Posts Tagged ‘Prospect Theory’

2019 NFL Draft

April 29, 2019

This post is based on an article by Sally Jenkins titled, “Smart teams trade down, but most teams just aren’t smart,” in the 27 April 2019 issue of the Washington Post. There have been previous posts on this topic. Behavioral economics which grew from Prospect Theory by Daniel Kahneman and Amos Tversky, for which Kahneman won a Nobel Prize (unfortunately Amos Tversky had passed on and was ineligible for the prize when it was awarded) can be used to guide NFL Draft Picks. The basic strategy is to trade down rather than trade up. Cade Massey of the University of Pennsylvania Wharton school and Nobel Prize winner produced papers in 2005 and 2012 that showed that teams profoundly overvalue first-round picks and simply don’t have the ability they think they do to discern between a great player and a good one.

Jenkins writes, “How often is a team right in picking a high-first rounder” What will be the quantifiable difference between the top choice at a position in the 2019 draft and the next available player, or even the third or fourth, in terms of games started and potential Pro Bowl success? The difference would need to be large given the amount of their investments. But their expenditures prove right only 52% of the time, which is effectively a coin toss.

Massey who does consulting for NFL teams says, “History suggests you do better by trading down from the top, using multiple lesser picks than one high pick.” The Patriots have done this with obvious success. From the article, “As of 2018, Bill Belichick had traded down fully 21 times on draft day to acquire more picks. Over the past 15 years, the Patriots have chosen 39 players in the second and third rounds, the highest number of any team in the AFC. And they won Super Bowls with them.”

Massey says, “If you recognize the uncertainty rather than throwing up your hands, you say, ‘We want as many draws as possible from the lottery. We can’t influence one ticket, but we can get as many tickets as possible.”

Andrew Brandt, a sports business analyst and former vice-president of the Green Bay Packers says, “It take a lot of willpower to trade out of that first-round pick, because there’s a lot of pressure. A lot of gravitas goes with that.”

Teams often do the dead opposite of what they should: give away fistfuls of picks to move up and grab a single star prospect. According to Massey overconfidence in their own judgment clouds their thinking. Brandt says, “Or sometimes it’s just a simple case of seeing a player ‘you lust after.’”

There is also extreme pressure coming from fans. There are many males who might not be about to tell you who their representatives to Congress or their senators are, who have definite strong picks for the NFL draft.

Massey says, “The quants are wrong to think you can quantify every single player. But you also can’t be right without the quantifications.”

Richard Thaler Wins the Nobel Prize for Economics in 2017

November 15, 2017

Assiduous readers of the Healthymemory blog should recognize the name from previous healthy memory blog posts. Richard Thaler is a behavioral economist. Early in his career he met up with the psychologists Amos Tversky and Daniel Kahneman. Amos Tversky and Daniel Kahneman formulated Prospect Theory. Most economic models are normative. That is they describe what a rational human should do if behaving optimally. Prospect Theory explained what people actually do. The theory states that people make decisions based on the potential value of losses and gains rather than the final outcome, and that people evaluate these losses and gains using certain heuristics. The model is descriptive: it describes what people actually do. Kahneman won a Nobel Prize in 2002 primarily for Prospect Theory. Unfortunately Amos Tversky had passed away and was not eligible for the prize.

Prospect Theory was the beginning of behavioral economics. In addition to describing how people actually behave in the economic realm, it develops techniques to nudge people in making good decisions. For example, making what is regarded as the best decision in a list of alternatives the default decision greatly increases the number of people who choose that option. For example, if making deductions for a pension is the default decision, that is the option most likely to be chosen.

Although it is good to know what the theoretical optimal decisions are, if the interest is in public policy, it is important to know what people will actually do. The field of behavioral economics is still young and there is much to be done. But they are working on how best to understand what people will do to better understand how to influence them to make decisions that will benefit them, individually, and society as a whole.

© Douglas Griffith and healthymemory.wordpress.com, 2017. Unauthorized use and/or duplication of this material without express and written permission from this blog’s author and/or owner is strictly prohibited. Excerpts and links may be used, provided that full and clear credit is given to Douglas Griffith and healthymemory.wordpress.com with appropriate and specific direction to the original content.

Trump and Behavioral Economics

June 2, 2016

On the June 6 & 13, 2016 “New Yorker” Financial Page there is an article by James Surowiecki.  He is the regular “New Yorker” correspondent for economics, business, and finance.  He has also written a book that Healthymemory would highly recommend, “The Wisdom of Crowds.”  His article is titled “Losers” and it is about how behavioral economics explains the attitude of Trump supporters.  The field of behavioral economics was founded by Daniel Kahneman and Amos Tversky. There have been many, many healthy memory blog posts on this topic and about these authors.   Prospect Theory is key to behavioral economics and resulted in a Nobel Prize being awarded to Kahneman.  Unfortunately Tversky had already passed away when the award was made.

Surowiecki notes that Trump plays to one of the most powerful emotions in economic life, which is what behavioral economics call loss aversion.  The basic idea is that people feel the pain of loses much more than they feel the pleasure of gains.  Empirical studies estimate that, in general, losing is twice as painful as winning is enjoyable. Consequently, people will go to great lengths to avoid losses, and to recover what they’ve lost.

Suroweicki notes that Trump’s emphasis on losing is unusual  even in bleak times.  But he believes that it has worked for him, because it resonates with what many Republican voters already feel.  A study by the Pew Research Center last fall found that 79% of those who lean Republican believe that their side is losing politically.  A RAND survey in January found that voters who believed that “people like me don’t have any say about what the government does” were 86.5% more likely to prefer Trump.  Trump supporters feel that they, and the country, are losing economically, too.  In the RAND survey, Trump did better  with the people who were the most dissatisfied with their economic situation, and exit polls from the Republican primaries show that almost 70% of those who voted for Trump were “very worried” about the state of the economy as compared to only forty-five % of all voters in Democratic primaries.

Surowiki notes some surprising things about all this.  The first is that, in objective terms, plenty of Trump supporters haven’t lost that much.  We’re familiar with Trump’s appeal among white working class voters, many of whom truly have seen wages stagnate and jobs dry up.  But Nate Silver has recently pointed out that the median Trump voter is actually better educated and richer than the average American.  But an important point of Kahneman and Tversky’s work is that people don’t look at their status objectively, they measure it relative to a reference point, and for many Republicans that reference point is a past time when they had more status and more economic security.  Kahneman argues that even people who simply aren’t doing as well as they expected to be doing feel a loss.  And people don’t adapt their expectations to new circumstances.  A study of loss aversion by Jack Levy concluded that, after losses, an individual will “continue” to use the status quo ex ante as her reference point.”  Suroweicki notes that Trump’s promise is precisely that he’s going to return America to the status quo ex ante.  He tells his supporters that he will will help recoup their losses and safeguard what they have.

Suroweicki goes on to say that the other surprising thing is that you might expect loss-averse voters to be leery of taking a risk on an unpredictable outsider like Trump, since loss aversion often makes people cautious:  offered the choice between five hundred dollars and a 50 % chance at a thousand dollars or nothing, most people take the sure thing.  However, loss aversion promotes caution only when people are considering gains; once people have sustained losses, impulses change dramatically.  Offered the choice between losing five hundred dollars and a 50% chance of losing a thousand dollars or nothing, most people prefer to gamble—opposite of what they did when presented with the chance to win a thousand dollars.  People are willing to run huge risks to avert or recover loses.  In the real world , this is why people hold falling stocks, hoping for a rebound rather than cutting their losses, and it’s why they double down after losing a bet.  For Trump’s voters, the Obama years have felt like a disaster.  Taking a flyer on Trump actually starts to feel sensible.

Suroweicki continues, noting that historical parallels are always tendentious, that loss aversion has been instrumental in the success of authoritarian movements around the world.   The political scientist Kurt Weyland has argued that it played a crucial role in the rise of such regimes in Latin American, where the fear of Communism drove putatively democratic societies toward the radical solution of strongman rule.  Suroweicki notes that Trump may not quite be an American Peron, but, to his his supporters, his unpredictability is a selling point rather than a flaw.

It is important to remember that the basis thesis of behavioral economics, a thesis that has ben consistently supported, is that humans do not behave or think rationally.  Rather they are driven by emotions.

Healthy memory feels compelled to note other facets of human cognition that contribute to flawed political decisions.  One is the success of the big lie and the continued persistence of these lies.  It is extremely difficult to correct these lies.

Another problem is  the fallibility of memory and how selective memory makes it difficult to correct erroneous beliefs.  Consider the Iraq war that the younger Bush took us into.  The weapons of mass destruction, on which the invasion was predicated, were never found.  France and Germany were urging Bush to delay an invasion until the inspection were completed and the existence of these weapons could have been ascertained.

It was also the case that the King of Jordan and Henry Kissinger warned Bush that an invasion would result in a broken country that would serve as a base for radical Islamist groups..  This is exactly what has happened.  So the costs of this war not just monetary, which added to the national debt, but more importantly human, produced a situation that is worse, not better, than what prevailed, before the beginning of the war.

People also seem to have forgotten the financial crisis left by the Bush administration that resulted in the very real possibility of a depression.  In spite of recalcitrant Republicans, Obama managed to prevent the depression and aid in an important economic recovery.  By most objective standards, the U.S. economy is in good shape, and the American economy is one of the best performing economies.

Healtymemory still wonders about Trump.  It is difficult for him to imagine Trump curling up with a copy of Kahneman’s “Thinking Fast and Slow.”  It is also difficult imagining Trump taking consul with an expert informing him how to exploit human information processing shortcomings for political gain.  Using the word “instinct” is inappropriate here, but Trump has a flair for exploiting human information processing shortcomings so that System 2 processing is avoided and System 1 prevails resulting in emotions rather than reasoning governing their voting.

© Douglas Griffith and healthymemory.wordpress.com, 2016. Unauthorized use and/or duplication of this material without express and written permission from this blog’s author and/or owner is strictly prohibited. Excerpts and links may be used, provided that full and clear credit is given to Douglas Griffith and healthymemory.wordpress.com with appropriate and specific direction to the original content.

Behavioral Economics

August 29, 2015

A number of previous healthy memory blog posts have been on the topic of behavioral economics. Mainstream economics is based on the idea of the rational man.  In 1978 the psychologist Herbert Simon was awarded the Nobel Prize in Economic Science for his research showing that human beings do not, and often cannot, evaluate all available information before making a decision.  He found that people satisfice, that is, use only enough information they think they need to make a decision.  In 2002, the psychologist Daniel Kahneman shared the Nobel Prize in Economic Science for his work with Amos Tversky showing the relevance of psychological research on human judgment and decision making under uncertainty to economics.  Kahneman and Tversky formulated Prospect Theory that showed how human behavior deviated from the economic norm.  Unfortunately, Tversky had passed away, so he was ineligible to receive the Nobel Prize.

Misbehaving:  The Making of Behavioral Economics by Richard H. Thaler provides a well-written and informative discussion of the development of behavioral economics.  Although he is an economist he had the good fortune to be able to work with Kahneman and Tversky early in his career.  So he was an early, perhaps the earliest, economist to come into the behavioral economics fold.  The book unfolds in chronological order so you are able to follow the development of Thaler’s career along with the development of behavioral economics.  His writing is quite entertaining.

Misbehaving: The Making of Behavioral Economics covers the course of the development of behavioral economics up until current times, so the coverage of material is quite large. The book begins with the discussion of SIFs (supposedly irrelevant factors).  These are factors that classical economics wave off as being irrelevant, but which are most certainly not irrelevant.  Early in his career Thaler began making his list of phenomena which were relevant to economics, but which were waved off as being irrelevant.  There are two types of theories:  normative and descriptive.  Normative theories inform us the right way to think about some problem.  Right here refers logical consistency.  Descriptive theories explain how problems are handled.  That is, what people actually do.  This differences is central to the difference between classical and behavioral economics.  Classical economics explains how logically people should be  behave, and behavioral economics explains how people actually do behave.

Perhaps the most dramatic example of this distinction can be found in the recent economic crash.  According to the rational model of man, this crisis should not have happened.  And, indeed, it was predicted by very few economists.   The crisis was due to the irrational, emotional nature of human beings.  The economics Alan Greenspan had a sign reading “Greed is Good” on his door.  Greed is also one of the Seven Deadly Sins.  I remember thinking that adjustable rate mortgages were a big mistake.  People tend to be overly optimistic and often overlook misfortune in their future.  This combined with increases in interests rates could cause many too default on their mortgages.  I had no idea of the extent of shenanigans  that were taking place.  Optimism regarding the never ending increase in real estate values precluded any rationality or safeguards.  Unfortunately, the changes in financial regulation were woefully inadequate, and another market crash looms in the future.  That is unless more attention is paid to behavioral economics and appropriate legislation is passed.  Unfortunately, although the influence of behavioral economics has grown, I was pleased to learn that Thaler had been elected President of the American Economics Association, it has yet to become mainstream.  Until it does, we remain at risk as the rational model of humanity is flawed.  Economics needs to be based on what humans do, not on a theoretical model based on rationality.

Misbehaving: The Making of Behavioral Economics is a real gem.  Unfortunately it presents me with a real dilemma.  I could easily spend several months writing posts based on this book.  However, I fear that some readers would not appreciate the emphasis being placed on economics and become bored.  Moreover, focusing on Thaler’s book would force me to neglect some needed topics.  So, what I shall do is to occasionally reach back to this book for posts that seem especially relevant.

© Douglas Griffith and healthymemory.wordpress.com, 2015. Unauthorized use and/or duplication of this material without express and written permission from this blog’s author and/or owner is strictly prohibited. Excerpts and links may be used, provided that full and clear credit is given to Douglas Griffith and healthymemory.wordpress.com with appropriate and specific direction to the original content.