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Masters in Business
Special Edition: Nobel Prize Winner Richard Thaler Live from the Economic Club of New York
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- [01:31]
C
Hey, it's a bonus Masters in Business Live. One of my favorite economists, Richard Thaler and his colleague at the Booth School of Business, Alex Emis, were going to give a presentation at the New York Economic Club. And they said, hey, why don't we make this a live conversation? And literally said, hey, how do you feel about being our interlocutor? And any opportunity I have to spend time with Thaler, I jump at. So, sure, let's do that. Uh, and so a few weeks ago, I sat down with Professor Richard Thaler and Professor Alex Emas, both of the Booth School of Business at the University of Chicago, live at the New York Economic Club, talking about their new version of the book, the Winner's Curse. Uh, it was about 30, 40 minutes of conversation. We had some questions from the audience. It was fabulous. In fact, it was so good, we're gonna have them back in the studio for a full Masters in Business, which is now already recorded. It won't be out for a couple of weeks. But in the meantime, to give you a taste of what that full interview is like, here is our live Masters in Business conversation at the New York Economic Club. I'm kind of fascinated by not only this book, but Richard's Entire history and a lot of what I know about him really came to the public eye through the anomalies columns that began so long ago. Tell us a little bit about the genesis of what the anomalies columns were and how that led to this book.
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A
Sure. About 1986, somebody at the American Economic association decided it would be a good idea to start a new journal in which the articles would be accessible to at least all economists and grad students and even undergrads because articles have becoming more and more specialized. That was the idea. I had a friend, I have a friend named Hal Varian who has been the chief economist at Google. He was a mere professor at the time and on the advisory board of this journal. They were planning some pieces that would appear in every issue, which is once a quarter. Hal and I cooked up the idea of having a feature on anomalies. So what's an anomaly in economics? An anomaly is something that cannot easily be explained using the standard assumptions that people are really smart, unemotional, selfish, no self control problems, basically not like anybody. You know. As a result of that, there were lots of anomalies. And I did this for almost four years. When it looked like a pile of them looked like a book, I stapled them together and that was the original version of the Winner's Curse published in 1992.
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C
So the book comes out in 92. I was curious how was it received by traditional economists? You're challenging core theses that they deeply believe in and did the lay public take any interest in this?
- [05:37]
A
So you know, I'm very good friends with Steve Levitt and Stephen Dubner. They basically invented a best selling economics book. Before freakonomics, there was no such thing. So this is pre Freakonomics. It was read, but the profession had read the articles in the journal and the book was an attempt to reach out. But you know, I've often said that I'm a professional heretic and troublemaker and I say I didn't change anybody's mind over the course of my career. And after realizing that, I decided instead to have a strategy of corrupting the youth. And Alex is.
- [06:34]
B
I used to be young.
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A
So yeah, I'll let Alex tell his version of the story. But you know, the book sold better than expected and was around. It was still in print, but for various boring reasons. It was going to go out of print and the publisher asked me if I wanted to freshen it up and that turned into a. Well, we first talked about that five years ago, so you can see how long it took but that's the story of the book.
- [07:19]
C
So, Alex, how did you get corrupted by Dr. Thaler?
- [07:24]
B
I didn't need much pushing, so I was a neuroscience undergrad major, so I was already kind of interested in, you know, how human minds actually worked. I took a bunch of abnormal psychology and things like that. But science, like STEM classes, were really, really hard. And so I took economics as kind of a way to boost my gpa. So. And I thought it was fun. The algebra was interesting, and. But I didn't, you know, I didn't think of much of it. And then at some point, I was like, I was moving and I was applying to medical school, by the way. I was pre med, good immigrant kid, and I was. I was driving cross country, and I was listening to the radio, and Richard was on the radio. This was 2008. I had no idea who Richard was. I didn't know what Nudge was. He was on NPR talking about Nudge and I. And it was about. About this field called behavioral economics that I've never heard about before. And I was like, wait, I could take this and combine it with that and it'll. That's amazing. I got to Los Angeles, went online, applied to econ PhD programs right away. Didn't end up going to medical school, and I ended up going to UC San Diego for my PhD. And lo and behold, Richard was not on the roster, but he spent his winters in San Diego in the office next to me. And I would come out, that was.
- [08:50]
A
Corruption at first sight.
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B
You corrupted me just way earlier. And so I would. We started chatting. Then I got a job at Carnegie Mellon. Afterwards, we kept in touch. And then I got a job offer at University of Chicago. And I think I got there in July 2020. I think within a few months, you gave me a call and said, hey, my publisher is asking I should freshen up the book, maybe give it a new preface. But I want to do something a little bit more ambitious than that. And we can play around with it, add some new things. It'll take about six months. Easy, easy work. We get to hang out. And I jumped at the opportunity. And then we kept talking. And then it grew and grew and grew. And that book is about 2/3 new content at this point. So it took five years of writing and going back and forth, and there's been 30 years of research since 1992. And so that's kind of the book. The original winner's curse is in there a little bit rewritten and freshened up. But the 30 years of research are now in there too. So every single anomalies column, there were new anomalies that were added to it that Richard had written afterwards. But also every single chapter comes with an update, basically reviewing everything that's happened in the last 30 years of behavioral econ.
- [10:10]
C
So I'm going to circle back to the book in a moment. But for people who are unfamiliar with Alex, this wasn't just a random kid next door. He wrote what could be one of the most cited finance papers of recent years called I'm going to get this wrong. Selling fast and buying slow. Is that right? Selling fast and buying slow. It's a chapter in my book, I've written about it. And you describe how professional fund managers are really, really good buyers of stocks. What turns out they're terrible sellers of stock. Nobody had discussed this in this sort of detail. And that's one of the reasons that paper has become so highly regarded. But I just wanted the audience to be aware of who you were. Tell us what it was like working on the book with Richard.
- [11:04]
B
It was just a lot of fun. I mean, we would get on the phone and why don't we talk about this topic. A lot of the research I took lead on the updates and we went back and forth on them. And then it was just a lot of conversations over the phone during COVID It was a lot of zoom. Then it moved on to we were colleagues at the University of Chicago coffees, just going back and forth on what should be included. Where a lot of it was about framing of where the field has come and what we kind of found out. I don't think this was obvious when we first started the book is that where the field has come has really gone from these lab experiments that were in the original columns in the winner's Curse, where it was college students, low stakes, maybe not even any stakes at all. And the pushback from the economics profession was, look, we don't really care about students, we care about market participants. The updates are all about look. All of these anomalies, as you mentioned, replicate in some of the most sophisticated economic participants out there, such as institutional investors, in the case of my paper.
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C
So there are some ideas in the book, endowment effects, status quo bias, the winner's curse that are today our everyday vocabulary. But back then people really didn't know about it. The whole book has aged fairly well. What do you think about those original ideas, Richard, and how they present in the modern world?
- [12:41]
A
Well, I mean, one of the motivations for writing the book is the so called replication crisis it's not really a crisis, but there has been several papers and several fields where the original experiments cannot be reproduced. Some of those papers are, let's say, adjacent to behavioral economics. I was worried that some of that bad aroma would rub off on us. I think the reason why things replicate so well is when I was choosing what topics to write about, I was picking big stuff. I wasn't picking some little minor thing. I was picking something with a very big effect size and topics. There had already been several papers. So it's not when we started this that we realized there really wouldn't be any problems. But we were pleasantly surprised not to find anything in the attic, so to speak.
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C
Nothing aged poorly?
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A
No, not really.
- [14:16]
C
What has persisted or if anything, have become more widely accepted today, that was a pleasant surprise amongst the chapters in the book.
- [14:30]
B
The Endowment Effect. Now, so, you know, back then, back in the 92 book, it was about mugs and pens. So the endowment effect is this phenomenon where, you know, buyers and sellers are in a market. The idea is that if you assign a good to a buyer or seller, there's a theorem in economics that underlies. Basically, that's one of the fundamental theorems in economics called the Coase Theorem. Basically, it means that it doesn't matter who's assigned property rights. There's going to be transactions where people. The person who wants it the most or values of the most is going to end up with it. And what Richard showed in a paper with Jack Netch and Danny Kahneman is that basically, let's say, Barry, you are sitting in a classroom. I'm sitting in a classroom. The professor gives me a mug and doesn't give you a mug. You have some money in your pocket, and he's asking what. What is the lowest amount that you would be willing to sell the mug? And he's asking you what's the most you'd be willing to pay for the mug? Because it doesn't matter. We were randomly assigned. We should have basically the same average valuation. But it turns out just because I own the mug, I start valuing it more. This is called the endowment effect. And what Richard and Danny and Jack showed is that it's about two and a half times more. So this. There's like a breakdown in the market because of this endowment effect effect. So what have we found? What has been documented thus far? There's a paper in the American Economic Review, the top journal in the profession, showing that there's an endowment effect for houses. And you can actually estimate exactly the amount of loss Aversion that people have which drives them to post. If they own the house, they post the house at a higher price. And the number, the actual quantitative number in housing markets, this is the crazy part about it, matches the number that Richard documented in the lab. So there's obviously a lot of back and forth between different experimentalists, different experiments and stuff like that. But even most of the quantitative magnitudes have been.
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C
It's robust. Let's talk about something that economic theory says shouldn't happen. Ultimatums and cooperations. Let's talk about the ultimatum game. Tell us a little bit about that.
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A
Okay, sure. So the ultimatum game is pretty simple. Let's say I give Barry $100 and I tell him that he's got to share it with Alex. He can make Alex an offer for some amount of the 100. You could give all hundred.
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C
Unlikely.
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A
Unlikely.
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B
I'll take it though.
- [17:07]
A
Alex gets to say yes or no. So it's an ultimatum. And if he says yes, deal. If he says no, they both get nothing. Now, that game was invented. It didn't really surprise us. It was invented because we kind of knew what was going to happen, which was so. But before that, let's say what does economic theory say and what does game theory say? Game theory says people are selfish. And Alex, if you offer him a dollar, don't insult him with a quarter or a penny. But if you offer him a dollar, $1 or something, and he knows a dollar is worth more than zero, so he'll take it. And you know that he knows that, and so you offer him a dollar and he takes it. No real world person has ever done that.
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C
Meaning in the lab experiments, what's the number? Under $20.
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A
Yeah. Offers less than 20% of whatever the pie is are likely to be rejected. Offers tend to be 50, 50. The profit maximizing offer is 40%. So we have two chapters that are about games, sort of like this. The big lesson is that in the world you're dealing with people and if you make insulting offers, they may get rejected. And if you want cooperation, you have to be cooperative. Let me tell you a story that's related to this. Years ago, my wife and I were in Thailand and we needed to take a cab, like a 20 minute ride, like three blocks here. But it was 10 miles in Chiang Mai, so. And everything is negotiated there. So I'm negotiating with this cab driver. And after wild negotiations, we agree on some fare, I don't know, $4. And we get to the restaurant. And then there was a question of how are we going to get back? And the cab driver said, would you like me to take you back? Notice there's a mutual risk of defection. He could not be there when we get done with dinner, or we could get done early and go back with somebody else. He proposed a contract that no economist would ever recommend. The contract was he said, don't pay me anything. Perfect. So when dinner's over, of course we went to look for this cab driver. We're not going to stiff the cab driver. And in fact, he dropped us somewhere else for some other same thing. Now, what's the lesson there? He knew that by being trusting, he would engender trust. And that's like a big important lesson both in business and in life and in politics.
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C
Coming up, we continue our live conversation with Dr. Richard Thaler and Dr. Alex Emis, both of the Booth School of Business at the University of Chicago, discussing the newest edition of their book, the Winner's Curse.
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As our use of AI expands, how do we make sure it doesn't end up breaking the Internet? I'm Hannah Fry, host of the Exponential Era, a series that explores the real world impact of future network technology. And I sat down with two experts to discover how we can support the massive connectivity needs of AI. Find out what I learned@Bloomberg.com Nokia.
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B
Hello and welcome.
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A
This is the Michelle Hussain Show.
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B
I'm Michelle Hussain. I speak with people like Elon Musk.
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A
I think I've done enough.
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B
And Shonda Rhimes.
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A
That's so cute. This will be a place where every weekend you, you can count on one essential conversation to help make sense of the world. So please join me, listen and subscribe to the Michael Hussain show from Bloomberg Weekend.
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B
Wherever you get your podcasts, you certainly ask interesting questions.
- [22:21]
C
I'm Barry Ritholtz. You're listening to Bloomberg's Masters in Business. Let's continue our live conversation with Richard Thaler and Alex Emis discussing the new edition of the book, the Winner's Curse. So let's talk about some other things within the book. The title, the Winner's Curse is really a fascinating story and leads so many places. Let's start off talking about oil leases. Tell us about the Winner's Curse.
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A
You want to go or you want me to go?
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B
You can do it. So.
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A
This is the only chapter in the book that the research, original research, was not done by psychologists or economists.
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B
The law of one Price.
- [23:12]
A
Oh, you're not counting financial economists as economists. And that gets back to Booth. You're going to be in a lot.
- [23:20]
B
Of I'm in a different part of the building.
- [23:25]
A
Finance is just a branch of economics. It's not its own field. We're both dabblers in finance. The research on this was done by engineers at Atlantic Ridgefield Arco. Here's what they found. They were bidding for oil leases in what I still call the Gulf of Mexico. What they found was that for the leases they won, there was less oil than they expected. They're thinking, we have great geologists, how can we be wrong? What's going on? And then they got an insight. The essence of the insight is that when you're in an auction, the ones you win are not a random sample of your bids. The auctions you win are when you bid high. Right now that sounds like a pretty obvious point, but it's not. Because if there are a lot of bidders. Let's suppose the version of this that we would run in classrooms is we'd have a jar of coins and we'd have people bid for the amount of money in the jar, not the coins. And what happens, the average bid is, let's say the jar is worth $100. The average bid is much less because people are risk averse, but the winning bid is always more than 100 because it's the most optimistic person or the person with the first eyesight or whatever. So this insight by the engineers applies everywhere. And contractors have either learned this or go out of business because when they're bidding on a job, low bid wins. And if you forget the roof or the H vac, you're going to go massively over. One of the interesting follow up experiments was to take a bunch of contractors and put them into one of these experiments and, and see what would happen. And the experimenters were a little worried that the contractors were going to take them to the cleaners, but they didn't. The reason is the contractors never understood the math of this. Instead they had a fudge. So they would figure out what they thought they could build it for and then add 25% and that covers the stuff they forget. But they didn't have that rule for bidding for jars. And so they were no better than the undergrads in the winter's curse.
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C
How has this held up since? What does the latest data on the winner's curse look like?
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B
Well, the winner's curse, as we discuss in the update, it's held up quite well as far as the experiment replicates. First of all, you run it in Harvard, you go into Econ 101 at Harvard, you auction Off a jar. Coins, they're going to be overbidding for the, for the coins. It's just, and then, you know, it's hold up, held up with NFL teams where you're, you're basically bidding for free agents and things like that. So it shows up in the data. And the big follow ups to the winner's curse has been the idea, the kind of abstracting from the phenomenon of the winner's curse, but thinking about like what leads to the winner's curse in the first place psychologically. And psychologically what leads to the winner's curse is you not taking into account that you're bidding against other people. You're not just kind of bidding alone. Oh, I think this is worth this much. That's how much I'm going to pay. Shading down a little bit. It's the fact that if I'm bidding with a lot of people, if I end up winning, that's real bad news for me because everybody else is just as smart as me and they're bidding with the similar information. And if I'm the one who's winning, I'm making a mistake. So you kind of have to bid down. And so the other follow up experiments have basically explored where this sort of phenomenon shows up in other places. So for example, one setting is kind of thinking about, there's the guessing game, the beauty contest game, which is meant to model from Keynes. From Keynes, exactly. So the follow up to the, the idea behind the winner's skirt. So Keynes had this model for the stock market where he said that the stock market is a beauty contest in the sense that it's not that the fundamental value of a stock would determine its price. It's what everybody else thinks the fundamental value is. It's all about the belief. So there was this. The reason it's called the beauty contest is the newspapers used to run these contests where you had a whole page of faces. And the winner of the contest was the one who chose the face that everybody else chose as well. He said the stock market's just like that. And so you run the beauty contest by saying something like, all right, guess a number between 1 and 100. The room guesses, everybody submits a guess, and the winner is the one who guesses 2/3 of the average. Now again, this game, think about it for a second. This game has an economic solution. And what's the solution we can do.
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A
Right now it's the New York Economics Club. Somebody should know. The Nash equilibrium.
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B
Anybody have a guess for the Nash equilibrium?
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A
Yeah, should be like 1 or 2%.
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B
Yeah, it should be 1. It should be 1.
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A
It should be 0 or 1. Yes.
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B
If the lowest number is 1, it's 1. And the reason is the following. Let's say I think I'm playing against a bunch of, you know, random people. They don't know what they're doing. They're guessing randomly. If everybody guesses randomly, the average is going to be 50. So I should do 2/3 of that. Right. But then I think, all right, if it's 2/3 of that, I guess that. Wait. Well, they're probably going to think the same thing. And so they're going to guess 2/3 of 50, so I should do 2/3 of that. But then I think, wait, no, hold on, hold on. I'm going to do two thirds of that and two thirds. Two thirds. Two thirds. I get to one. Right. So that's the Nash equilibrium solution. Would you win guessing one? No, you would not win guessing one, because other people are not guessing one. So the way that when you run this experiment, essentially what you see is the majority of people guess something like 50. Times two thirds, times two thirds. So they make it to level two and then they stop.
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A
I played this game once in the financial times with two business class tickets from London to the US as a prize, and the winning guess was 13. So there were lots of 0 and ones and they didn't win. There were a bunch of 99 and 100.
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C
They didn't understand the game.
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A
No, they were jerks trying to skew the numbers. Yeah, and they were all from Oxford and they were trying to pull it off. They weren't disguising. They all had the same dorm address, but it was one guest per person. So my TAs and I were the judges in this. We had 1300 entrants, but. Yeah. So again, this is the sort of thing that we can do in class. If you do it with MBA students, you're going to get a number in the teams.
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B
13, eight, something like that. The more so kind of, oh, I've taken Economics. They'll go like 8. Oh, I haven't taken economics 13. 16. So it's always above 1. And it just mattered. You can see these spikes in the data. That's the craziest part about it.
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A
So, you know, I've written a paper with one of my former students showing that the NFL draft is subject to this.
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C
Literally where I wanted to take this into the real world.
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A
You know, ESP is one of my. One of my skills, Barry.
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B
So.
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A
You probably are all familiar with the NFL draft, the end of the season, the worst team gets the first pick of the eligible players. What you may not know is there's a chart that the Dallas Cowboys first created, one of the owners that plots what somebody thought should be the prices to trade picks. So, for example, you can trade the first pick for the seventh and eighth picks or for half a dozen second round picks. And what we show in that paper is the early picks are massively overvalued.
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C
And where does the value show up? Round two. Round.
- [33:06]
A
Yeah, round two. Now, even bigger anomaly is you can trade this year's pick for next year. And the rule of thumb is if you trade a second round pick this year, you get a first round pick next year. So you move up one round per year. And we calculated that's a discount rate of 137%.
- [33:35]
C
Really? Why such a big discount rate?
- [33:37]
A
Because owners want to win. Now we have one former franchise owner in the room, and I'm pretty sure he didn't get his money by borrowing at 137%. NFL teams are even more expensive than NBA teams, but they still have that rule. And we're in the process of replicating that study. And it's all exactly the same.
- [34:13]
C
This conversation reminds me of the discussion that took place after Michael Lewis, Moneyball. So everyone's familiar with the book about the Oakland A's and how they brought a essentially behavioral, economic approach to selecting players. What happened after that book came out?
- [34:38]
A
Well, it's interesting. I mean, one thing happened is I got in touch with Michael Lewis and we didn't know each other at the time, but through his publisher or something, I said, if you're ever in Chicago, let me know. I'm there next week. And we've become very good friends and have come to realize that sports analytics and behavioral economics are the same field. It's trying. Why? Well, what was Billy Beane, who also lives in our Northern California, what was Billy trying to do? He was trying to buy a team more cheaply than others. It's just like being a portfolio manager. You're trying to buy undervalued stocks. He was trying to buy undervalued players. Michael got so interested in this, he. He ended up writing the book the Undoing Project, which is a great book. It's about my mentors, Danny Kahneman and Amos Tversky. He did stick an irrelevant chapter in the beginning about Daryl Morey, but that's good.
- [35:53]
C
But anyway, the line I was looking to pull from you is not for nothing. Michael, but what you're writing about, these two Israeli psychologists have been writing about and experimenting with for years, Moneyball directly led to your relationship with him and that becoming a book as well.
- [36:14]
A
Yeah. And I mean, it's about the biases from psychology and it's also about markets. Right. So the difference between behavioral economics and psychology is markets. So a psychologist would be interested in the fact that teams are overconfident in their ability to tell good players from bad. That's pure psychology. The fact that it gets reflected in the market for picks, that's economics.
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C
So let me push back a little bit on this and the winner's curse in that all the topics that you write about in the winner's curse, oil leases, where we don't know what the future oil production will be, first round draft picks, where we don't know how that player is going to perform. And in the markets, either picking stocks or picking fund managers to pick stocks or picking somebody to pick the fund managers in a fund to fund to pick stocks, they all seem to deal with, hey, we really are unaware of how this is going to play out, and we're making decisions under uncertainty. All of this comes back to Kahneman and Tversky. Well.
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A
I'm not going to disagree with that. Look, I became a behavioral economist when I discovered them. I claim that was my big discovery was discovering these two psychologists who were over in Israel that economists hadn't heard of. And I went and spent a year at Stanford where when I got wind that they were going to be there and basically stalked them.
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B
Well, a lot of the phenomenon, they go away when there's not a lot of uncertainty. The winners course needs uncertainty. If we know what the value of the plot is, there's no winners because it doesn't matter how many people are bidding if we know. So there's a famous anchoring effect, right? So if I. The anchoring effect is essentially, you know, you ask the question like how many countries there are in Africa before. But before I do it, I spin a big wheel. Right? The wheel has nothing to do with the question. And the wheel gets to like 17 or 8 or whatever. And it turns out wherever that number gets to affects how what number people guess about the number of countries in Africa. But if people know the number of countries, they're not gonna be affected by the wheel. Right. So all of this has to do. Almost every single behavioral economic phenomenon is bred and fed through uncertainty. And I think the way that people react to that uncertainty and shape their preferences and beliefs, that's where all the biases seep in in the first place. When experts know what they're doing, when they're, you know, they know the value of the plot, they know what you know, whether the stock is going to go up or down. There's not a lot of biases to talk about.
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A
You know, one aspect of this that surprised me is in, in the sports world, teams have learned, but really slowly. I mean, it's like shockingly slowly when the three point shot was introduced in basketball. Daryl Morey, I always tease him. He's the general manager of the Philadelphia 76ers. I always tease him that he was the first guy who figured out that three is 1.5 times two. So you should take three point shots because they have a higher expected value. Every team has somebody who can make 40% of their three point shots and they make about half their two point shots. But if you look, Larry Bird was really good at making three point shots and he took two or three a game. Steph takes 20. He's a little better than Larry Bird. But the. Now if you look at that trend, it's really shallow. And the same as football, teams have learned to punt less but go for.
- [40:32]
C
It on fourth down.
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A
They should go for it on fourth down. They get it right now half the time. And the closer they get to, if they get over the 50 yard line, they're more likely to get it right, but they're still terrible. So the learning is slow. And the reason is people don't like to look like foolish rules.
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C
There, there was a Wall Street Journal article about, I don't remember if it was a high school or a college coach who always went for it on fourth down.
- [41:03]
A
Yeah.
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B
And I love that guy.
- [41:05]
C
10, 10 years ago, right?
- [41:07]
A
Yeah. 20 years ago probably. He didn't have a kicker. He didn't have any. He didn't, he didn't, he didn't have a field goal kicker or a punter. Now it's, this is obviously the case for high school because think about, you gotta hike it back to some kid. He has to catch it, he has to put it down and then the other kid has to kick it. And the weather's lousy, so he just had no kickers and he was winning the state championship in Arkansas. I mean, not some place with lousy football. So teams get better, people do learn. But you know, people are always asking me what surprised me. What has surprised me is how slowly the learning has taken place in. Look, how long did it take? It's a World Series. How Long did it take them to add a pitch clock? Baseball had become unwatchable. They add a pitch clock, it cuts half hour off the game. You know, that's not a genius. They had a 24 second clock in basketball for 40 years. So they could have figured this out.
- [42:24]
B
But it's not just sports. I think the thing that economists push back with behavioral economics, it's people just don't have opportunities to learn. Right. In the endowment effect, if they trade enough, if people know what they're doing for long, even for a short period of time, they'll figure it out. These biases are gonna go away. That's the whole like, look, these are just confused subjects. They go to the market, they'll get some feedback, everything will be fine. But I think that's the biggest, I think with Richard being surprised, I think not just in sports everywhere, that these anomalies have held up and the fact that these anomalies are holding up in very, very experienced people. So in the paper with traders, we find that they trade really well when they're buying, but on the selling, they have to do a lot of selling. They sell all the time. They have to sell in order to buy. They sell all the time. Some of them have years, decades of experience and they're doing worse than random in their selling.
- [43:17]
C
Well, explain that because that was what was so brilliant about that paper. In order to figure out how well they sold, you guys came up with the solution of let's randomly sell anything else from that manager's holdings and compare it to what they actually sold. Right. So what are the results?
- [43:36]
B
The results are. So we basically said, look, we want to give these guys a large benefit of the doubt. We don't know what their conditions are. So we're just going to compare them to a very, very easy counterfactual. I don't know what they're facing. I'm just going to throw a dart in their portfolio and sell that instead. And they did worse than random. And basically what we found is that they were, they didn't have, they weren't spending a lot of time on the selling decisions. We interviewed them and we said, like, what are you guys doing? It's like, ah, selling is not really that important. It's not really an investment decision. And I'm like, you know, all right. I told my friends at the University of Chicago finance department, they were very surprised that selling wasn't an investment decision. And so they were just not really paying attention to it. So they were just selling the things that were very Very salient on their screens and the things that they were least attached to. So going back to the endowment effect, they were selling the things that they had recently bought. But if you're good at buying, that's not what you should be selling. You should be holding onto that for longer to get that alpha out. And we actually. We have a graph in the paper called, like, the alpha decay graph, and it was about nine months, and they were selling it around six.
- [44:50]
A
You know, we all have blind spots. You just wrote a book recently. You have a chapter on selling because of Alex's paper.
- [45:00]
C
Exactly 100%.
- [45:01]
A
If he hadn't written that paper, you wouldn't have had a chapter on selling.
- [45:05]
C
I would have had a different chapter. It wouldn't have been as good.
- [45:07]
A
Or there are no articles about selling. Basically.
- [45:12]
C
Very few.
- [45:13]
A
Very few. So if you look at the Journal of Finance or one of the other top journals, there'll be 100 articles of the form. Use the following three criteria to form a portfolio. Hold for one year, then sell. And these guys said, oh, maybe selling could be interesting, and they could maybe double their alpha if their selling decisions were as good as their buying decisions.
- [45:45]
C
Coming up, we continue our live conversation with Dr. Richard Thaler and Dr. Alex Emis, both of the Booth School of Business at the University of Chicago, discussing the newest edition of their book, the Winner's Curse.
- [46:13]
A
Are you looking for a new podcast about stuff related to money?
- [46:17]
B
Well, today's your lucky day.
- [46:19]
A
I'm Matt Levine.
- [46:20]
B
And I'm Katie Greifeld, and we are.
- [46:22]
A
The hosts of Money Stuff the podcast. Every Friday, we dive into the top stories about Wall street, finance and other stuff.
- [46:30]
B
We have fun, we get weird, and we want you to join us.
- [46:33]
A
You can listen to Money Stuff the Podcast on Apple Podcasts, Spotify, or wherever you get your podcasts. Foreign.
- [46:46]
C
I'm Barry Ritholtz. You're listening to Bloomberg's Masters in Business. Let's continue our live conversation with Richard Thaler and Alex Amos discussing the new edition of the book the Winner's Curse. Well, we talked about this last time we discussed this issue. The buys are very quantitative and rigorous. The cells are just squishy. And every emotional bias that comes in, oh, this is starting to falter. It's not doing what I expected. Something else shiny comes along and it catches their attention. They need to make room in the portfolio. You mentioned blind spots your friend Danny Kahneman used to talk about. I asked him on occasion, how do you avoid all of these biases? We all succumb to and he's like, I'm subject to every one of them. We all have a bias blind spot. There's no getting away from it. Is there hope for us?
- [47:47]
A
Well, the only way you can learn anything is feedback. And most of us don't bother, so we don't get the feedback. And you know, when, when my friend Cade, my former student that I did the football paper with, we were hired for a while by one of the NFL teams. And they're showing us around their facility and we go and there's some room about the size of this, full of file cabinets. And we say, what's in there? Oh, old scouting reports. Our eyes are getting big, you know, like. Well, have you ever studied those? No. Right. So, you know, they have probably 20 scouts going around watching games. They've built a $2 billion Taj Mahal Stadium. But do they invest a little research in improving the process of picking players? No. And I must say, most firms are not that much better, really. Well, firms still do interviews. Interviews.
- [49:16]
C
Symphonies are doing blind auditions.
- [49:18]
A
Yeah. But they still listen.
- [49:23]
C
Yes.
- [49:23]
A
So arguably interview look. And I think a great musician can hear whether you're playing well or poorly. Learning anything useful about how somebody is going to do on the job from the usual job interview is very difficult.
- [49:47]
B
One of our postdocs actually has a paper Brian Jabarian on. So he worked with a company in the Philippines. They replaced all first round interviews with artificial intelligence, and retention ended up increasing. Basically, they were able to extract the signals that they needed to extract at that stage and that humans were missing.
- [50:06]
C
So let's talk about this before we're going to open this up for questions in a minute, but let's talk about that sort of choice architecture. And I just have to share some numbers with people as to how significant this could be. Richard's book Nudge described a variety of different ways to affect decision making. Perhaps the most significant was when you open a 401, there's no obligation for you to participate in the company. When money goes into it, there's no obligation to put that money to work. And Richard convinced the SEC and the government to change that so that the default is that you're assumed to participate and the money goes into some qualified fund, either a balance fund or a target date fund. And to just put some flesh on how significant that is, the US's 401k, not counting today's trading action, is $4.7 trillion. Historically, 40% of that was defaulted to cash, which means there's $2 trillion being invested today. That otherwise would have been sitting around in cash for God knows how many years. So given what we know about choice architecture, how should we be addressing choices and options? Whether it's in hiring or putting money to work or bidding in auctions, what should we be doing better?
- [51:40]
A
I mean, there's so, you know, on the retirement saving thing, we did three things. One was change the default and we had to get congressional approval for all of this because companies said, oh, if we enroll somebody without their permission, some lawyer is going to sue us as soon as the market goes down. So we were able to get a bill passed in 2006 that said it was okay to automatically enroll. It was okay to invest in something like a Target date fund, even though it could go down. And it was okay to slowly ramp up their contributions. What I call save more tomorrow because we all have more self control next week. So that, you know, those three ingredients were important. Maybe that 4 trillion is twice what it would have been without it. It's not easy to just say, what can you do to solve obesity or some other problem? My mantra is make it easy. If you want people to do something, make it easy. I always say what I would like is a world that's like gps. I have a terrible sense of direction and now I don't get lost, hardly ever. Right. And notice the GPS doesn't tell you where to go. You had the wrong address coming tonight, but I plugged in the right address and well, I just had to walk down fifth Avenue, but even I could do that. But right. So for complicated things like improving your diet or exercising more or whatever problem you're trying to solve, you have to figure out what's preventing people from getting it right and then eliminate that. When David Cameron was elected prime minister and in the uk he had, get this, they don't have platforms, they have manifestos. And they had told me that they were going to put in their manifesto that if they got elected, they were going to create a nudge unit. And I said, yeah, yeah, because I'm used to the us but they did it and they called me up and said, hey, we're starting this thing. You better come over and figure out how to do this. And the main lesson I learned was we go to the branch. One of the things we did was we changed the way they dealt with people who owed money on their taxes. And I said, what do you do? Well, we send a letter. What does the letter say? Oh, well, they showed us the letter. Oh, I think we can improve the letter. And we told them truthfully. 90% of people paid their taxes on time. That increased the speed. So brought in money very fast. Cost nothing, Right? They're sending the letter. It doesn't cost any more to write a good letter. But you have to, you have to talk to the experts and understand what it is that's preventing them from doing the right thing and then make it easy for them to do that.
- [55:52]
C
Right? Remove the obstacles, make it easy. All right, so we have a few more minutes. Let's get some questions. Can I see some hands? Wait for the mic. Let's start right up front and work our way back.
- [56:05]
B
Thank you so much for super interesting discussion. I'm curious. Robert Oman has a theory that says that reasonable people can't disagree. And I'm curious, like, how you would relate that to the winner's curse. And if you've ever had a discussion.
- [56:20]
A
With him about that, reasonable people can't disagree.
- [56:24]
C
He's never been online.
- [56:25]
A
I mean, you know, Alex and I are both extremely reasonable. We disagree, we disagree on all kinds of things.
- [56:34]
B
Well, his theorem is basically, if you have the same information set, you have to arrive at the same beliefs. You don't even need the same information. You have need common knowledge.
- [56:45]
A
You need common knowledge of each other's rationality.
- [56:48]
C
You don't need.
- [56:51]
B
And then you arrive at the exact same posterior belief.
- [56:55]
A
Right?
- [56:55]
B
But the problem is that people have confirmation bias in the real world, right? So they seek out information that confirms their beliefs. So they end up, not only. They basically end up in completely different worlds thinking that they're rational and somebody else who's not agreeing with them is irrational. And that if you go back to Robert Auman, that breaks that condition for being able to agree. So one of the things about the Internet age and the digital transformation is that, look, if you read the texts of what technologists were writing, we're going to be in a utopia. Millions of Library of Alexandria is at our fingertip. Everybody will have all information at the same time. We should all agree, right?
- [57:40]
A
But we're not there yet.
- [57:43]
B
We have all the information. We are there yet. But what ended up happening.
- [57:47]
A
But we are not all agreeing.
- [57:48]
B
But it's because people are seeking information that confirms their priors and confirms the priors of the people that they're the. And because you can't think that your prior is wrong, if you could, if you meet somebody with a different prior or a different belief, you assume that they are irrational. And then we're not going to agree. I'm going to hold on to My belief you're going to hold on to your belief. And the more this kind of ramps up the ability to endogenously gather information and the feeding of that process from the information providers gets worse and worse.
- [58:21]
C
The fascinating part about the stock market is all the economic data is out there, all the market analysis is out there. Bulls and bears go out and they find what supports their view. They rarely seek disconfirming advice. And hey, trade is where there's a disagreement on value, but an agreement on price. And it's all the same information people cherry pick.
- [58:45]
A
And perhaps the biggest anomaly in financial markets is the volume of trade that.
- [58:50]
B
People are trading in the first place.
- [58:53]
A
That's the counter example. How can we have a trillion shares traded if everybody agrees? Yeah, the mic right behind.
- [59:06]
B
So this is actually a related question. You wrote a paper in 1997 on the equity premium puzzle. You finished it by saying you have any issues with this, call me in 2017. So 2017, two fourth years at the University of Chicago who studied economics emailed you trying to call you on your bluff. You met with them, which me and my now husband do appreciate and we both work in finance now. And I am curious especially you mentioned the volume of trading democratization of trading Robinhood traders as you were refreshing this book. More broadly, how has technology changed or magnified some of the behavioral econ effects that you were writing about in 1992?
- [59:49]
A
So of course I vividly remember this. And there's a bridge over near Brooklyn. So you're right, there was a chapter. It wasn't a chapter in the original book, but I did write a column on the equity premium puzzle and then a paper about it and we talked about whether to include it. Instead we just have a couple pages saying the Equity Premium is within 1% of what it was when the first paper was published. It's going from seven down to six or something like that. It didn't seem worth a chapter, but.
- [60:33]
B
It is in the appendix.
- [60:34]
A
But I'll let Alex, who's the now part, talk about the technology.
- [60:41]
B
Yeah, so I think you mentioned the democratization of finance and I think there was this hope that again people have access to basically there's no transaction fees, you log onto your phone, you have access to these equities and financial products that you didn't have access before. So now everyday people can get a piece of the pie. They can get a piece of the real growth of the economy. So some of our colleagues wrote a paper at the University of Chicago recently. I think he came out this year doing an audit of what people are trading on platforms like Robinhood. They're trading weekly options and they're losing billions of dollars. I think within the last two years they lost $6 billion. Right. And so. And why is that? Well, the same sort of biases that you have that you're documenting in the lab, that you document in the field, they're on steroids in digital spaces. Right. What is Robinhood doing? Where is it making its money? Because Robinhood does make money. It's making it on spreads. Right. And the widest spreads are crazy instruments like options that get generate these lottery like returns that we know human people are really attracted to. And so it's making money off of behavioral biases and people are losing a lot of money on it.
- [61:59]
C
So it's not even the weekly options. It's the single day options now have become the biggest volume.
- [62:05]
A
Right. And of course, pure gambling, sports gambling is even worse odds where you can.
- [62:14]
C
Bet on every play, not even the outcome of the.
- [62:18]
A
Well, and now they're learning that these, these bets on what a specific player does, they've got to get rid of those because there's just gonna be too many scandals.
- [62:30]
C
That was my live conversation with Richard Thaler and Alex Emis. Be sure and check out the full version of this coming sometime in the coming months. I would be remiss if I didn't thank the crack team that helps put these conversations together. A special thanks goes to the Economic Club of New York for hosting this event. My audio engineer is Justin Milner. Anna Luke is my producer. Sean Russo is my researcher. I'm Barry Ritholtz. You've been listening to a bonus live edition of Masters in Business on Bloomberg Radio.
- [63:16]
B
Ah, greetings from my bath festive friends. The holidays are overwhelming, but I'm tackling this season with PayPal and making the most of my money. Getting 5% cash back when I pay in 4. No fees, no interest. I used it to get this portable spa with jets. Now the bubbles can cling to my sculpted but pruney body. Make the most of your money this holiday with PayPal. Save the offer in the app ends 1231.
- [63:40]
C
See paypal.com promoter points can be redeemed for cash and more pay and for subject to terms and approval.
- [63:44]
A
PayPal Inc. And MLS 910457. Are you looking for a new podcast about stuff related to money?
- [63:51]
B
Well, today's your lucky day.
- [63:53]
A
I'm Matt Levine.
- [63:54]
B
And I'm Katie Greifeld and we are.
- [63:56]
A
The hosts of Money Stuff the podcast Every Friday we dive into the top stories about Wall street, finance and other stuff.
- [64:04]
B
We have fun, we get weird and we want you to join us.
- [64:07]
A
You can listen to Money Stuff, the podcast on Apple Podcasts, Spotify or wherever you get your podcasts.