Human Decision Making - Statman Chapters Flashcards
What are the three kinds of knowledge?
- Financial facts knowledge (financial markets, benefits of diversification, …)
- Human-behavior knowledge (wants, cognitive shortcuts, emotional shortcuts and errors)
- Information knowledge (Exclusively vs narrowly vs widely available knowledge)
What are examples of wants, cognitive shortcuts and emotional shortcuts and errors?
Wants: riches, social status, adherence to values
Cognitive shortcuts: framing, hindsight, confirmation
Emotional shortcuts: hope, fear, pride, regret
What is meant by “sunk costs” in the transition from ignorant to knowledgeable investor?
Costs that have already incurred and cannot be salvaged even when probed otherwise by cognitive and emotional errors
What is meant by the transition from ignorant to knowledgeable investor?
A transformation from System 1 (intituitive) to System 2 (reflective “think”) can be worthwile when the benefits exceed the costs of transition. A transition from System 1 to System 2 costs money, time and physical and mental exertion.
A transition needs be done when System 1 leads to errors.
What is meant by trade-offs between wants?
E.g. between utilitarian benefits of great wealth and expressive and emotional benefits of adherence to values.
What is an example of a conflict between people’s wants and wants of others?
E.g. conflicts between benefits received by corporate managers and shareholders or financial advisors and clients
There are 9 main wants of people. What are they?
- Riches and protection from poverty
- Nurture of children and families
- Demonstrate competence
- Playing games
- Staying true to our values
- Enjoy the comfort of familiarity and passion of patriotism
- Gain high social status
- Promote fairness
- Paying no taxes
What is the problem between wants for riches and protection from poverty and how can it be solved?
- Hope for riches encourage to invest entire portfolio in stocks or lottery.
- Fear of poverty encourages to divest portfolio in government bonds & social security.
-> Solution: Balance two wants by dividing money into layers of portfolio pyramids (bottom: bonds, top: stocks)
What is meant by “ambiguity aversion” and to what want is it related?
=The preference from known risks over unknown risks (its part of the want to demonstrate competence)
The investor rather chooses alternative where he knows the probability distribution of the outcome.
What are examples where investors want to demonstrate competence?
- Ambiguity aversion (prefer known risks)
- People prefer to guess before the event -> that is more satisfactory when they are right and less uncomfortable when they are wrong -> influences trading frequency
- males and investors with larger portfolios or more education perceive themselves as competent
- People who trade more frequently perceive themselves as more competent
What are examples for wants to stay true to our values?
E.g. mutual funds can follow precepts of religions
E.g. financial crisis and housing markets -> changes in circumstances affect trade-offs between utilitarian, expressive and emotional benefits
What are wants for fairness?
- Freedom from coercion is violated when one party possesses inside information and therefore refrains from trading.
- Freedom to equal power is violated when income inequality is high; one trader possesses inside information.
How can taxes be perceived as wants?
Low taxes deliver utilitarian benefits (tax-savings strategies also deliver expressive + emotional benefits)
Tax avoidance increases utilitarian benefits (keep more earnings), BUT can also reduce utilitarian benefits (engaging in tax avoidance results in paying higher interest in bank loans)
Whats the difference between investors and consumers?
Rational investors only care about wealth production whereas consumers care about all benefits of wealth (utilitarian, expressive, emotional). Rational investors separate roles as investors from roles as consumers compared to normal investors.
Whats the difference between a “sensation seeker” and a “knowledgeable sensation seeker”?
The “sensation seeker is blind to errors by overconfidence and keeps on buying lottery tickets due to the want for thrills and sensations, while he is ignorant of the price.
The “knowledgeable sensation seeker” acknowledges his overconfidence and is willing to pay the price to have thrills and sensations.
What is meant by “Our Wants and Shoulds”? How do they differ?
Rational people are free of conflicts between wants and shoulds, normal investors are not.
Wants: Visceral, Benefits in present, Focus attention on expressive and emotional benefits, prompted by System 1
Shoulds: Reasoned, Benefits usually in future, Focus attention on utilitarian benefits, prompted by reflective system 2
An investment advice is filled with shoulds: save more, spend less, diversify, buy and hold
What is an example of an conflict / trade-off between utilitarian, expressive and emotional benefits WITHIN a person?
Utilitarian benefits are dominated by expressive and emotional benefits.
E.g. workers value purpose and meaning of work, and are willing to trade utilitarian benefits of higher wage for benefits for socially responsible employer.
What is an example of an conflict / trade-off between utilitarian, expressive and emotional benefits AMONG people?
Wants of agent (managers) can conflict with wants of principal (investor).
E.g. Agents may attempt to satisfy own wants rather than wants of clients -> principal-agent-conflict
E.g. CEO forced to retire during takeover