CHAPTER 6 Why Envy Explains More than GreedRead more at location 2143
Note: 6@@@@@@@@@@@@@@@@@@ RAGIONI X PRIVILEGIARE LA SPIEGA DELL INVIDIA. L INVIDIA RENDE IL ROSCHIO CONTESTUALE Edit
a relative utility function can explain the general absence of a risk premiumRead more at location 2146
6.1 Robust Hard WiringRead more at location 2153
Note: HARD WIRED... AVVERSIONE IMPLICA UTILITÀ DECRESCENTI MA QS NN È IL CASO. SOLUZIONE: UTILITÀ RELATIVA Edit
evolution favors a relative utility function as opposed to the standard absolute utility function, and the evidence for this is found in psychology, ethology, anthropology, and neurology.Read more at location 2155
The instinctive utility that guides individual decisions under all time periods is presumably the same.Read more at location 2158
It seems reasonable to assume the fraction of investor portfolios allocated to risky assets has remained stableRead more at location 2160
This is necessary if real interest rates are constant over the past century, as most researchers believe.Read more at location 2163
This specific utility function is necessary so that when we think of a risky investment today, it means about the same thing as a risky investment to our grandparents.Read more at location 2166
Matthew Rabin highlighted that any risk-averse utility function extrapolates poorly. He proved that any person who turns down wagers where he stands to lose $100 or gain $110, each with 50 percent probability, must also turn down 50–50 bets of losing $1,000 or gaining any sum of money.Read more at location 2168
The downside is so much more curved than the upside that the differences in utility on the upside basically become indistinguishable above a certain point, where having $1 million or $1 billion would feel the same to someone currently with only $10,000.Read more at location 2176
The objective you face is to give these agents a goal, such that they are motivated to be fruitful and multiply over generations.Read more at location 2183
you can add a mechanism so that agents feel hungry if low on calories and lustful when in the presence of mating opportunitiesRead more at location 2184
you don’t want these agents eating or having sex so much they ignore everything else, such as taking care of their children,Read more at location 2185
a governor that signals the desire to want more “stuff”, which ensures that these beings don’t become lazy and unproductive once basic levels of material wants are satisfied,Read more at location 2187
even though compared to average wealth at the start of their existence, they are all fabulously wealthy compared to ancestors five generations prior.Read more at location 2188
The CRRA utility function is needed so we allocate about the same amount of our wealth to risky assets over generations but implies we should be at a much higher level of happiness relative to our grandparents, which seems counterfactual (see section 6.2 below on the Easterlin paradox).Read more at location 2192
A solution that would generate a more stable level of overall happiness, and still incent them to better themselves, would be to have a little governor that simply says try to be above average, to have a higher percentile of wealth among your peers.Read more at location 2194
A relative-status utility function is more of an evolutionary stable strategy than an absolute functionRead more at location 2200
In a similar way, our sensitivity to wealth would be much more robust if we made sure agents merely monitor their relative output, not absolute.Read more at location 2209
Like God setting up the laws of the universe and letting them run, here the designer merely has humans want to do better than their peers, and they will continue to build, create, and multiply regardless of the technology shocks they face.Read more at location 2211
Biologists Insel and Fernald (2004) argued that because information about social status is essential for reproduction and survival, specialized neural mechanisms have evolved to process social information,Read more at location 2215
Neurologists have done experiments and found thinking about other people is biologically concentrated in a specific area of the brain (the right temporo-parietal junction), and damaging this region diminishes one’s ability to empathize and this is profoundly debilitating.Read more at location 2218
In the late 1980s, researchers discovered mirror neurons that fire both when an animal acts and when the animal observes the same action performed by another.Read more at location 2222
In the book I’ll Have What She’s Having, the anthropologist authors argue that we mostly copy everyone else: first our parents, then our peers, then anyone who seems to be doing well.Read more at location 2227
Mark Pagel takes this a step further by stating emulating others is the basis for almost every idea we have,Read more at location 2230
Most innovators spend their formative years producing derivative work: Bob Dylan’s first album contained 11 cover songs, comedian Richard Pryor began his career doing imitations of Bill Cosby,Read more at location 2234
anthropologist Dan Brown documented a concern for status (what I am calling envy) as a “human universal”—whereas greed is not.Read more at location 2239
Status relates to longevity and health, even when factors such as income and education are controlled for.Read more at location 2241
Lastly, greed and envy are in the seven deadly sins, but envy is more prominent in the Ten Commandments.Read more at location 2244
A fundamental problem with the standard utilityRead more at location 2247
The Easterlin paradox (1974) highlighted that although within a society rich people are happier than poor people, rich countries are not much happier than poor countries,Read more at location 2249
as a population gets richer, they do not get happier.Read more at location 2250
A good example of this is Japan, where per capita income rose 500 percent from 1958 through 1987, yet there was little change in subjective well-being.Read more at location 2251
Chinese real income has risen 250 percent from 1994 through 2006, and surveyed happiness actually declined.Read more at location 2252
Most Western countries experienced 200 percent growth in per capita income from 1960 through 2007, without any obvious increase in happiness.Read more at location 2253
Easterbrook’s The Progress Paradox, David Myers’s The American Paradox, and Barry Schwartz’s The Paradox of Choice,Read more at location 2255
Studies using functional magnetic resonance imaging (fMRI) to monitor brain activity found that social context is an important factor in processing rewards.Read more at location 2261
It is important to note that Wolfers and Stevenson (2008) dispute the assertion that happiness has not increased over the past one hundred years,Read more at location 2265
noticing that the wording of the question has changed over the decades.Read more at location 2266
If you adjust the time series for the way the question is worded, they found that happiness in Europe and Japan has significantly increased.Read more at location 2269
even Wolfers and Stevenson still conceded that in the United States, Korea, and China, happiness has not trended upward over the past thirty-five years,Read more at location 2270
taking a view of the broader scope of data and then looking at the best underlying narrative is so important, because the data are never definitive within one case, regardless of the power of the statistical technique.Read more at location 2274
It is clear from extreme examples such East and West Germany and North and South Korea that individualism is more efficient than the more materially egalitarian socialist economies.Read more at location 2279
classicist Moses Finley liked to say, all revolutionary movements had a single program, “cancel the debts and redistribute the land,” the ultimate economic equalizer.Read more at location 2281
Anthropologist Christopher Boehm at UCLA notes that dominance hierarchies are a defining characteristic of every known civilizationRead more at location 2284
It is a curious fact that dominance hierarchies are rare in the ethnographic literature describing hunting-and-gatheringRead more at location 2286
all the lesser males in a group who were in danger of being dominated by an alpha male would form a reverse dominance hierarchy to put the would-be tyrant in his place.Read more at location 2291
In this way, dominance behavior, though not eliminated, could be moderated and dispersed. Unlike gorillas, humans can do things such as get up in the middle of the night and use a spear to dispatch the most physically intimidating personRead more at location 2292
Leaders generally maintain their positions not by dominating but by consolidating majority opinion.Read more at location 2294
As anthropologist Harold Schneider put it, “All men seek to rule, but if they cannot, they seek to be equal.”Read more at location 2297
!Kung bushmen will mock the gift of someone because they see gift giving as an attempt to signal superior status.Read more at location 2298
Politics is fundamentally about redistribution and efficiency, usually with the latter a pretext for the former because no one is against efficiency.Read more at location 2302
The focus on outcomes and not rights is based on the idea that the market is generally a rigged game, and people become unequal mainly through forces beyond their controlRead more at location 2304
top-down directives are generally even less fair for reasons outlined by Friedrich Hayek among others.Read more at location 2306
Many people are bored by talk of utility and philosophy but readily understand benchmarking. In equity mutual funds, the practice is taken as a given—the top funds are generally given top honorsRead more at location 2309
obvious that adding market timing to stock selection was an inferior strategy. In the index next toRead more at location 2312
if everyone is benchmarking, the result is no general risk premium,Read more at location 2314
Markowitz said, “Let’s look back at the last bubble—the tech bubble. People would look around and see other people making money much faster than they were, so they decided they would imitate them—a natural thing.”Read more at location 2327
In other words, all the key academics who developed the standard model act as if they were maximizing a relative status utility function, not the one holding up their seminal papers.Read more at location 2330
risk, intuitively, is a return relative to a benchmark.Read more at location 2332
6.5 Virtue Always in ModerationRead more at location 2334
Risk taking is synonymous with the virtue of courage.Read more at location 2335
Most courage is not related to physical courage today because warfare and violence have decreasedRead more at location 2336
courage is even more needed intellectually when we reject the opinions of others. Often this puts one in the position of being a crank, like those who think the moon landings were faked, but other times we have heroes like Nikolai Tesla, who fought the famous Thomas Edison advocating the more efficient alternating over direct current.Read more at location 2337
The four classic virtues are temperance, prudence, courage, and justice,Read more at location 2344
Roman Stoic Seneca argued that all virtues are the result of prudence.Read more at location 2347
Aristotle defined a virtue as a balance point between a deficiency and an excess of a trait.Read more at location 2350
Tolerance is a virtue, but too much tolerance can show a lack of integrity or courage.Read more at location 2352
different virtues conflict at extreme points, which is why Plato stated that virtues cannot exist independently but rather like the ingredients that make a cake: all in the right amounts.Read more at location 2357
There does appear to be a large wage premium differential for college graduates—about 80 percent—though it is unclear whether this reflects signaling or true increases in value. Nevertheless, this income correlation breaks down at higher levels, where PhDs involve another five years work without much increase in earnings compared to stopping at a bachelor’s degree.Read more at location 2363
Consider anger. Aristotle noted that being angry was easy, “but to be angry with the right person and to the right degree and at the right time and for the right purpose, and in the right way”, is not easy.Read more at location 2370
An example of how a virtue as an explanation wealth can be wrong is the premium to courage that supposedly explained the natural position of the aristocracy.Read more at location 2373
aristocracy prior to 1900 generated their legitimacy via their willingness to lead groups into battle, often needlessly.Read more at location 2378
While they subsequently lost proportionately more of their sons than those of other classes in WW I, the decline of the aristocracy continued unabated after the Great War.Read more at location 2380
The lower classes felt no sense of gratitude toward the aristocracy, having lost enough themselves.Read more at location 2382
Battlefield courage is admirable, but it is not sufficiently rare to generate privileged status;Read more at location 2383
many would accept a probability of death for such success, so this “courage premium” was not a real equilibrium result, as WW I showed.Read more at location 2386
Courage was a necessary, not sufficient, condition for acquiring power. Similarly, risk taking is a necessary condition to achieving riches, but that does not logically imply a positive general relation.Read more at location 2387
In standard financial theory, if you take risk, on average you will get rich quicker than others,Read more at location 2389
A lot of our bad intuitions arise from bad analogies, and here the analogy is that because risk taking at some level has a positive return, it generalizes to any level of risk taking.Read more at location 2394
Consider that professional athletes are both wealthy and risk takers. They have high levels of testosterone, which is correlated with higher-than-average financial risk taking.Read more at location 2397
The New York Times estimated that 60 percent of NBA players are broke only five years after retirement, even though the average salary was $5.85M in 2009.140 If mere risk preferences were sufficient, they should have above-average returns, but in reality their poor returns are what happens when risk taking is combined with a lack of prudence.Read more at location 2402
That is, framed probabilistically, the lower the cognitive score, the greater the chance of not accurately framing expected values.Read more at location 2408
This suggests less intelligent people will make more analytic mistakes,Read more at location 2409
They found that IQ was positively correlated with equity market participation, and higher IQ investors tended to be more diversified with lower beta stocks.Read more at location 2412
If risk were the mere pain of loss, the same pain experienced by others, it would be a lot like exposing oneself to working in smelly occupations.Read more at location 2417
Yet septic tank work does not pay well, and the untouchables in India have long had a monopoly on cleaning sewers manually without much compensation; people get used to a lot of things.Read more at location 2418
As Dan Pink noted, researchers have documented that monetary incentives work pretty easily for straightforward mechanical tasks such as keeping one’s hand in hot water for extended periods, while monetary incentives tend to not work well for creative goals.Read more at location 2420
Society does not pay people merely for exposing themselves to bad things such as death, smelliness, or portfolio volatility.Read more at location 2423
Just like all the other virtues, risk must be pursued with moderation and prudence applied to the trade-offs with other virtues.Read more at location 2424
If we do not see risk premiums in general, rather than piecemeal explanations a more parsimonious solution is to change this fundamental assumption.Read more at location 2428
The movement from greed to envy or from absolute to relative wealth can get you there.Read more at location 2429
only the relative wealth assumption is consistent with a missing risk premium.Read more at location 2433
Relative utility seems more evolutionarily robust, more consistent with what makes us happy, more consistent with ubiquitous benchmarking, and more consistent with research from neuroscience, ethology, anthropology, and psychology.Read more at location 2433
The standard utility function, with its implication of a linear reward function, would be unprecedented within the context of all our other virtues.Read more at location 2435
CHAPTER 7 Why We Take Too Much Financial RiskRead more at location 2437
Note: 7@©©©©©©©©©©©©©©LA NATURA CI VUOLE RISK TAKER I SETTE MOTIVI CHE CI ONDUCONO A PRENDERE RISCHI OVERCONFIDENCE PREFERENZE IDENTITÁ INNAMORAMENTO FAMA FUND MANAGER TOP TEN SEGNALARE ABILITÀ INFORMAZIONE ANEDDOTO ASTA MODA 1) MOTIVI IDENTITARI 2) OVERCONFIDENCE 3) CONOSCENZA ANEDOTTICA 4) VOGLIA DI SEGNALARSI 5) NATURA MASCHILE. RISCHIO SENZA ABILITÀ 6) ASTA 7) VOGLIA DI GREGGE Edit
If risk taking did not pay off, presumably no one would do it because, by definition, risk is something we do not like.Read more at location 2439
Risk taking, however, is unavoidable, and it does pay off, just not in the way implied by the standard model, where incremental amounts of risk taking, which is the same for everyone, pays off.Read more at location 2441
Consider the optimal stopping problem,Read more at location 2442
Assume you are looking to get married and have kids, and your lifetime and fertility are finite.Read more at location 2444
The question is about the optimal strategy (stopping rule) to maximize the probability of selecting the best mate,Read more at location 2447
your choice relative to the optimal choice seen by an omniscient deity is invariably inferior.Read more at location 2451
Both choosing to move on or staying with what you have involves risk; risk cannot be avoided.Read more at location 2452
historically, 80 percent of females have reproduced, but only 40 percent of males have passed on their genes. The rest of the males have been genetic dead ends.Read more at location 2456
Males have to beat out other males to get access to females. Thus men built ships and traveled to far-off lands because those were the guys who had more children, whereas a bunch of women could bear children just as easily staying put.Read more at location 2459
Everyone’s male ancestors have been disproportionately risk takers;Read more at location 2461
not taking risk is genetic suicide,Read more at location 2462
Risk takers dominate our lives via their disproportionate effect on our genes and their influence on our technology and culture.Read more at location 2463
One might say this is not relevant to markets where rational traders at the margin determine prices and returns.Read more at location 2469
stupid investors do influence equilibriumRead more at location 2471
given the multidimensional complexity of any asset class, where different trading tactics and complementary positions generate very different returns,Read more at location 2472
The economist Robert Aumann discussed the difference between rule and act optimality and gave the following example.148 In the ultimatum gameRead more at location 2475
Most people reject an offer less than 20 percent of the pool. Economists see this as irrational because there is no upsideRead more at location 2480
but Aumann sees it as rational in the general sense that one does not want to appear a chump, even if the appearance is just to oneself. The chump rule overrides our act rationalityRead more at location 2482
humans have evolved to follow rules, as it is simply too costly to go through life without such heuristics.Read more at location 2483
People have an intuitive rule that risk taking is good.Read more at location 2487
People should see risk taking as a process of self-discovery, becoming the best you can in that which you are best suited.Read more at location 2489
If some risk taking demands nothing of you other than willingness, it is surely foolhardy because such willingness is hardly in short supply, so these types of risks do not generate higher-than-average-returns as a general rule.Read more at location 2491
Textbook investment choices are usually completely defined and reducible to simple logic.Read more at location 2497
Yet it is precisely because real risk taking is quite different, making different decisions than the consensus based on a radically different interpretation of the objective odds implicit in the investment, that we experience anxiety.Read more at location 2500
In practice, financial risk taking involves a great deal of anxiety, not about the realization of objective odds but rather sensing whether or not one has correctly ascertained the correct odds, what is called “ambiguity aversion.”Read more at location 2502
Note: NON È LA PRESENZA DI UN RISCHIO A RENDERCI ANSIOSI MA LA POSSIBILITÀ DO DEC IDERTE MALE. SE SCELGO SU UN DADO SONO MENO ANSIOSO Edit
Classic investors like J.P. Morgan and Benjamin Graham distinguished between gambling and investing, the former being simple exposure to randomness, the latter something amenable to special insight and intuition.Read more at location 2506
Economists have long known the behavioral implications of the CAPM were incorrect. Investors are underdiversified,Read more at location 2509
25 percent of investors have only one stock, and more than 50 percent owned fewer than three stocks.Read more at location 2511
consider that brokerages recommend only stocks with above-average returns.Read more at location 2513
In practice, no one, not even the high priests of this view, act as if their theory were true whenever they discover a higher-than-average returning strategy.Read more at location 2529
doing things that generate above average returns because of perceived systematic errors made by the masses.Read more at location 2532
Of course such person could be making an error himself, which is why these choices produce anxiety;Read more at location 2533
Below are the several reasons that could explain this preference for highly risky assets.Read more at location 2540
The “wisdom of crowds” applies to the means,Read more at location 2542
In the 1950s, they came up with the term “winner’s curse” to describe the fact that for auctions of offshore oil fields, winners were generally cursed by winning.Read more at location 2545
If we assume that the average bid is accurate, then the highest bidder overestimates the item’s value. Thus the auction’s winner is likely to overpay.Read more at location 2547
Over time, Miller’s winner’s curse argument has become more popular for several reasons.Read more at location 2558
Interestingly, Ed Miller was the first to emphasize the efficacy of low-beta investing in a Journal of Portfolio Management article in 2001, noting that if the winner’s curse was responsible for the poor performance of high-beta stocks; the risk-reward ratio for low-beta stocks was obviously higher.Read more at location 2565
The effects of the winner’s curse or any of the following theories that lead to higher demand for volatile assetsRead more at location 2572
Perhaps the most celebrated overconfidence anecdote is Svenson’s (1981) finding that 93 percent of American drivers rate themselves as better than the median.Read more at location 2579
94 percent of college professors think they are above-average teachers;Read more at location 2581
90 percent of entrepreneurs think that their new business will be a success; 98 percent of students who take the SAT say they have average or above-average leadership skills.Read more at location 2582
Barber and Odean (1999) used overconfidence to explain why men, who psychological studies show are more overconfident than women, trade too much.Read more at location 2584
People who think they are better than average at stock picking or picking mutual funds, will necessarily focus on the highly volatile stocks that generate better rewards for their prescience:Read more at location 2586
This involves constantly inflating our achievements and abilities and rationalizing our mistakes. For example, he noted that children not only lie, but lie more the higher their IQ.Read more at location 2593
Economist and Psychologist Danny Kahneman states this is the one bias he most wants his children to have because of its myriad benefits.Read more at location 2601
Friedman and Savage (1948) were the first to really apply utility functions to financial decision making, and, interestingly, it was not the concept risk aversion that they concentrated upon but rather the paradox that people liked to gamble and buy insurance.Read more at location 2609
Such a utility function is also present in Kahneman and Tversky’s prospect theory,Read more at location 2612
Consider that one of prospect theory’s key implications is that our aversion to losses is much stronger than our enjoyment of gains: the basic frame for our utility functions is at our current wealth, whatever that is. On its face, this suggests not so much risk loving but loss hating,Read more at location 2617
This makes people willing to pay for insurance to avoid big losses, and also why they gamble, because they overweight the small probabilities of winning large amounts.Read more at location 2619
Risk loving shows up in the literature on skewness preference, where investors presumably pay a premium for assets with right (up) payoff skewness.Read more at location 2622
Risk loving and overconfidence are difficult to distinguish in practice, as they both would explain why people prefer highly volatileRead more at location 2630
Stocks with higher volatility generate more news than less volatile firms.Read more at location 2641
Stocks that are in the news generate lots of information that fiduciaries can use to sell their ideas to clients.Read more at location 2642
it is much easier to talk about something in the news than something where everyone is fairly ignorant,Read more at location 2644
institutional preference could be it is easy to form an opinion on companies that are moving around, generating lots of commentary and analysis.Read more at location 2648
Objective tests serve two purposes: to inform the test taker and those observing him. To outsiders, this is signaling and serves as useful information as to whether this person should be entrusted with greater financial responsibility,Read more at location 2657
to see if an investor is able to generate a superior return. That is, does she have alpha? Many people believe they have an ability to pick stocks successfully.Read more at location 2660
if people believe that their short-run performance signals alpha, that information would be considered valuable regardless.Read more at location 2662
This biases investors toward the more volatile assets so they can assess their investing alpha more clearly,Read more at location 2663
Many people trade as if they might have alpha.Read more at location 2664
The idea is base rate information is neglected in a Bayesian sense relative to the ease to which some anecdotes are recalled.Read more at location 2669
Almost by definition, any stock that rose tenfold was highly volatile over much of its meteoric rise. This is implied in the saying, “To get rich, you have to take risk.”Read more at location 2671
The problem with this thinking is that one needs to find all the stocks that were like Apple in 1977 or Microsoft in 1986,Read more at location 2674
Steve Jobs and Bill Gates, both of whom dropped out of college, also contain this bias. CertainlyRead more at location 2677
People under the presumption that risky assets are in the class of assets that makes people rich are operating under this bias.Read more at location 2680
The flow of investor funds is a highly convex function of fund performance: really high for the top decile but then evening out to almost indifference below the 50th percentile, rather like a call option.Read more at location 2684
The nature of this call-option type mechanism is highlighted by the standard nature of quarterly and annual reviews of portfolio managers. Generally, a top ten list is created based solely on returns.Read more at location 2692
Bloomberg Magazine actually highlights analysts by their most profitable picks,Read more at location 2695
Those uncertain choices we make with incomplete information are not confined to finance, and indeed surveys show that the most prominent regrets in people’s lives are not portfolio choices but choices about careers, romance, and parenting.Read more at location 2703
