in a greedy way would have been selected for. As Amos Tversky, one of the leading behavioural economists points out (Zweig, 2007): ‘Sensitivity to losses was probably more [beneficial] than the appreciation of gains … it would have been wonderful to be a species that was almost insensitive to pain and had the infinite capacity to appreciate pleasure. But you probably wouldn’t have survived the evolutionary battle.’ It has been estimated (Kahneman and Tversky, 1979) that humans have a pain-to-gain ratio in investing of 2:1 i.e. losses hurt twice as much as gains – we are risk averse.


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

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

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

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


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Busy by Tony Crabbe

airport security, British Empire, business process, cognitive dissonance, Daniel Kahneman / Amos Tversky, fear of failure, Frederick Winslow Taylor, haute cuisine, informal economy, inventory management, Isaac Newton, job satisfaction, knowledge worker, Lao Tzu, loss aversion, low cost airline, meta analysis, meta-analysis, Milgram experiment, placebo effect, Richard Feynman, Rubik’s Cube, Saturday Night Live, science of happiness, Shai Danziger, Thorstein Veblen, Tim Cook: Apple

An Easier Way It’s amazing, really how seldom we are stuck when faced with complex decisions. Occasionally you might be asked to do some long division when you don’t have a calculator on hand, but most of the time, we breeze through our decisions. There are two reasons for this: The first is that when faced with too much choice, we simply move on and don’t make a decision at all. The second reason we are seldom stumped was identified by Amos Tversky and Daniel Kahneman early in their work together. When faced with a hard question, we simply substitute it with a much easier one. The following experiment shows this nicely. German students were given a survey including the following questions: • How happy are you these days? • How many dates did you have last month? When the responses were analyzed, there was virtually no correlation between the answers given for these two questions.

It has to do this because, although your gray matter only accounts for about two percent of your body weight, it uses about 20 percent of all the energy you consume. It’s the 4 x 4 of your organs. The worst offender of all is the part responsible for decision-making, the most recent part of the brain to evolve: the prefrontal cortex. This isn’t just any old 4 x 4, it’s a 6.6-liter Hummer! This means that making rational choices is hard work, so the brain does all it can to avoid the effort. Psychologists, such as the Nobel Prize–winning Daniel Kahneman, have split our thinking into two forms: System One and System Two.2 System One is fast, automatic and unconscious; System Two is slow, effortful and conscious. Both systems are always on while you are awake. System One automatically and effortlessly responds to experiences, generating immediate impressions, intentions and feelings. The more energy-sapping System Two prefers to take things easy when it can, spending most of its time coasting along, vaguely scanning what is generated by System One.

Great research and humor Author: Daniel Goleman Title: Focus Why you should read it: Describes the importance and mechanisms of focus Author: Jonathan Haidt Title: The Happiness Hypothesis Why you should read it: Accessible blend of modern and ancient wisdom Author: Edward Hallowell Title: CrazyBusy Why you should read it: Description of busy, likening it to ADHD Author: Tim Harford Title: Adapt Why you should read it: Why we have to fail to succeed—a great read Author: Chip and Dan Heath Title: Decisive Why you should read it: Great book on how we decide Author: Chip and Dan Heath Title: Switch Why you should read it: One of the best on how to make changes Author: Arianna Huffington Title: Thrive Why you should read it: Inspiring read on how to thrive today Author: Maggie Jackson Title: Distracted Why you should read it: This book really influenced my thinking Author: Daniel Kahneman Title: Thinking, Fast and Slow Why you should read it: A brilliant overview of System One and Two thinking Author: Tim Kasser Title: The High Price of Materialism Why you should read it: Explains the research behind Chapter 9 Author: Robert Kegan and Lisa Laskow Lahey Title: Immunity to Change Why you should read it: A great book: make deep, adaptive change Author: George Leonard Title: Mastery Why you should read it: Describes the joy of practice Author: Jim Loehr and Tony Schwartz Title: The Power of Full Engagement Why you should read it: Inspiring book on managing your energy Author: Steve Peters Title: The Chimp Paradox Why you should read it: A simple concept that helps manage emotions Author: David Rock Title: Your Brain at Work Why you should read it: Remarkably simple application of neuroscience Author: Brigid Schulte Title: Overwhelmed Why you should read it: Fantastic, and relevant book on the subject of busy Author: Barry Schwartz Title: The Paradox of Choice Why you should read it: The subtitle says it all: “Why more is less” Author: Martin Seligman Title: Flourish Why you should read it: The latest book by the founder of Positive Psychology Author: Sherry Turkle Title: Alone Together Why you should read it: Insightful: our response to technological immersion Author: Timothy D.


pages: 322 words: 77,341

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

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

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

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

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


pages: 309 words: 78,361

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

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

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

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

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


pages: 240 words: 73,209

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

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

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

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

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


pages: 471 words: 124,585

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

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

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

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


pages: 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

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

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


pages: 368 words: 96,825

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

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

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

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

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


pages: 337 words: 86,320

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

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

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

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

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


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