Curiouser and Curiouser: Incentives Through the Looking Glass

Demotivated by Design

The world is full of schemes aiming to incentivize us; we’re spurred on to achieve new targets and scale new heights by the carrot of lucre-based incentivization schemes designed to appeal to our selfish natures.  Which is not surprising because we live in a society characterised by a belief that we’re all out for what we can get, wheeling and dealing in our own self-interest, forever trying to get the maximum reward for the minimum effort.

Which is like determining that 5 is the square root of 17.  Anyone who truly believes that money is the main motivation for most of our behavior is someone whose belief system needs to be carefully inspected with one of those devices used for stirring septic tanks.  Worse still, financial incentive schemes may actually miss the point by undermining our most cherishable quality: curiosity makes the man, even if it flattens the feline.

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Unrealistic Optimism and the Impoverished Investor

Hope is the thing with feathers that perches in my soul – Emily Dickinson

Eternal Optimists

Humanity is unrelentingly optimistic in the face of contradictory evidence.  Our ability to demonstrate unrealistic optimism bridges cultures, races, genders and societies.  We simply will not face up to the nasty reality of the real world, whatever that is.

This bias is so pervasive that it’s highly unlikely to be a social adaptation to culture and is probably an evolutionary trait, hard-wired into our brains.  No matter how it arises, it’s going to induce investors to take a positive view of the world: a view which cuts right across behavioral investing rule number one.

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Craving a High: Trading on Dopamine

Pathological Investors

“A pathological gambler dies and thinks he is in heaven because he wins every time he plays. Very quickly after constantly winning his wagers, he requests to be sent to hell, only to find out that he is already there.”

Sapra and Zak, Neurofinance: Bridging Psychology, Neurology and Investor Behavior

Neuroeconomists, that breed of behavioral researchers seeking to link actual brain function to real human behavior, are fascinated by people who exhibit what they refer to as excessive risk taking and whom the rest of us refer to as “scary”. Whether this behavior is pathological gambling, compulsive shopping or simply eerily unworried stockmarket trading, there seems to be an underlying theme: risk takers crave the buzz of novelty and are turned on by the uncertainty it generates, not by the outcomes.

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Are You A Born Investor?

Your Stocks in Your Genes

One of the many problems that have perplexed economists, along with why more people aren't like them and why no one listens to them any more, is why more people don’t participate in the stock market when it's regularly feted as being the safest place to put your money, long-term: the so-called equity premium model (for more of which see Mental Accounting: Not All Money Is Equal). Of course this isn’t necessarily true, as it’s been shown that it's another myth of the market, but given the amount of money spent on promoting the idea of stocks as bound to outperform, it’s as good as, and you might expect people to invest accordingly.

One line of thought suggests that the participation puzzle of why more people don't invest in stocks may be explained by genetic differences in brain function. As usual, IQ is a suspect, but the evidence suggests most investors are as dumb as everyone else, especially IQ researchers, and we should look instead at an old friend: emotions. It may be that some of us are just born investors.

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Economics & Psychology: Reconciliation?

Continued From Economics & Psychology: The Divorce …

By the early 1970’s, as the long bull market of the post war years collapsed in a welter of unforeseen problems, financial professionals confronted the real meaning of risk on a systemic basis. As markets crumbled in the face of economic uncertainty trading companies turned to economists in academia in the hope of finding a way through the mess, or at least some excuse to get people to buy stocks.

What they discovered was a way of measuring risk that appeared to offer the option of quantitatively managing investments in a rational way, rather than relying on the intuitions of individuals. This approach has come to dominate the securities industry ever since. At the same time, though, a small revolution was brewing in psychology. And it's been fermenting revolution ever since.

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Eat Your Stocks

Much Ado About Nothing?

Scientists study stuff which exist: physicists the physical laws of nature, biologists the nature of life and psychologists the human mind. Economists, on the other hand, study money: which is surely a figment of the human imagination.

Given the ephemeral nature of the subject it’s a wonder that there’s any mileage in spending any effort on the subject at all, but huge amounts of time and money are expended in doing so. So if money is fundamentally unreal, what the hell is economics all about?

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The Neuroeconomics Revolution

A Marriage Made in Heaven – or Hell?

A recent development in economics sees the combining of neurology, psychology and economics in an attempt to reduce economic behaviour to brain function and to predict market behaviour from observable brain patterns. Its aim is to glue together a subject that can’t predict human behaviour from analysis of the brain with a subject that can’t predict human behaviour from analysis of people to a subject that can’t predict human behaviour from analysis of economic data.

Welcome to the Neuroeconomics Revolution.

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Gambling, From Iowa to Soochow

Bodies and Brains

One of the more convoluted and, to the majority of the world, boring arguments among psychologists is around the extent to which we use our brains to learn. Of course a commonsense view has it that brains are fairly essential things for learning type activities but there’s also a view that bodies have a part to play as well.

Through a series of convoluted jumps this takes us from William James' research on phantom limbs, through the Somatic Marker Hypothesis and onto the odd findings of the Soochow Gambling Task. On the other, less invisible, hand it might be better for all of us if I simply skip to the nub of the problem: investors are addicted to gains, so much so that they’ll happily make overall losses just as long as they make lots and lots of small wins along the way.

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Adam Smith’s Monkey Business

The Theory of Moral Sentiments

Before Adam Smith got round to inventing economics in The Wealth of Nations he invented social psychology in The Theory of Moral Sentiments. Under Smith’s synthesis it’s sympathy that’s the glue that brings people together, underpins human morality and drives the engine of economic progress. Without fellow feeling there’s no basis for any kind of exchange, whether of simple gifts, bodily fluids or physical goods.

Smith, of course, was a man way ahead of his time. However, it’s still rather remarkable to discover it’s taken to the twenty first century to uncover the evidence that his intuition was not just correct as a theory of economics but is actually built into the structure of our brains. If you’ve ever bounced out of a feel-good film, full of effervescent vim you’ll know exactly what Smith was on about: we’re designed for sympathy and thus built for trade.

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When a Dollar’s Not Just a Dollar

Reciprocity Rules

If you have nothing and someone offers you a dollar you’d take it, right? But what if you’ve just seen your aunt give your cousin $100 and told to share it between the two of you? After all, a dollar is still a dollar more than you had a moment ago.

What studies of so-called reciprocity in humans show, time and again, that while we’ll accept the dollar in the first situation we’ll refuse it in the second. Our sense of fairness is offended and, it turns out, that given half a chance half the population will seek revenge on the perpetrators of this swizz and take pleasure in it. So, sometimes, a dollar is not just a dollar.

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Stocks Aren’t Snakes

Rational or Emotional?

How do humans make decisions? Are we careful, rational processors of information or emotional, rapid – but possibly illogical – decision makers?

Well, the easy answer is that we’re both. Sometimes we take our time over decisions and sometimes we don’t. Some of us make more decisions one way rather than the other but we all use both methods some of the time. The question is, why do we do this? Why have two decision making processes, the results of which must inevitably lead to different outcomes on occasion? To answer this let's don our outdoor gear and go for a ramble in the wild.

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The Media, Fear and Stockmarket Manias

Breast Cancer

If I were to ask you at what age are women most at risk from breast cancer, what would you answer? Write down what you think. Or, at least remember carefully. We don’t trust our memories around here.

I’ll come back to that later.

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