Advancing Behavioral Economics with Colin Camerer

What would YOU like to hear about on Bloomberg? Help make shows like ours even better by taking our Bloomberg audience survey https://url.avanan.click/v2/r01/___https://bit.ly/4eIFhe5___. YXAzOnJ3czphOmc6MjNiM2JiNmFlZTc1Y2UzZDhjZGNiMGY4OTRlMDc3ZjE6Nzo3YTY2OjgwNjEwYzM4MGYyMDAxNDZhNjY1NDViYzM1NmYxMGQ0MTQxYmYwYWM5NmUyOTlmNWE4Zjg1NGJmN2E1ZmVmNjc6aDpUOk4. Barry Ritholtz speaks with Colin Camerer, Robert Kirby Professor of Behavioral Finance and Economics at California Institute of Technology. Prior to joining Caltech in 1994, Camerer was a faculty member at various institutions including the University of Chicago GSB and the Kellogg Graduate School of Business at Northwestern University. He also held a visiting professorship at Oxford University. He is a member of the American Academy of Arts and Sciences and holds fellowship at the Econometric Society, and the Society for the Advancement of Economic Theory. Camerer has also authored numerous academic papers and books, like "Behavioral Game Theory: Experiments in Strategic Interaction." On today's episode, Barry and Colin breakdown the behaviors that drive our financial decision making. See omnystudio.com/listener https://omnystudio.com/listener for privacy information.

Speaker names marked ? are inferred from speaking time and the show’s known hosts — they are not voice-verified.

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• 0:58Speaker 01

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• 1:05Speaker 02

  This is Masters in Business with Barry Ritholtz on Bloomberg Radio.

• 1:12Barry Ritholtz?

  This week on the podcast, finally, I get Colin Camera in the studio to talk about neuroeconomics, behavioral finance, and really, all the fascinating things he's been doing at Caltech for the past, gee, he's been there for almost 30 years, is that about right? He's really an interesting guy, not just because he has the mathematical and behavioral finance background, but because he essentially asks the question, what's going on inside our brains when we make decisions? What's happening before we even have a degree of awareness of our own decisions?

• 1:52Barry Ritholtz?

  I just find what he does fascinating, not just fMRIs, but eye tracking and EEG and galvanic responses of the skin, and just on and on, all these different ways to measure what's going on with your hormones, what's going on pharmacologically within your body. It's both fascinating and terrifying because you've come to realize what you think is a decision you're making very often is a decision your brain is making with or without you. I found our conversation to be absolutely fascinating and I think you will also, with no further ado, my sit-down with Caltech's Colin Camerer.

• 2:36Speaker 04

  Thanks for having me.

• 2:37Barry Ritholtz?

  So I've been looking forward to having this conversation with you for a long time, not just because of my interest in behavioral finance, but because of the space you occupy in neuroeconomics. We'll talk a little bit about that in a bit, but let's start with your background, which is kind of astonishing. You get a bachelor's in quantitative studies from John Hopkins at 17, and then an MBA in finance, and a PhD in decision theory from the University of Chicago at 21. That's a lot of school really quickly. What were the career plans? Were you thinking academia or were you thinking finance?

• 3:18Speaker 04

  I was actually kind of not quite sure. So I went to Chicago grad school for PhD in the now Booth School of Business because I had learned a little bit about finance. I took an independent study from Carl Christ, who's a famous econometrician at Johns Hopkins, when Jean Pama's book, Foundations of Finance, had just come out. In fact, I literally worked in the college bookstore part-time and I remember unpacking the box that had this Pama book. And so I immediately bought one and I was going to do this independent study and read through. And by the way, it really is, some books are often called Foundations of Blank. It really was Foundations of Blank. It was a summary in 1976, very early days.

• 4:05Speaker 04

  And so Carl Christ had said, "Well, you should think about Chicago. That's a powerhouse place for finance." And so I started studying finance there and passed the prelim, which is no, which is no small feat. It's very selective. And then I got interested in behavioral science because finance was really obsessed with market efficiency. And, you know, there was no behavioral science, behavioral finance in sight at that time, but there were other folks at, at Chicago.

• 4:35Barry Ritholtz?

  Well, if I recall correctly, Dick Thaler was there early in behavioral finance. Or did he end up there later?

• 4:43Speaker 04

  Yeah, he came later. He came later. So when I came in the late 70s, a lot of Nobel Prize winners were there. Fama, Miller, Scholes. I think Fisher Black might have just left for MIT when I came. But it was pre-Andre Schleifer and Rob Vishny, who did a lot of interesting behavioral finance. And then Dick Thaler came, I think around 1995, 1996.

• 5:08Barry Ritholtz?

  And you were at Caltech by then, right?

• 5:11Speaker 04

  Correct. Yeah. So Dick and I had just passed like ships in the night. And I regret that sometimes, not having just stayed, you know, been part of a new vanguard.

• 5:21Barry Ritholtz?

  Well, but you are, you actually are part of a new vanguard because the work you do in neuroeconomics, which we're going to get into, especially FMRI's and all the other things you've done, more or less created that space. I mean, that's pretty foundational. Behavioral finance has a number of fathers, including Dick Thaler and Danny Kahneman. So, well, let's circle back to, to the neuroeconomics in a little bit. But I want to ask, what led you into decision-making research? How did you find yourself taking the background you had in, in quantitative studies and your PhD and MBA and go into decision-making?

• 6:06Speaker 04

  So some of it was when I was in college at Johns Hopkins, I studied physics and math. That was too abstract. And number theory was just too mind blowing, you know, for me, like, I'm just not going to work at that level. And then I studied psychology. And that seemed like just kind of a list of things that happened to people, but there was no unifying principles.

• 6:27Barry Ritholtz?

  Squishy, right?

• 6:28Speaker 04

  And then economics, which I really only took a little bit of, a lot fewer than my peers I later competed with in grad school, was kind of in between, like the three little bears, you know, there was math.

• 6:39Barry Ritholtz?

  I love that.

• 6:39Speaker 04

  And there was people.

• 6:40Barry Ritholtz?

  Right. Physics didn't have people, psychology didn't have math, economics was kind of the right mix.

• 6:45Speaker 04

  Exactly, exactly. And I think a lot of, a lot of social scientists may feel that way. And the people who like math less stay in psychology or go to sociology or something where the, the mathematical structure isn't really the cannon and the foundation.

• 6:59Barry Ritholtz?

  So what led you into game theory? You end up writing a book, Behavioral Game Theory, that was published in '03. How does that relate to economics and decision making and investing?

• 7:11Speaker 04

  So in graduate school, when I pivoted away from finance, there was a couple of psychologists, Hilly Einhorn and Robin Hogarth, who were interested in judgment decision making. They were doing things very similar to Kahneman and Dvorsky. It was sort of somewhat mathematical attempts to understand actual human decision making, not really stylized like Bayes' Rule and optimization. You know, those are good things to know, but they were interested in deviations from those and what that might tell us and what the practical value was. So that's what I ended up doing in grad school. Game theory came a little bit later because at Chicago at that time, in the late 70s, there was hardly any interest in game theory for peculiar reasons.

• 7:53Speaker 04

  They were, you know, the economic world was dominated by price theory, supply and demand, like Gary Becker, you know, there was a lot going on. Game theory just was not flourishing there. But my first job was as an assistant professor at Northwestern. And that happened to be through just historical coincidence, a hotbed of great game theory. Paul Milgram was there, Bengt Holstrom was there, Robert Weber, who worked on lots of things on auction theory, Dave Baron, who was interested in political economy and, you know, political systems as games. So Milgram and Holstrom went on to win Nobel Prizes and went to other places. So it was sort of this incubator place that then, you

• 8:35Speaker 04

  know, like a incubator like Hewlett-Packard and things like that, where people then went off to do other stuff. And so I basically learned game theory in my, in my first job as a assistant professor. And, and that game theory is similar to behavioral economics. The, the standard theory that everyone teaches in every introductory course is people are rational and make the best choices given what they think others will do, and they're correct guessing about what others do. Like a bunch of people who played poker with each other, you know, every Friday night for decades.

• 9:08Barry Ritholtz?

  Right.

• 9:09Speaker 04

  They kind of know what the tells are and, but we, we were interested in what happens before you get to this kind of what's called Nash equilibrium, you know, where everyone has guessed correctly what everyone's going to do. And so to me, there was a huge room for, for understanding the psychology of strategic thinking in game theory.

• 9:25Barry Ritholtz?

  So, so that's really interesting. To me, I always found the traditional economic homo economists of humans as rational, calculating, profit maximizing actors is just complete contradiction of real life experience. How did you go from your initial interest in behavioral finance into neuroeconomics where you're looking at the biological underpinnings of what happens as people make decisions?

• 9:56Speaker 04

  Yeah. So the neuroeconomics to me was sort of a natural extension of behavioral economics, which was we're going to grab for any interesting data and different ways of thinking about humans. Outside of standard economics and kind of pull it in and try to, you know, generate a kind of hybrid. It was almost like an import-export business. I'm going to import some psychology, or Dick Thaler imported from Kahneman, and what is this going to tell us about fairness and reference points and loss aversion and what have you. And neuroeconomics seemed to me like just another thing to do. Part of it is, my personality is kind of like intellectual entrepreneurship, so I liked, you know, doing different things. You know, over the years, I've worked on lots of different methods and with different groups of people, and neuroeconomics was just a chance to do something even more dramatic.

• 10:39Barry Ritholtz?

  And, and tell us about your patent on active learning decision engines. What on earth is that?

• 10:46Speaker 04

  So, active learning is the computer scientist term, is sometimes called dynamic adaptive learning, for basically, like, if I was going to try to figure out how much you like risk, like you're a client, and a financial advisor is asking, you know, I might start by saying, "Well, here's a portfolio. Is this too risky or not risky enough?" And if you say, "Nah, that's not risky enough," I'd, you know, I'd rather go for more. And then I would, I would give you a better one that's a little, has a little more risk in it. And in chemistry, it's called titration. You know, you kind of change the mixture of the chemicals. And so for each person, you're asking them a dynamic, customized set of questions to get to the best answer as quickly as possible. And that's called

• 11:28Speaker 04

  active learning. So, one of my colleagues at Caltech at that time, Andreas Krauss, was studying, he was a computer scientist, so they're always on the frontier of how to get the truth faster and subject to computational constraints. Like, you know, because sometimes, it's not just a question of getting there, but can you do it in real time, so you don't have to wait half an hour, you know, to ask the, ask the next highly informative question? And so the patent was just a, a method that Andreas and another guy who now works at Google, I believe, Daniel Golubin, and me, had worked on to apply this in a, in a particular way. And so it was basically a software patent. There was a, it was a patent on an algorithm.

• 12:09Barry Ritholtz?

  So, so you're asking people questions... How do you know they're giving you honest answers? And I ask that question for very specific reasons that will be evident in a moment. How do you know the answers are legitimate?

• 12:23Speaker 04

  Okay, so in experimental economics, one of the the the main rules, like a commandment, is we almost always pay people, unless we can't, like with children sometimes, or what have you. We almost always pay people money or something we know they value, based on the decisions they made. So when we do these kind of risk assessments, again, not with clients, but say in a simple experiment for modest amounts of money, 20 bucks, 50 bucks. What we'll do is we say, at the end, we're going to pick one of the things you said you wanted, and we're going to actually play that for money. And if you, you know, if you don't tell us what you really want, you're going to get stuck with something you don't want.

• 12:56Barry Ritholtz?

  Right. So you're creating an incentive for them to to be somewhat honest.

• 13:00Speaker 04

  Correct.

• 13:01Barry Ritholtz?

  The reason I ask, we're recording this about two weeks before the 2024 presidential election. I wrote something a month ago about why polling errors are really a behavioral problem. Because when you ask people, who are you going to vote for? What you're really asking is not just their preference, but, hey, you're going to get your lazy butt off the couch and go to the library and vote. And I assumed, hey, there's an error of 5, 6, 7% built into that, and that's why polls are so bad. Researching your work about hypothetical bias, I was shocked. The data that you came is, when you ask people if they're going to vote, about 70% say they will. In reality, just 45% of them do.

• 13:45Barry Ritholtz?

  That's a massive error of 25%. What value is there in polls when people have no idea what they're really going to do?

• 13:54Speaker 04

  Yeah, so, I mean, I think the best pollsters are, know that. And so they try to phrase the question or gather some other data. But this is often called acquiescence or yes bias.

• 14:04Barry Ritholtz?

  Right.

• 14:05Speaker 04

  So you say people, are you planning to vote? Oh, yeah, I'm planning to vote. Well, are you going to, are you going to not vote because it's too? Yeah, I may not vote.

• 14:10Barry Ritholtz?

  What happens if it rains? What happens if you're busy?

• 14:13Speaker 04

  Exactly. So you could often get numbers that add up to more than 100%. You know, yeah, I'm going to vote. No, you have 70%. Yeah, I probably won't vote. 55%. That's 125%. The math doesn't math. And you see it particularly, one of the things we studied was product purchases. So when you show people new products and say, you know, you think you'd be interested in this, you get way too many yeses. And that's one reason new products fail is because somebody who's the product champion inside the firm, like in a consumer products company, looks at this polling data and says, see, see, you know, give me money to roll this out in a test market. So what, one of the things we have done is to try to see if, we didn't, we wrote a few papers on this, but I don't feel like we exactly cracked the nut, was to see if a

• 14:57Speaker 04

  combination of what people look at, if you measure where their eyes are looking, like how often they look back and forth between a price and a product, and maybe brain signals could help us predict when they say, yeah, I'm gonna vote, are they really gonna vote or not?

• 15:12Barry Ritholtz?

  And neuroeconomics, as, as I've learned about it through you, is you're putting people in a functional MRI machine, you're asking them a series of questions, and you're identifying what parts of the brain are actually lighting up.

• 15:26Speaker 04

  Correct, exactly. So that, so, and by the way, FMRI is glamorous and fantastic, but there's lots of other methods that are used as well. It, you know, it's unnatural because people are in this tube.

• 15:37Barry Ritholtz?

  Right.

• 15:38Speaker 04

  It's very loud, you know, if you want to study-

• 15:40Barry Ritholtz?

  A little claustrophobic.

• 15:40Speaker 04

  If you want to study claustrophobia, you cannot, you know, because the claustrophobics won't go in there. But it does give you a picture of the whole brain. And in the, in the case of the, we did some experiments where we show people to consume a good, and in one condition, the first part of the experiment, we say, you don't have to actually buy this, but just tell us, you know, if it was on sale for this price, like, yes, no, strong yes, weak yes. So we get a four-point scale. And then we surprise them and say, now we're gonna show you some different products, and these you're gonna actually buy. So if you say yes, and we choose that one out of this bin-

• 16:15Barry Ritholtz?

  You get it.

• 16:16Speaker 04

  You have, you have to buy it.

• 16:17Barry Ritholtz?

  Oh, really?

• 16:17Speaker 04

  We give you some money, and we're gonna take the price out, and give you the residual money and the product, and you're gonna leave here with this product. Or I think some of them, we have, we have mailed it to them on Amazon, and some of them, we actually had, you know, products there in a, in a box. And so the question is, what's going on in the brain when they're seriously thinking about buying something for real versus hypothetical, which is like a survey?

• 16:40Barry Ritholtz?

  Right.

• 16:41Speaker 04

  And what we found was, the tricky part is to predict when people say yes hypothetical, but the brain says no. You know, can you, can you see a brain signal?

• 16:51Barry Ritholtz?

  And can you identify that?

• 16:54Speaker 04

  Modestly well.

• 16:55Barry Ritholtz?

  Right.

• 16:55Speaker 04

  And it turns out, the most, there's two interesting markers. One is, there's a very old area in the brain, old evolutionary.

• 17:03Barry Ritholtz?

  Lizard, lizard brain, right.

• 17:05Speaker 04

  Yes, called the midbrain, which is actually where all of the dopaminergic neurons live, and then, and then connect to middle areas of the brain called basal ganglia that are kind of computing reward and value, and then frontal cortex, which is really putting together.

• 17:20Barry Ritholtz?

  The modern portion of it.

• 17:21Speaker 04

  The modern, exactly, like the, it's like a thinking cap on top of the monkey brain. And in the midbrain, there's a stronger signal, when they say yes, and they actually do, do yes hypothetical, and it's a yes real, there's a stronger signal than when they say yes hypothetical, no real. So it's almost like way upstream in the brain. If, if, if in that region, they say yes, I'm gonna buy it hypothetically, there's enough activity, they're gonna buy it.

• 17:52Barry Ritholtz?

  So, my general sense of this, and I'm curious as to how you, what, what the reality is, my sense of it is, on the one hand, people are social animals, and they wanna be agreeable, and say yes to people. On, on the other hand, we really don't know what the hell we want, especially if you're talking about something six months from now. I guess the tricky part is, how do you get people in MRI machines when you have a question for them? We can't even get people to pick up their phone to answer polls. How difficult is it to get subjects to go through this process? Or are these all mostly undergraduates, and, you know, they're lab rats, you can do whatever you want to them?

• 18:32Speaker 04

  Some of them are undergraduates, although at Caltech, they're very unusual human beings, because they're, they're actually useful, they're very useful lab rats for payable economics, because the median math SAT is 800. They're the most mathematically skilled people.

• 18:47Barry Ritholtz?

  Except for some other places. That's a perfect score, isn't it?

• 18:49Speaker 04

  Like, exactly, that's the perfect score, like Harvey Mudd, MIT, there are other places that have, you know, similarly hyper analytical kids. So if like if they can't do something like a computation easily, nobody can. So it's very useful establishing like bounds on rationality. You know, we often get critiques like, well, you wouldn't get bubbles if people were smart enough. Like, well, we have the smartest people and you get bubbles.

• 19:14Barry Ritholtz?

  It's got less to do with the frontal cortex and intelligence and everything with that limbic system and the lizard brain back there.

• 19:21Speaker 04

  Yes, exactly. So they have they have all the things in the brain. They have they have other skills that are cortically expressed. But so in a lot of these MRI studies, we also use, we work pretty hard actually to get regular folks from the community who and who, you know, are different ages. You know, we, we don't really have a representative sample, although you could, you could try to get pretty close in Southern California. And then we, we, we almost always never do a study that's just take Celtic undergrads because we worry about the robustness across.

• 19:51Barry Ritholtz?

  Right.

• 19:51Speaker 04

  It is true in the case of something like trying to get brain signals to break when people actually buy products. The other type of study we've used involves eye tracking and things like that. And it turns out that when, when you ask people hypothetical questions, would you buy that you don't really have to buy this, but would you? They just don't look at the price that much.

• 20:10Barry Ritholtz?

  Right.

• 20:10Speaker 04

  And when they're really shopping, they really look at the price. So one way to tell whether people are being serious in expressing a genuine, what I'm going to really do it is just something like how much time they spend looking at the price and looking back and forth. And there may be other, like if, if, if a consumer products company was trying to use FMRI or other methods, there are others that are much more portable like EEG and you can get a pair of glasses, you walk around and it, you know, it records where your eye is looking. So there are, there are things you can do outside of the confines of a campus lab. I think we would just look for things that are, that are easy, easily seen biomarkers

• 20:52Speaker 04

  of this midbrain activity and FMRI because we're never going to be able to do that, you know, at scale in a shopping mall or something.

• 20:59Speaker 00

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• 22:06Barry Ritholtz?

  So let's go through each of these. We know what FMRI is, right? You're in an MRI machine. EEG and SCR, tell us what those do.

• 22:14Speaker 04

  So EEG is electroencephalography, and it's basically...

• 22:18Barry Ritholtz?

  All the little things on your head?

• 22:19Speaker 04

  Yeah, you paste little electrodes. If you're bald like me, that's good for signs. You know, if you're a supermodel with big, puffy Texas beauty pageant hair, then...

• 22:30Barry Ritholtz?

  No good.

• 22:30Speaker 04

  No good.

• 22:31Barry Ritholtz?

  So you're measuring electrical activity in the brain, and you could really specify where it is by, you know, just triangulating with all the different leads that you put on your head?

• 22:42Speaker 04

  Yes, exactly. So the, you know, you can put 16 to 128 different electrodes. The signals are very weak. But the advantage of EEG is it's really fast. So if you want to study something like thinking fast and slow, you know, like if I show you a picture of a person, and you have a snap reaction that they're scary or they're someone you want to vote for, then FMRI is too slow because it measures these blood flow signals that take like one or two seconds to show up.

• 23:07Barry Ritholtz?

  But EEG is really good. Like, one or two seconds is too slow?

• 23:11Speaker 04

  For, you know, a lot is going on in the first two seconds where people are thinking out of decision.

• 23:18Barry Ritholtz?

  That's really interesting.

• 23:19Speaker 04

  Not necessarily, you know, which mortgage to finance their, refinance their house in, or who to look for.

• 23:24Barry Ritholtz?

  Literally, system one, thinking fast, system two, thinking slow.

• 23:27Speaker 04

  Correct, exactly. So, it's, and the term psychology, social psychology uses is also called thin slicing.

• 23:31Barry Ritholtz?

  Uh huh.

• 23:32Speaker 04

  Which is that, and the thin slices on the order of, meaning a, a very aggregate, somewhat confident judgment is made within, you know, 10 seconds, 30 seconds. There's a big literature in, in interviewing about this, that, you know, face-to-face interviewing, unless you're really trained to have a comparable interview for different people, you know, the first couple of minutes of the interview, you're kind of making up your mind. Um, at least a lot of studies indicate that.

• 23:58Barry Ritholtz?

  And, and SCR is what?

• 24:00Speaker 04

  So SCR, skin conductance response, also called galvanic skin response. And so basically, it turns out, when people are aroused in any, any direction, it doesn't tell you good or bad, but it just tells you arousal, you have this detectable increase in sweating you can measure in the fingers.

• 24:18Barry Ritholtz?

  So, and, and in all of these things, you're actually taking measurements, not asking people things, and, and one of the quotes that caught my attention, since most of our brain activity goes on without our awareness, subconsciously, we cannot solely rely on individuals' accounts when analyzing their behavior. How important is the concept of the subconscious to, to neuroeconomics?

• 24:44Speaker 04

  Um, it's pretty important. So, the saying we use is, sometimes you want to ask the brain rather than ask the person.

• 24:49Barry Ritholtz?

  Uh huh.

• 24:50Speaker 04

  Um, and there's some, there's some extreme ways in which that works. For example, if I show a, a face of somebody who's expressing fear, but only for 30 milliseconds, which is, which is one movie frame.

• 25:01Barry Ritholtz?

  Right.

• 25:02Speaker 04

  Right? And then I, I show a mask, meaning another face right on top, that's neutral. Or in another condition, I show a happy face, very enthusiastic, and then neutral mask. If you ask people, did you see a happy or fearful face, they say, like, I have no idea, I didn't see, I didn't see either one. But if you look at amygdala activity, which is a region that's known to be rapidly detecting potential threats, and, and including fear, uh, the amygdala activity will respond to fear, not... Um, in 30 milliseconds, not, um, not happiness in the same way. So the, the brain knows. It's just that it doesn't get to the, like, the publicist's desk. You know, to good consciousness.

• 25:43Barry Ritholtz?

  So I'm so glad you said it that way. So don't ask the person, ask the brain. How do you think of the different parts of the brain? So obviously the amygdala and, and any of the, is it fair to say that's part of the limbic system?

• 25:56Speaker 04

  Yes.

• 25:57Barry Ritholtz?

  Um, so when you're talking about the publicist, what portion of the brain are we discussing?

• 26:04Speaker 04

  Um, well, in terms of sheer territory, it's probably not very much.

• 26:08Barry Ritholtz?

  Mm hmm. Forebrain, hindbrain?

• 26:12Speaker 04

  Yeah, prefrontal cortex would be. And, and, and, um, there's a lot of sensory processing that is going on, you know, pre-conscious or like before we could say, you know, motion to something or use words to explain what's going on. I, I think it's, it's, it's genuinely hard to pin down a number like is, you know, if I read, for example, it's 90% subconscious and 10% conscious. I don't know if that's right, and it may vary across life cycle. Um, uh, so, you know, we usually were reluctant to pin down a number. I think it's fair to say that there's a lot of things that are going on, we usually say implicitly, that are not, people aren't explicitly aware of. Enough, enough to make it very interesting.

• 26:55Barry Ritholtz?

  So whenever I hear people talk about, you know, things happening within the brain that you're not aware of, I always think of the split brain experiments and.

• 27:03Speaker 04

  Bingo.

• 27:03Barry Ritholtz?

  Um, tell us a little bit, what does that reveal about our decision-making process?

• 27:08Speaker 04

  So the split brain was actually, uh, first explored by Roger Sperry at Caltech, actually, and his student Mike Kazaniga, um, you know, made a big chunk of career, uh, over, out of it. And so the split brain patients means they don't have much communication between left and right hemispheres.

• 27:25Barry Ritholtz?

  Corpus callosum, is that right?

• 27:27Speaker 04

  Bingo, you're A+.

• 27:28Barry Ritholtz?

  So you're, you're, you, these are, the one I remember was, uh, it was some seizure or epilepsy and they found cutting that stopped the seizures, but then your left brain and your right brain don't really communicate anymore.

• 27:42Speaker 04

  Exactly. So for example, so, so if you have, um, a breakdown of corpus callosum, the right and left aren't really communicating. Despite the right brain, left brain, most modern neuroscientists don't think there's that much specialization. There's some interesting kinds, but one kind that's pretty rugged is languages mostly in the left brain in regions called Broca's area, Vernerki's area. And we know that because, you know, when you have specialized damage in that area, you can see people start to talk differently. Like they can remember, they can't remember words.

• 28:12Barry Ritholtz?

  The aphasia. I remember reading about people who can speak, could write, but couldn't read. Just all sorts of wacky things happen when, when those two areas are damaged.

• 28:22Speaker 04

  Correct. Exactly. So there are these very localized, pretty well-understood aphazias that have to do with local damage. So there's, there's often what we call plasticity, where another part of the brain will take over. So if you had some damage as a young child, it might be that the aphasia, you know, another, another part of their brain like takes over that function. But if it happens later in life, not so. Anyway, so language is somewhat specialized to the left region. So for example, if someone with a, and the sensory systems are contralateral. So the right side of the brain sees the left side of a picture. Left side sees the right side. So suppose I show you on the left of a picture, a picture of

• 29:02Speaker 04

  a friend of yours. And I ask the person, if you see this friend of yours, what might, what, what gesture might you do? Or what might you, if you see a friend here as opposed to a house or a shovel, what would you do? And the person waves their hand. And then you ask them, why did you wave your hand? Now the left side of the brain has to answer the question because that's the language area. But the left side doesn't know that the right side saw a friend and that's why they waved. So the left side makes stuff up.

• 29:31Barry Ritholtz?

  Confabulates an, an explanation for why they're waving.

• 29:34Speaker 04

  Exactly. It's like the publicist for, you know, for a very guilty person. And, or Mike Gazaniga calls it the interpreter. So the interpreter says, I don't really know why. So I'll kind of make, give a plausible answer. And they'll say something like, oh, I saw somebody I knew walking by out the window outside. So that's an example of where we know what the brain saw and why the wave occurred, but the left part of the brain doesn't know.

• 30:00Barry Ritholtz?

  That's really fascinating. Let's stay with the idea of tracking eye movement. So you could do this with glasses, you can do this with a computer. When you're tracking eye movement, asking people about, hey, would you purchase this product? How big of a tell is it when they look at the price? And is it something they just kind of glance at? Or is it a repeated and obvious they're focusing on the cost?

• 30:26Speaker 04

  There's sort of two interesting markers. Number one, it's not that big of a tell. So if we try to predict whether they're going to actually buy something, we might get, say, 42% right. And with the eye-tracking data, it might get up to like 54. You know, so as academics, we think that's kind of a modest effect size. If you're running a business and you want a 2% lift in purchase, maybe a billion dollars, right? So sometimes we're a little cautious as academics about, is this a big deal or not? Whereas some of these things, the same in the world of nudges and so on, sometimes a small, you know, a half percent increase and get out the vote. If we could do that scientifically, may well decide an election. Right?

• 31:10Speaker 04

  Anyway, so the lift is not that big. But the two tells are basically looking at the price. And the other is refixation, which basically means not just looking once, but going back and forth. You know, it's the rapid brain equivalent on a one or two-second basis of, say, a couple who's shopping for a house, going to look at a second time and a third time. You know, the repeated looking.

• 31:32Barry Ritholtz?

  Right. Usually a good signal.

• 31:34Speaker 04

  Exactly. Tells you they're serious.

• 31:36Barry Ritholtz?

  Huh. That's really interesting. So give us some examples of what the studies or the experiments look like when you're doing eye tracking. What are you trying to? What parts of the brain are you looking at? Or is it just the eye tracking? Is this by itself? Or can you combine this with other types of neuroeconomics?

• 31:57Speaker 04

  Yeah, so actually, the eye trackers we use, which are commercially made for science, basically, and sometimes for clinical use, they use cameras to look at where the eye is looking, and they sync that up with where on the computer screen you're looking. And so besides the location of where the eyes are looking, you also measure pupil dilation.

• 32:20Barry Ritholtz?

  Mm hmm.

• 32:21Speaker 04

  And pupil dilation turns out to be, you know, the eyes are the window to the soul. So the pupils actually generate a lot of information, although it's crude. What the pupil dilation is telling you is about cognitive difficulty. I might have a hard time thinking about this. And arousal, which again may be negative or positive. It's like something dramatic is happening.

• 32:41Barry Ritholtz?

  So wide pupil is you're aroused, tight pupil is you're having a hard time with it.

• 32:44Speaker 04

  Exactly, exactly. And so I think if you train yourself and maybe depending on the color of the eyes, you might be able to tell, like a poker player might be able to train themselves with a, to notice pupil dilation. But just in case, that's why poker players often will wear glasses.

• 33:02Barry Ritholtz?

  Sunglasses, yeah.

• 33:04Speaker 04

  Sunglasses, right? Because the idea is if you look at your cards and you have two aces, your pupil will dilate. Like, and it might be hard to see with the naked eye, but the machines we use can definitely see it. That would be a big jump, you know, a big tell. And so we're able to use pupil dilation and eye tracking to judge things like cognitive difficulty. A lot of the early studies actually were used in game theory because in game theory, the assumption is if, I might want to see what my opponent's payoff is in order to decide what they're going to do. And if you ask people, what are you looking at on this computer screen? You know, there's, there's a four by four matrix of numbers and I'm trying to think of what you're going to do. There's a lot to look at. And if you ask people for a self-report, they're not going to tell you exactly what their

• 33:49Speaker 04

  eyes are doing the whole time. They're probably looking at 42 different things, sometimes very quickly, sometimes they're going back and looking again and again and again. They just don't have conscious access to that process the way that the eye tracking does.

• 34:02Barry Ritholtz?

  So, so that's really fascinating that speaking to the brain, but not the person, gives you a whole lot more insight into the decision-making process. Speaking generally, what does this tell us about people as, you know, rational, profit-seeking actors in the world of, of finance and investing?

• 34:27Speaker 04

  I think it's useful to think about, say, young naive investors, or I didn't mean to be young, but people with less knowledge about the markets and people who've spent a lot more time thinking about estimating fundamentals, reading 10Ks.

• 34:42Speaker 04

  You know, having years of trading experience because another important fact which we try to keep track of in behavioral economics is that a lot of decisions and structures people have to make are not things that we're necessarily evolved to be particularly good at, but people are also extremely good at learning and able, you know, and able to like collect memories and distill things into into knowledge. So let me turn to the concept of price bubbles because I think that's a useful one. So we have a couple of one F M R I study on price bubbles and we have some new stuff that includes skin conductors measurement to see if, you know, can you kind of predict when a crash is coming from people's hands, you know,

• 35:23Speaker 04

  reflecting nervousness. It looks like we can predict a little but not great. You know, that's a high mountain to climb. What we found in our first F M R I study about bubbles was people trade an artificial asset. So we know the value, the fundamental value of the asset, which we never know in, you know, in natural markets and that the price is completely what they agree upon. So typically what happens is that the fundamental value is a number that we control, which happens to be 14 and that because the value of the asset comes from the fact that if you hold at the end of a period of trading, you get a dividend or you can invest currency in a risk free bonds. And so the trade off between

• 36:04Speaker 04

  the risk free earnings and the value of the dividends establishes an equilibrium price. It's a very simple equation.

• 36:10Barry Ritholtz?

  Sure.

• 36:11Speaker 04

  And typically the price starts around 14 and goes up to maybe 20 or 30 and then crashes. And then, and then in order to bring the experiments to a close, we have them trade for 50 periods or 30 periods. And at the end, they were able to cash the assets out at 14.

• 36:27Barry Ritholtz?

  So what would you pay for an asset that you'll get 14 for?

• 36:31Speaker 04

  Correct.

• 36:32Barry Ritholtz?

  After a series of dividends, 30 or 50 trading periods in the future.

• 36:35Speaker 04

  Exactly. And so, so put yourselves in the mindset of somebody who in period 31, the price is 60.

• 36:41Barry Ritholtz?

  Right.

• 36:42Speaker 04

  And you, you kind of know that in period 50, 19 periods from now, it's going to be 14.

• 36:47Barry Ritholtz?

  Sell.

• 36:48Speaker 04

  Well, unless you think it's going to go up to 75.

• 36:51Barry Ritholtz?

  Right.

• 36:52Speaker 04

  Right? So it's, it's true. And in fact, that's very helpful for me. So what we found from the brain was that there was two interesting signals. I'll start with the more interesting one. The other one's a little more obvious. The interesting signal is people who sold. Uh, before the bubble crash, which was the smart thing to do. And again, the bubble crash is not announced. It's something you only see a story looking back in the rearview mirror. Right?

• 37:17Barry Ritholtz?

  Same in natural markets also.

• 37:18Speaker 04

  Exactly, just like in natural markets, right? Bubbles are only shown in hindsight. Gene Pham has written a lot about this. It's one reason he's skeptical that, that we should even talk about bubbles, you know, as a scientific phenomenon.

• 37:28Barry Ritholtz?

  Okay, I, I think he goes too far with that, but anyway.

• 37:31Speaker 04

  Anyway, yeah, you know what I mean? So it turns out the people who are more likely to sell when the price is at 60 and we know it's going to crash, but we're not sure when, um, have heightened activity in insular cortex.

• 37:43Barry Ritholtz?

  Uh huh.

• 37:44Speaker 04

  Which is another region that's involved in emotion and interoception. So interoception means.

• 37:49Barry Ritholtz?

  Knowing what's going on, on the inside of your own body, like a self-awareness.

• 37:53Speaker 04

  Exactly. So perception is the outside world. Interoception is the brain's, like the body's ambassadorship to the brain, you know, knowing if I'm nervous or, and it's often activated by, particularly by negative emotions. So if you see something disgusting, insula. If you, if you choke a person a little bit, or you, you know, you cut off the oxygen, not so it's dangerous, but just to make them uncomfortable, insula.

• 38:16Barry Ritholtz?

  Really?

• 38:16Speaker 04

  Financial uncertainty, insula. And so we think of the, is insula is the early warning signal that there's going to be a crash. And the other interesting brain region is nucleus accumbens, which is basically a reward center in what's called stratum, um, part of basal ganglia in the very center of the brain. And that's active in the people who are fueling the bubble, like when the bubble's, you know, forming, the people who have the highest nucleus accumbens activity by the most.

• 38:44Barry Ritholtz?

  So you, you have a run of traders participating in this and you could tell by the brain activity who's contributing to the bubble and who's saying, this is getting crazy. I want to take my chips off the table.

• 38:57Speaker 04

  Now, number one, we can't tell with exquisite precision. You know, we, you can sort of see these groups and we're only looking at this X post. So I think it's, it's conceivable, but challenging to do this in real time. You know, so there's you're watching the market unfold, you're doing real time FMI measurement, that can be done. Um, and, and it's like, okay. Okay, traders seven, nine, and 11, you know, we think they're probably going to sell. They're the skeptics, they're the bulls. And 14, 17, and 21, their nucleus accumbens activity seems they're really all in. They're going to be forming the bubble and so on and so on. I mean, we're a few steps away from being able to do it, but we see these as what we call proofs of concept. Like, it can be done. It may take a few million dollars, if any donors are listening.

• 39:42Barry Ritholtz?

  But it makes perfect sense that

• 39:44Speaker 04

  It is possible.

• 39:45Barry Ritholtz?

  Different parts of the brain are responding to different inputs. And it's consistent with what we've observed amongst, you know, just various investors and traders. There are people with, as the, you know, in the latter stages of a bull market, they think it's just going to keep going forever and they pile in. And the flip side of that, there are people, the famous irrational exuberance speech by Alan Greenspan. In 1996, you still had a ton of gains until the March 2000 top. So some people, I'm just curious, what drives that?

• 40:25Barry Ritholtz?

  Now that you know what to look for and how to measure it in traders in real time, what do you think is the underlying drivers of whether a person is going to be participating in one tribe or the other?

• 40:39Speaker 04

  That's a great question. I'll say a little tiny bit more about that. You mentioned the term irrational exuberance, which was coined, as I recall, by Bob Shiller in his book about

• 40:49Barry Ritholtz?

  I think it was from the irrational exuberance speech.

• 40:52Speaker 04

  Oh, no, he, um, Shiller may have helped Greenspan with that speech, if I'm remembering.

• 40:59Barry Ritholtz?

  Because I've seen, I've seen both, whether it was Shiller's phrase or Greenspan's speech.

• 41:03Speaker 04

  It may be, you know, it's kind of lost the history. You know, it was some apocryphal, you know, we're not sure exactly who said it first, but certainly there was a kind of meaning of the minds that this was useful. And in fact, when we didn't, we use the phrase in our paper, but we didn't put it in the title. It just seemed a little too unscientific. It's okay for USA Today or something, but this is the proceedings of the National Academy of Sciences, you know. And, but we think of this nucleus accumbens activity, that's the, that's the measure of irrational exuberance. And the irrational part is, you know, when it's too high, you're going to end up paying a high price for something that crashes fast. So the irrational is really in there. Literally, but yeah, and also, when I present this in academic seminars and later

• 41:48Speaker 04

  today, I'm meeting some Caltech people, we talk about this famous saying from Warren Buffett, I believe, "When people are afraid, be greedy; when people are greedy, be afraid." And these brain areas like insular, similar to fear and greed and nucleus accumbens, you know, it's about as close you're going to get to brain areas matching what Warren Buffett had to say, which was such a wise thought.

• 42:11Barry Ritholtz?

  So you really kind of answered the question I was about to ask, which is, why has behavioral economics been so successful describing decision-making where traditional economics seems to have faltered, but what you're really saying is, we don't know what's going on in our brain when we're making decisions as individuals, and when you look underneath the hood, it turns out, there's a lot more things happening than at least classical economics seems to imply.

• 42:42Speaker 04

  Yes, exactly, exactly. And also, this isn't something we've carefully researched, but I think it's a good speculation for your audience, which is, when I was going to Chicago in the late 70s, all of my graduate student friends were also kind of critics of, nobody liked behavioral economics at that time.

• 42:59Barry Ritholtz?

  Oh, really?

• 43:00Speaker 04

  Oh, yeah, it was, you know, people said things like, "I think, you know, you might be ruining your career because you switched out of finance," and, well, what it was, was there was a series of critical questions, which were, "But if people make all these mistakes, couldn't someone profit from, you know, arbitrage, or from selling them crappy goods?" Like, "Well, it seems like that may happen," you know? Or, "If people make these mistakes, don't they learn over time not to make mistakes?" That may also happen. It may be that there's a sucker born every minute, but there's a generational process, and markets are always filled with some combination of new investors, or, you know, sovereign funds of people who aren't very savvy about markets, or something like that.

• 43:42Speaker 04

  So, early in the history of behavioral economics, there was really a lot of hostility about it. And then we gradually, one thing about Chicago and the economics profession in general is, data do win arguments. So ideology will often persist, like for Gene Fama, for example, he's, he'll always be skeptical about behavioral finance. For his own reasons and, you know, their ideas, but, um, but eventually data win arguments. And there were, you know, there were just so many anomalies and ways in which investors were making mistakes. And, and it wasn't just small investors, you know, who were refinancing their mortgage mistakenly. It was, you know, some of these implicit things may be very big, you know, like a venture capitalist joked about how, well, you know, when I, I

• 44:27Speaker 04

  think of Mark Zuckerberg in a hoodie, and that's kind of my template for a good founder to invest tens of millions of dollars.

• 44:34Barry Ritholtz?

  Right, right.

• 44:35Speaker 04

  Like, that's not as sophisticated, that's not home economicus.

• 44:38Barry Ritholtz?

  And, and I recall reading one of the papers Bob Shiller wrote was looking at dividend yield and saying, if, if markets are fully pricing in all data, why does this dividend yield swing around so much? It should be much more consistent than this.

• 44:54Speaker 04

  Correct.

• 44:54Barry Ritholtz?

  Uh, but apparently it's not. Uh, I just, I was very amused by Fama and Shiller being awarded the Nobel together. It's almost as if the committee said, look, markets are kind of efficient and except when they go crazy, you two guys work it out.

• 45:10Speaker 04

  Yes. Yeah. Yeah. It was quite a, um, it was kind of a charming and I, and I think sensible award for that reason. And the, you know, the journalist said like, well, is there, you know, one person says A is true, one says A is not always true. Like, how could you give that award? The answer is they both made, made a lot of progress, you know, in, in different ways.

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• 46:07Barry Ritholtz?

  Let's talk about some of the other ways that we can look inside. Are we looking at things like adrenaline or dopamine or any of the sort of hormones that seem to affect our behavior when, when we're trying to analyze decision making?

• 46:23Speaker 04

  Yeah, so actually, that's a very good question, Barry. Neuroeconomics uses a lot of different methods. The FMRI is sort of like, you know, the movie star in a family with four sisters. You know, the glamorous one that everyone pays attention to, but is actually high maintenance. And then, but all the other siblings are, you know, kind of contributing in some interesting way. So pharmacology is something people are really interested in.

• 46:47Barry Ritholtz?

  Meaning specifically pharmacology drugs that are in your system?

• 46:51Speaker 04

  Yeah, so pharmacology is drugs. But some of those, for example, L-dopa will actually ramp up dopamine levels. And you can see if some interesting things happen.

• 47:00Barry Ritholtz?

  L-dopa is a drug you can consume?

• 47:03Speaker 04

  Correct.

• 47:03Barry Ritholtz?

  In order to raise your dopamine levels?

• 47:05Speaker 04

  Exactly. So it's, it's, L-dopa is basically administered to, so Parkinson's patients have a degradation of dopamine. And so to kind of ramp them up to normal levels, L-dopa is often used in treatment.

• 47:17Barry Ritholtz?

  Pharmacology is one. What are some of the other four sisters?

• 47:21Speaker 04

  So we, we do look at neurotransmitters like oxytocin. Argonine vasopressin is one that we've studied.

• 47:27Barry Ritholtz?

  Oxytocin sounds a lot like oxycontin. Any overlap?

• 47:31Speaker 04

  Correct.

• 47:31Barry Ritholtz?

  No, okay.

• 47:32Speaker 04

  No, exactly. So oxytocin is, is sometimes called as like an affiliation hormone. So for example, if you get a really pleasurable massage, you might feel a surge of oxytocin. When my wife was giving birth, they often, to induce labor, they often give somebody synthetic oxytocin. And oxytocin is also produced after birth and when the mom is first cutting the baby and probably the dad, although maybe less. You know, it's this very pleasurable thing that makes you want to like hug somebody and feel, feel affiliated. Affiliated is the sort of bio term. So there's a bunch of studies on oxytocin suggesting that improves trust. But there's a cautionary tale, which is, we, me and some colleagues went back and looked

• 48:18Speaker 04

  at those carefully and It seems that giving people artificial, giving people oxytocin for a modest dose, and then seeing what happens, you know, an hour later, it improves trust a little bit, but it's scientifically very, very tricky. And some of the standard results, if you do the same exact experiment over again, you just don't always get the same result. So we don't know how sturdy oxytocin is.

• 48:42Barry Ritholtz?

  What are some of the other chemicals you mentioned? Neurotransmitters?

• 48:46Speaker 04

  When we studied, I'll say a little bit, it was argon vasopressin. And so that's another hormone, which is similar to oxytocin, in that when, when animals are bonding in groups, this argon vasopressin sort of, you know, you'll get a surge, and it shows that.

• 49:02Barry Ritholtz?

  So when you say bonding in groups, I'm thinking of a wolf pack or a hyena pack, where?

• 49:07Speaker 04

  Yes.

• 49:08Barry Ritholtz?

  They're cooperative species that work together, and there are chemicals that contribute to that? Is that what we're suggesting?

• 49:15Speaker 04

  Yeah, exactly, exactly.

• 49:16Barry Ritholtz?

  So part of me wants to say, we're just meat sacks, operating obliviously to what's going on underneath our skin, where we think it's free will, but it sounds like there's a lot of things happening below the surface that's really influencing our decision making.

• 49:34Speaker 04

  Yeah, oh, absolutely. I mean, think about things like breathing. You know, breathing is so automatic. And when we stop and do sort of breath work and try to think about it, like maybe seals might have a breathing exercise to calm down before a terrifying thing they have to take, you know, it actually takes a lot of executive function to think about breathing, because we never have to.

• 49:53Barry Ritholtz?

  Because it's automated.

• 49:54Speaker 04

  It's because it's so automated. So the fact that it's actually grabs a lot of attention is because the automation is, we've completely flipped back into the opposite situation. Let me tell you what argon vasopressin study we did. So there's a game, similar to President's Dilemma, but not the same, called the stag hunt game. And the idea is two people decide to show up in the morning and hunt for a stag. It's a very old fashioned name from the Jean-Jacques Rousseau in the 1600s.

• 50:20Barry Ritholtz?

  We're talking about a male elk or deer?

• 50:23Speaker 04

  Yeah, an elk or deer, yeah. The point of the stag is it's so big that no, one person can't catch it themselves. One person has to spot, and the other to shoot, or something like that. Or they cannot show up in the morning at the appointed spot and just hunt for rabbits on their own. And so the structure of the game, when we do it with money... Or reward with with animals is you get one point if you just go for rabbit. If you both hunt for stag, you get two if you hunt for stag. But if you show up by yourself, prepared to hunt for stag, you can't catch any, you get zero. And so the choosing a rabbit is choosing one and not helping your friend. Both showing up for stag is better for the both of them, but they have to somehow coordinate that activity.

• 51:06Speaker 04

  And so what we found was when you give people this AVP. And it's a crossover design, which means sometimes they get AVP and sometimes they get a placebo. Because there's a, you know, well-known placebo effect where if they think maybe they got the AVP, it might subconsciously affect the

• 51:22Barry Ritholtz?

  Right.

• 51:23Speaker 04

  behavior. So we always control for placebo effects, just like in drug trials, you know, the same thing, very routine. When you give them AVP, they're more likely to choose stag, which is the socially risky and beneficial thing. It's like it generates this willingness to join the group in a way that's going to help everybody if another, if no people join. And the other thing that was really nice in this paper was we also used fMRI. So we had two groups of people administering AVP. One group was scanned and one was not scanned, which is just to see, like to replicate, do you get the same behavioral thing if they're not, you know, boom, boom, boom in the scanner? And in the scanner, you see activity in globus pallidus, which is known to be, it's a small region.

• 52:07Speaker 04

  It's not one of the more familiar areas, you know, that show up lots over and over in neuroeconomics, like basal ganglia, amygdala, unsula, PFC. But you do see activity in globus pallidus when people under AVP are choosing stag. So it looks like the AVP is sort of promoting the stag choice.

• 52:28Barry Ritholtz?

  But when we see people working cooperatively, you see a similar neurotransmitter

• 52:35Speaker 04

  Correct.

• 52:35Barry Ritholtz?

  as you do in the pack animals.

• 52:37Speaker 04

  And it's causal, right? So these are the group of people and sometimes they just get this drug.

• 52:43Barry Ritholtz?

  And it makes them want to cooperate.

• 52:44Speaker 04

  And it makes them want to cooperate in a way that's risky but benefits the group. But we sometimes think of it, it overcomes their inhibition to be, well, I don't know if you're going to choose stag and I don't know if you're going to show up.

• 52:56Barry Ritholtz?

  Well, the prisoner's dilemma is you're always better off throwing the other person under the bus.

• 53:01Speaker 04

  Correct. This is not that.

• 53:03Barry Ritholtz?

  And this is the opposite.

• 53:04Speaker 04

  Because here, if the other person helps out, you want to help out too.

• 53:05Barry Ritholtz?

  Right.

• 53:06Speaker 04

  It's the best response. So it's different structurally than the prisoner's dilemma.

• 53:10Barry Ritholtz?

  So I keep coming back, every time I read a new, anything about behavioral finance, neuroeconomics, anything about this, I can't help but come back to the conclusion that all of our evolutionary biology has led us to a state where we're so well-adapted to adjusting to changes in the natural world. And all of those things that have developed over the millennia really don't help us in the modern world. If anything, it's prob, certainly in investing, it seems to be pretty problematic.

• 53:46Speaker 04

  Yeah, exactly. In fact, that's called the evolutionary mismatch hypothesis.

• 53:50Barry Ritholtz?

  Oh, really? I didn't know it had a name.

• 53:52Speaker 04

  Yes, exactly.

• 53:53Barry Ritholtz?

  So tell us about...

• 53:54Speaker 04

  We can call it the Ritholtz hypothesis.

• 53:56Barry Ritholtz?

  If only. So this mismatch is simply, we evolved to adapt on the savanna and that doesn't help us figure out which bonds to buy? Is it that simple?

• 54:06Speaker 04

  Exactly, exactly. So another way to think of it is, is institutions, sometimes it's families, it's political advertisement, it might be fine print about fees in a, you know, in a financial advertisement. Those are all things that are kind of tricking or exploiting vulnerabilities in our basic ancestral biology. Now, again, people are smart too, so there's, there is adaptation and kind of plasticity. So over a lifetime, you might, or maybe in one MBE course, or even possibly a high school course, you might learn... Some principles of basic finance really help you avoid dumb mistakes. You know, like compound interest really compounds quickly.

• 54:48Barry Ritholtz?

  Right.

• 54:49Speaker 04

  You know, the caveman brain thinks compounding quickly. I have no idea what that means. My brain can't imagine that if I invested in the S and P $1,000 40 years ago, how much I'd have, you know, I can't compute that number.

• 55:01Barry Ritholtz?

  Right. Well, we live in an arithmetic world. Exponential numbers are hard to comprehend.

• 55:06Speaker 04

  The brain is mostly linearizing things.

• 55:09Barry Ritholtz?

  Right.

• 55:09Speaker 04

  That, and if they're not linear or they're dramatically nonlinear, like pandemic, um, uh, compound interest. We can learn to overcome it, but we need these kind of external tools. It's almost like exoskeleton, you know, whether it's education, advisors and so on.

• 55:24Barry Ritholtz?

  So let's talk a little bit about risk aversion, which has been this behavioral finance concept. People dislike losses twice as much as they enjoy gains. What does the world of neuroeconomics say about loss aversion? I've seen a few mathematicians claim, oh, it's just a statistical anomaly. I remain unconvinced that that's the case.

• 55:51Speaker 04

  Yeah. So actually I know a lot about loss aversion. We, we published a meta-analysis last year about.

• 55:56Barry Ritholtz?

  There's a reason I'm asking you this question. It's not out of left field.

• 55:59Speaker 04

  Right. Um, you came to the right place.

• 56:03Speaker 04

  So the meta-analysis, we looked at hundreds of studies, basically every study we could find, you know, using informatics. And nowadays you can really do this. It's like industrial fishing, you know, you throw this net out and you get 4,000 studies. Then you winnow it down to the ones that are really just all trying to measure the same thing. So you can add them up. There was something like 370 estimates of lambda, which is the Greek symbol that means the ratio of the disutility of loss to gain. And as you mentioned, two is sort of a, we think it's a little bit smaller, like 1.7. But, you know, it's.

• 56:35Barry Ritholtz?

  Comparable.

• 56:35Speaker 04

  Yeah, it's comparable and it's not one, which, which would be the case in which you're not distinguishing loss and gain at all. You know, they're just like one scale. So the evidence is pretty good. Some other fun facts about loss aversion, which is you might think that loss aversion is some kind of handicap. But actually, we published a paper with two people who have brain damage and bilateral amygdala, which means neither part of the amygdala can compensate for the other. It's a very unusual disease. It comes from an Urbaga Vita disease and they basically, the amygdala is kind of like calcified. So it's there, but it's like deep freeze. You know, it just doesn't work.

• 57:16Barry Ritholtz?

  So you, these people lose the ability to have these emotional responses to stimulus?

• 57:22Speaker 04

  Correct, correct. And a lot has been known about because they've been studied. One of my colleagues, Ralph Fadoff, has studied several of them for years and they, you know, they come back every so often and do a different kind of task and.

• 57:33Barry Ritholtz?

  So let me guess, they're pretty good traders.

• 57:36Speaker 04

  Generally, they're in disability because the amygdala damage is enough to make, they basically take too much risk in a lot of areas of life.

• 57:44Barry Ritholtz?

  So they're risk embracing, not risk averse at all?

• 57:48Speaker 04

  Exactly. So the idea that risk and fear are there to kind of protect you, it applies to them. Like when you remove that, like one of the patients, SM, makes a lot of poor choices.

• 57:59Barry Ritholtz?

  Give us examples.

• 58:01Speaker 04

  Well, this example I recall, I hope I'm not getting that, my memory's not mangling it too badly, is she went on some kind of a date and the person was very sexually aggressive and she ended up okay. And then somebody said, well, would you want to go out with that person again? She said, yeah, yeah, it was fine. It was fine. You know, she just didn't have this trauma. The amygdala was not processing. This is really bad. Run away, run away, avoid, avoid.

• 58:26Barry Ritholtz?

  So how does this manifest itself amongst investors making risk decisions if their ability to process threats, process fear is in present? What happens with those sort of decisions?

• 58:41Speaker 04

  Well, so for these two patients with amygdala damage, they have no loss aversion.

• 58:45Barry Ritholtz?

  None whatsoever?

• 58:46Speaker 04

  None, in fact.

• 58:47Barry Ritholtz?

  So aggressive traders and investors.

• 58:49Speaker 04

  Well, yeah, so the way we measure is we give them these financial, simple financial risks, like you could win, most people, if you say you could win 10, but you might lose eight or might lose seven, they're kind of just indifferent because a loss of seven and a gain of 10 or, you know, it's one and a half.

• 59:04Barry Ritholtz?

  If I could do that on a billion dollars, I would, you know, I'd love to do that.

• 59:08Speaker 04

  Yeah, yeah, yeah.

• 59:09Barry Ritholtz?

  But.

• 59:10Speaker 04

  But these two, so damaged amygdala, no more loss aversion. So that's partly a reminder that be careful what you wish for.

• 59:17Barry Ritholtz?

  Right. Like, you don't want to react emotionally to everything.

• 59:22Speaker 04

  Correct.

• 59:22Barry Ritholtz?

  Right. The, the reason it's so hard to do what Warren Buffett says is when everybody's clamoring to buy, you get, most people get caught up in that enthusiasm where, we're social primates. And when the group is screaming, buy, buy, buy, it's very hard to go the other direction. And then at the bottom, when everybody is selling, the fear is palpable.

• 59:45Speaker 04

  Exactly. The fear is almost contagious.

• 59:47Barry Ritholtz?

  Yeah, very much so.

• 59:48Speaker 04

  Right. Yeah, yeah, yeah.

• 59:49Barry Ritholtz?

  So, so you lose that risk aversion. Do you have the ability to just go opposite the crowd? Because you don't care?

• 59:57Speaker 04

  It, it could be. I mean, I've, I have a feeling successful traders, it's, it's not that they're not loss averse, but they manage to inhibit it somehow. Or we, we did a such study in this, but it's, I don't think the details are all that interesting for your readers, but, or they're able to do what we call bracketing, or kind of portfolio view, which is to say, you have bad days and good days. And at the end, it's my, you know, it's my P and L at the end of the month, or at the end of the year, or the end of the quarter, and manage to kind of shrug off a loss. Now, I don't think that's that easy to do, if you have intact amygdala.

• 1:00:34Barry Ritholtz?

  Right.

• 1:00:34Speaker 04

  Right. So it's, it's almost, it's, it leads into another interesting topic, which we've studied a little bit called emotion regulation, which is the fact that a lot of our emotions are sort of involuntary. You know, if there's a loud boom, you and I are both going to have this fear reaction, you know, hair will stand up, we'll freeze. But you can also learn to, to regulate emotions. I mean, kids are learning that when, when they learn to, you know, not be too afraid on their first day of school. As people get older, they learn to regulate emotions. It's a pretty important skill. And so.

• 1:01:07Speaker 04

  I think successful trading is probably some kind of cocktail of either a little less natural loss aversion, but not too little, right? Because you don't want to like going crazy. You don't want to be immune to loss, just like you don't want your hand to be immune to pain, right? Because you're going to lean on a on a hot stove one day and not notice that your hand is on fire, right? So you a good trader probably has a little less natural loss aversion and then a really good ability to emotionally regulate, you know, when too much loss is is acceptable or getting you into trouble.

• 1:01:41Barry Ritholtz?

  So so the emotional regulation aspect is really interesting. I'm going to push you a little outside of your your normal, I think of your normal research area. One of the interesting comments that have come up when discussing who's a great fund manager, who's a great trader, who are these folks that have put together these really impressive track records? A surprising number of neuroatypical folks.

• 1:02:10Speaker 04

  Oh, yeah.

• 1:02:10Barry Ritholtz?

  Reason I ask you this is, it seems like not only is there a little bit of ability to manage the emotions, but there's that ability to step outside of the crowd and say, I don't care what the rest of the primates are doing here on in March 2009, stocks look really attractive and I want to be a buyer even though everybody else is selling. Is there an aspect of that to those sorts of traders?

• 1:02:35Speaker 04

  Yeah, I think that's a fantastic topic. In fact, it is close to something.

• 1:02:38Barry Ritholtz?

  Oh, it is. All right, good.

• 1:02:40Speaker 04

  We've been thinking about. So one thing is, I was going to mention from before. So one of the striking things, I was working on a neuroeconomics book, and I was reading a lot of papers on social conformity. It turns out that almost every study finds the typical paradigm is something very stylized and simple, like, you know, you see a face, and three other people see the same face, and you're asked to say, is this person friendly or unfriendly? And in the conformity case, the other three people say friendly. And for some other subject, the other three say unfriendly. And people's, people's, there seems to be reward activity when you conform to the group.

• 1:03:18Barry Ritholtz?

  Right.

• 1:03:19Speaker 04

  And these are not, we're not super stress testing, so we're not quite something like, you know, you're in the depth of a crash, 2008 crash, and everyone's selling and, you know, ethically, it's hard for us to generate that dramatic event in the lab. But, but even for these mild effects, and a lot of these people, if you ask them, "Do you follow the crowd?", they would say, "No, no, no, I kind of go my own way." Like, if a bunch of people said someone was friendly and you weren't sure, if you thought they weren't friendly, would you disagree? "Yeah, yeah, yeah, I wouldn't bother me." But study after study after study shows there's generally reward value from conformity, which is essentially just the, the modern evidence for what you were talking about, which is that part of being a social animal.

• 1:04:00Barry Ritholtz?

  Right, the evolution of cooperation has, has been very successful for us. And it's hard to fight the crowd.

• 1:04:07Speaker 04

  It did its job, yeah, exactly.

• 1:04:09Barry Ritholtz?

  Huh.

• 1:04:09Speaker 04

  So I thought that was quite striking. Again, if you were, if you wanted to study anti-authoritarian personality, it might be a way to get into that, that there may be people who almost pathologically. But let's get back to your point about neurotypical people. So, we're actually working on, beginning a study on autism. So autism is called a spectrum disorder, which basically means it's not like you have it or you don't, like schizophrenia. So, you know, statistically, it's, it doesn't look like two humps.

• 1:04:38Barry Ritholtz?

  Right, you have a little, you could have some, you could have more, you can have a lot.

• 1:04:41Speaker 04

  Correct, correct. And there's often differences of symptoms, like extreme autism often involves catatonia and severe language deficits and what have you. And so, when people often think about Asperger's Syndrome, which is something that's called high functioning autism.

• 1:04:54Barry Ritholtz?

  Right.

• 1:04:55Speaker 04

  Which is basically you're just socially awkward and hard to understand what people do. But, a lot of these pathologies, or disorders, I should say, pathology is not the right word, a lot of these disorders are accompanied by some enhancement. So for example, Asperger's patients have, are more likely to have perfect pitch for sound. They are better at ignoring some costs, which is a classic behavioral economics.

• 1:05:21Barry Ritholtz?

  Right.

• 1:05:21Speaker 04

  You know, I spent so much on this dessert, you know, I came to New York, it was $18 for some flower, you know, flowerless cake.

• 1:05:29Barry Ritholtz?

  Cheap.

• 1:05:29Speaker 04

  I have to finish it.

• 1:05:31Barry Ritholtz?

  Right.

• 1:05:31Speaker 04

  The autists are like-

• 1:05:32Barry Ritholtz?

  The money is spent whether you get the calories or not.

• 1:05:34Speaker 04

  So the autists have the right idea.

• 1:05:36Barry Ritholtz?

  Right. And there is a sweet spot. I'm going to get you a list-

• 1:05:40Speaker 04

  Bingo.

• 1:05:40Barry Ritholtz?

  -of the people who I know in this field who have put up-

• 1:05:44Speaker 04

  That would be fantastic.

• 1:05:45Barry Ritholtz?

  -impressive numbers-

• 1:05:46Speaker 04

  Yes.

• 1:05:47Barry Ritholtz?

  -and have either stated they're on the spectrum-

• 1:05:51Speaker 04

  Uh huh.

• 1:05:51Barry Ritholtz?

  -or it's kind of obvious, hey.

• 1:05:53Speaker 04

  Yeah, yeah, yeah. You could look at film, video, or written statements and, you know, machine learn them and say, this person talks or looks-

• 1:06:02Barry Ritholtz?

  I'll ask on Twitter, who's on the autism spectrum in the world of finance and has a good track record, but I have like two dozen names in my head.

• 1:06:12Speaker 04

  I'll give you a name. Unfortunately, he just died not too long ago, Charlie Munger.

• 1:06:16Barry Ritholtz?

  Oh, of course.

• 1:06:16Speaker 04

  So I got to meet Charlie a few times.

• 1:06:17Barry Ritholtz?

  Right.

• 1:06:18Speaker 04

  And he-

• 1:06:19Barry Ritholtz?

  Doesn't strike me as a very spectrum A.

• 1:06:22Speaker 04

  Well, but one marker of autism is, is like, poor conversational turn-taking.

• 1:06:27Barry Ritholtz?

  Mm-hmm.

• 1:06:29Speaker 04

  You know, and so when I, the times I met Charlie, just twice, and if you see him at the Berkshire Hathaway, I mean, he's amazing. I think he was like the Mark Twain of finance.

• 1:06:37Barry Ritholtz?

  For sure.

• 1:06:37Speaker 04

  You know, because he was really witty, and, but also there's always like, a really deep psychological insight in there. You know, it wasn't just funny. It was like funny and true.

• 1:06:46Barry Ritholtz?

  Mm-hmm.

• 1:06:47Speaker 04

  And often something other people didn't want to say. But when I met him, he was just like a freight train. And so you had to interrupt. And I realized, the goal is to not have a conversation. You're just going to move the train in different-

• 1:07:00Barry Ritholtz?

  Just nudge him in different directions. Right, exactly.

• 1:07:02Speaker 04

  Well, you know, that reminds me of X. Boom, and then he's off discussing X.

• 1:07:06Barry Ritholtz?

  I never realized that about him. So you're saying-

• 1:07:08Speaker 04

  But anyway, that's my non-clinical, I am not a clinician, like, you know, disclaimer. Part of it is reflected in why he was successful. You know, he, he saw himself as an average person who wasn't making the dumb mistakes. Other people make, but some of those dumb mistake people make, you know, he may have not made them because he doesn't get caught up in social conformity, or because he's very focused on, he has good metacognition. Like if I don't, I don't buy a company, I don't understand.

• 1:07:33Barry Ritholtz?

  Right.

• 1:07:33Speaker 04

  You know, that's probably a good intuition.

• 1:07:36Barry Ritholtz?

  Strategy. So I'm working on a new book, I'm almost done, and Munger is one of the two people I dedicate the book to, and the quote of his that very much informs the the theme of the book is someone once asked him, was Berkshire successful because you and Warren are so much smarter than everybody else? And his response was, it's not that we're smarter than everybody else, we were just less stupid. Which is such an insightful observation. Hey, just fewer Charlie Ellis, make less unforced errors. And you'll do better in tennis or investing than the guy trying to slam the ace in.

• 1:08:17Barry Ritholtz?

  Most people are not going to get it in. Him and Munger had, the two Charlies had the same belief system. Just be less stupid. It's really fascinating. So when you've interviewed Munger, what are some of the takeaways you've had from your conversations with him?

• 1:08:35Speaker 04

  One thing I remember was, so we went and looked at our neuroimaging center.

• 1:08:40Barry Ritholtz?

  Did you ever get him in a machine?

• 1:08:41Speaker 04

  No, I wish we, I wish we had. He may have gone for it too. He's a, you know, he's a pretty interesting person and I think very

• 1:08:49Barry Ritholtz?

  Open minds into crazy stuff, right?

• 1:08:51Speaker 04

  Scientifically curious, as well as in his financial life. He had gone to Caltech for a while, so he was, we got to run into him every so often. Of course, we're always people like that. They're always trying to get them to give money and, or at least show up and

• 1:09:05Barry Ritholtz?

  Give a speech, something.

• 1:09:06Speaker 04

  Yeah, talk. And so, so we showed him the brain scanner. He had a really interesting thought, which I didn't quite appreciate till later, which was

• 1:09:17Speaker 04

  He said, what you guys should be doing is if you're trying to change behavior, like let's say you're trying to get somebody to vote or to wear a mask or, you know, quit smoking opioids, the really hard stuff, you know, weight loss. He said, what you should really do is rather than doing one little thing, you should go for a Lollapalooza, you know, like basically try to add in six different things to get the biggest ability to get people to quit smoking, let's say.

• 1:09:41Barry Ritholtz?

  Makes sense.

• 1:09:42Speaker 04

  And so he was thinking as a practitioner, like I want, I want to know what's, what's going to work. As scientists, we're often thinking piecemeal. Like if we put six different things in and it works, we don't know which of the six is the active ingredient.

• 1:09:56Barry Ritholtz?

  But it could be a different combination for each different person.

• 1:09:58Speaker 04

  Exactly. So exactly. But, and so the reason I was thinking about that was nowadays, one of the fallouts or one of the products, I should say from, fall is definitely the wrong word, one of the products from behavioral economics was this idea of a nudge that often, because people are often sensitive to very subtle things like opt-in versus opt-out.

• 1:10:16Barry Ritholtz?

  Right.

• 1:10:16Speaker 04

  You know, there may be a low-cost, light-touch way to change behavior a little bit.

• 1:10:22Barry Ritholtz?

  Well, just look at the 401K.

• 1:10:24Speaker 04

  Exactly.

• 1:10:24Barry Ritholtz?

  Making the default go to just some specific investment as opposed to it just sits there in cash.

• 1:10:35Speaker 04

  Correct.

• 1:10:35Barry Ritholtz?

  For, for God knows how long, seems to have really had a big impact.

• 1:10:39Speaker 04

  Yes, exactly. That, that was definitely the, the, the poster child for the simplest nudge. And we kind of understand the psychology of it. Anyway, so, so now what a lot of people are thinking about nudges is exactly this Lollapalooza idea of Munger's, which is if we want to get people to get out the vote, rather than try six different things, we should be trying like six combinations of three things. Statistically, it's messy because you, you'll never really end up knowing which of those is the active ingredient. But to just get results, that's useful information. It's useful information. So the Nudge Enterprise, which I've been connected to a little bit, is moving somewhat in that direction that Munger mentioned many years ago.

• 1:11:19Barry Ritholtz?

  Huh. Really interesting. All right. I only have you for a limited amount of time. So let me jump to my favorite questions that I ask all of my guests, starting with, what are you watching or listening to these days? What's keeping you entertained?

• 1:11:34Speaker 04

  So Katie Milkman's podcast, Choiceology, is one that I've been on that I think is quite good. It's basically the behavioral economics. Podcast. There are quite a few others, but Katie is a real expert on this and is a great interviewer and has had good guests.

• 1:11:48Barry Ritholtz?

  Choiceology.

• 1:11:49Speaker 04

  Choiceology.

• 1:11:50Barry Ritholtz?

  Tell us about your mentors who helped to shape your fascinating career.

• 1:11:55Speaker 04

  So two people who were on my thesis committees, Robin Hogarth and Hilly Einhorn were two. And there's an interesting story. So Robin was Scottish, very verbal. Every sentence started with, um, howsoever, therefore, notwithstanding. Hilly was a very blunt Jew from Brooklyn. And it was the exact opposite.

• 1:12:19Barry Ritholtz?

  Right.

• 1:12:19Speaker 04

  So Hilly would mark up my thesis and put in all these fancy, uh, Hilly would rather would take out the whatsoevers and the howevers and the therefores. And he was like, put in more like boom, like short sentences, no semicolons, but like he had one punctuation mark, period. That's it.

• 1:12:34Barry Ritholtz?

  Right.

• 1:12:34Speaker 04

  Like, you know, he like, he bought a million periods at a store and like, I'm likely use those. And Robin was the other way around. Oh, this really does use semicolon, you know, let's plop this in. And at one point I was going back and forth, you know, near the completion of my thesis with the two of them were co-advisors. And I got so frustrated and I said, how should I write this? And we had this, this kind of like grasshopper moment of it's your thesis. You figure out how you want to write it. And I realized they were kind of waiting for me to find my voice, like they say in writing.

• 1:13:05Barry Ritholtz?

  Right.

• 1:13:06Speaker 04

  You know, like, and one of them loved tables and the other loved graphs. So the drafts of my thesis was the table and a graph that were exactly the same thing. And I had to decide, was I a graph person or a table person? Or was I kind of like bilingual? So I basically became kind of bilingual in terms of how I was thinking about science. That was very helpful. The other person probably is Dick Thaler because he, um, he's a very good writer. He did exactly what so many academics aspire to, and we always ask for more of. We should write a small number of extremely high-quality papers. It's very unusual because for career reasons and stuff, you have to get tenure and da-da-da.

• 1:13:45Barry Ritholtz?

  Right.

• 1:13:45Speaker 04

  And Dick just couldn't really write a bad paper. I don't write as many great papers as him. And as a result, I write too many okay papers, but that's something I think is useful for everyone.

• 1:13:56Barry Ritholtz?

  He's one of my favorite people in the world. I got to interview, I don't know, half a dozen times. Only once since he won the Nobel Prize, but I always find him so informative and entertaining. And I just loved his response to winning the prize. What are you gonna do with the money? His answer was, "I'm gonna spend it as irrationally as I possibly can." It's just so, so him.

• 1:14:20Speaker 04

  He enjoys life.

• 1:14:21Barry Ritholtz?

  He very much does. He's just also a fascinating, charming guy. Let's talk about books. What are some of your favorites? What are you reading right now?

• 1:14:30Speaker 04

  I am reading Emma Klein, a book called "The Guest." Especially for New Yorkers in your audience, it's about a very grifty, sketchy woman who goes to the Hamptons and kind of cons her way around the Hamptons. It's really, it's almost like a very...

• 1:14:46Barry Ritholtz?

  Didn't we have kind of a real-life thing like that happening a year or two ago?

• 1:14:50Speaker 04

  Yes, exactly. It may be loosely inspired by Anna Delvey in Manhattan or some similar cases. It's basically almost like a 19th-century novel about class. Because she's very conscious of not belonging in the Hamptons, but she's very beautiful and charming in this sort of man-eater femme fatale way. And I'm almost done with that. It's really delicious. The other thing, I love movies and books about capers and heists and grift, which includes Emma Klein, "The Guest." So I'm reading these books by Jim Swain, who's not well-known. I got onto it because Lee Child, who I love.

• 1:15:26Barry Ritholtz?

  My wife reads all of his books, plath through all of them.

• 1:15:29Speaker 04

  Exactly, yeah.

• 1:15:29Barry Ritholtz?

  And did that include the Reacher series?

• 1:15:32Speaker 04

  The Reacher series, yeah. That's what he is most famous for, Lee Child. But so Jim Swain was blurbed by Lee Child, saying, "Jim Swain's the best at what he does." And what he does is, he writes about a very sophisticated cheater in Las Vegas who cheats casinos. And... It, you know, I'm gonna use recycle this in your, very shortly for you, but um, basically there are procedurals about how to cheat a casino.

• 1:15:58Barry Ritholtz?

  Uh huh.

• 1:15:58Speaker 04

  But in the end, if you get caught, there's also this sort of socio psycho political thing of, you know, if I make up a story about why something happened, like if there's a murder in a casino, and I make up a story about it that helps them act like the murder was freakish and won't drive away customers, I'm actually delivering a gift to them and they're gonna trade off, they're not gonna send me to jail if I give them this gift. So there's a lot of layers of, this is not Dostoevsky, it's not brilliant, this is not highbrow literature.

• 1:16:28Barry Ritholtz?

  It's this fun summer beach reading, it sounds like.

• 1:16:30Speaker 04

  But for me, there's a lot of like, psychology and, you know, in a way, it's like game theory, what if there's an arms race between the Vegas Gaming Commission and each of the individual casinos who are very sophisticated, they hire a lot of ex-cheats, you know, to tell them what to look for, and then these cheaters who know, you know, so truly there's arms race of who's gonna win, I've found those really interesting.

• 1:16:51Barry Ritholtz?

  Um, if you like books on grifts and cheats and um, corruption, I'm gonna recommend pretty much anything he's written, I've been a fan of his for years, Carl Hiasen was a reporter for the Miami Herald, the crime reporter, and then just one after another, these series of novels, and his, one of his more recent books is now a TV series on Apple Plus, Bad Monkey.

• 1:17:20Speaker 04

  Oh, is it?

• 1:17:21Barry Ritholtz?

  But all of his books, it's Bad Monkey and the, I think the sequel's called Razor Girl, but all his books take place in Florida, everybody's corrupt, the police are corrupt, the building inspectors are corrupt, the politicians are corrupt, and there's always one or two good people in the heart of the story, and it's how do they navigate this just endless sea of treachery and corruption, um, and he's just a delightful entertaining writer, if you, you could randomly pick any of his books, and they're just all, they're great beach reads.

• 1:17:53Speaker 04

  Um, yeah, let me also mention The Wire, because I grew up in Baltimore County, and um, I read-

• 1:17:59Barry Ritholtz?

  The series?

• 1:18:00Speaker 04

  Yes, and David Simon's book, The Corner, is a kind of a precursor, I mean, he's a very interesting person, he was a reporter, and um, I think he made it a teacher-

• 1:18:08Barry Ritholtz?

  In Baltimore, is that right?

• 1:18:09Speaker 04

  In Baltimore.

• 1:18:10Barry Ritholtz?

  Yeah.

• 1:18:11Speaker 04

  And The Corner is like this- Beautiful, I think it was a precursor to The Wire, but it's basically about a corner in West Baltimore where everyone buys drugs and it's about drug addiction and all the things that surround it. So as somebody who, you know, one of the things we study in behavioral economics is habits and addictions and, you know, and neuroscience, of course, is fascinating along the way. And that one is great. And The Wire, having grown up in Baltimore County, which is not Baltimore City, The Wire is almost like a documentary and it has all this Baltimore stuff as well as Baltimore accents where you can have people talking about, talking like this. And it has Tommy Garcetti is this political character who's sort of inspired by Tommy Dela Sandro, whose daughter is Nancy Pelosi.

• 1:18:52Barry Ritholtz?

  Oh, really? That's amazing. I found the series The Wire, it's a tough watch. It's a great show, but it's brutal. Gritty is mild. I mean, some of the stuff that goes on in the show is just like-

• 1:19:06Speaker 04

  Yeah, there's a famous scene with a nail gun, which if your listeners have the stomach, that's pretty classic.

• 1:19:14Barry Ritholtz?

  Similar in the Jack Reacher series. There's a-

• 1:19:17Speaker 04

  Oh, really?

• 1:19:19Barry Ritholtz?

  Something not that far off. Yeah. They toned it down for television, but the book is, is really brutal. All right, we're up to our final two questions. What sort of advice would you give to a college grad interested in a career in fill in the blank, neuroeconomics, behavioral finance, or even just investing?

• 1:19:38Speaker 04

  For somebody who would say, doesn't want to get a PhD, that's a different track and probably of less interest. There's, you can get a lot of guess, advice on how to do that. I would study not just finance, like straight asset pricing and derivatives, but also behavioral economics, game theory, I think, because even though game theory is usually like two players or small numbers of players, it really sharpens the logic of, you know, when do I know something another person doesn't know? And do I know that they don't know it? You know, you have to really relentlessly think about the math underlying that. And then there's a lot of experimental and real world data. One of my, I just got a text from our students this term, and there's a lot of data from

• 1:20:22Speaker 04

  sports about whether sports activities are like equilibrium responses to other players. So you can actually, there's, there's a lot of sources of data besides just say the lab experiments I talk about in my book from 2003, sneak in that plug in. Cognitive science is something I would study too. So cognitive science is a modern brand of cognitive psych that has more math in it. And a lot of it actually goes back to something we spoke about, like evolutionary mismatch. But they're quite interested in what they call resource rationality, which means a lot of the mistakes people might make, like anchoring on one number and being influenced by that, the famous anchoring adjustment heuristic, may actually be rational if you if you only have so much working memory, or you're under

• 1:21:07Speaker 04

  time pressure, or you're tired. It's also closely related to the way economists would think about mistakes, which is they may be optimal given some constraint, like what is that constraint? And can we test that experimentally? So I think there's a lot of stuff you could learn there that will help you think about markets. The other thing I would say is get experience thinking about markets, whether interning or, I mean, I'll tell you a story about what worked for me, which was when I was 12 years old in Cockeysville, Maryland, every August, there was a one month racing program at a small racetrack called Timonium, Maryland. And it was a five eighths of a mile track. So it's like a, you know,

• 1:21:48Speaker 04

  small. I would go with my dad and a friend of his who was a stockbroker. And we would also go to the big tracks like Pimlico, where the pre- to stakes is. But if you go to Timonium, you get to see all the horses. There was so much interest, you learn so much about markets. Number one, it gives you, I think, a respect for market efficiency.

• 1:22:07Barry Ritholtz?

  Because the odds are actually not that bad.

• 1:22:09Speaker 04

  They're extremely good.

• 1:22:10Barry Ritholtz?

  They're pretty, pretty dead on.

• 1:22:12Speaker 04

  Exactly. And so you see, you know, eight horses come out, they all look pretty similar. You know, they're, the jockeys are all, you know, the same size, and they're all pretty good. There's a lot of statistics you can see. But somehow, the crowd has decided that number three is even money favorite, which is a 50/50 chance to win. And number six, who looks pretty good, too, is like 70 to one. And they're mostly right. So, you know, part of why I got into economics and psychology was thinking about episodes like that. How does the market put this information together? And are there mistakes? Like, how do you beat the market?

• 1:22:47Barry Ritholtz?

  So Fama turns out to be more or less right about the efficient market.

• 1:22:50Speaker 04

  He was right about Timonium, Maryland. And there were other interesting lessons, too. Like, so if you go with like around the third race, you know, I was, I was a kid, so I was broke. And my poor mom, my Irish mom was worried I was gonna, you know, lose too much money. I kept telling her, it's tuition, mom, it's tuition. But if you go in the third race, there are these people who'd sell tip sheets for like $5.

• 1:23:13Barry Ritholtz?

  Right. Because they know what's gonna happen. They're selling the tip sheets, not making the bets.

• 1:23:18Speaker 04

  Exactly. The customers' yachts. Exactly. But if you go like in the, you know, the third or fourth race, they would quit selling them, they would just give them to you.

• 1:23:26Barry Ritholtz?

  Oh, really?

• 1:23:27Speaker 04

  Well, like a loss leader. Maybe you'll, maybe next time you'll buy it. And so I'm sitting, here's my little cynical 12, 13-year-old brain thinking, why are you giving away for free tips that you claim can make me money? Like, this does not, the math does not math. And I think that's a good lesson in life for markets, right?

• 1:23:48Barry Ritholtz?

  Yeah.

• 1:23:49Speaker 04

  It's, you know, just to clear away like the most naive, you know, immunize yourself to the most naive schemes, you know?

• 1:23:56Barry Ritholtz?

  You would think if the tips were valuable, rather than waste your time printing it up and selling them, you would just bet on the winning horses, right?

• 1:24:05Speaker 04

  Especially in a paramutual system, right? Because, you know, the more, the more your tip sheet buyers are betting on your horses, the less you can make.

• 1:24:15Barry Ritholtz?

  The lower the odds, right.

• 1:24:16Speaker 04

  Exactly. Then you're betting against yourself.

• 1:24:18Barry Ritholtz?

  It's counterproductive. Our final question, our final question, what do you know about the world of neuroeconomics today might have been helpful when you were first getting started back in the 1980s?

• 1:24:28Speaker 04

  You know, I'll answer that like a politician will answer a question I have a better answer for, which is about behavioral finance.

• 1:24:36Barry Ritholtz?

  Sure. Well, either or, BFI or neuroeconomics.

• 1:24:39Speaker 04

  Got it. So, neuroeconomics, I don't think we made too many mistakes. I think, I wish we had, you know, we got a lot of grant support, Caltech was very supportive. I got to know a lot of interesting people who were generous with their time, who were kind of my tutors on neuroscience. I never took any formal, you know, coursework on it. It was, it came way, way, way after my original grad training. So, thank you, everyone. I wish we had, we have not had much impact in academic economics particularly, and that's something we're kind of working on, maybe we can do better. Behavioral finance, I think, I started graduate school in the late 70s. In 1978, Mike Jensen published a very influential paper.

• 1:25:20Speaker 04

  It was an introduction to a special issue, and one of the first sentences is, "The market efficiency hypothesis is one of the most well-established empirical regularities in economics."

• 1:25:31Speaker 04

  But, and that, but that was like the high watermark.

• 1:25:35Barry Ritholtz?

  Right.

• 1:25:35Speaker 04

  And the special issue was about, there's some things that are anomalous, like earnings drift.

• 1:25:40Barry Ritholtz?

  Right.

• 1:25:40Speaker 04

  You get a weird earnings announcement, the market reacts, but then the market reaction drifts up for, it takes a couple of weeks, almost like food for the market to absorb. It should not take a couple of weeks.

• 1:25:51Barry Ritholtz?

  Right.

• 1:25:51Speaker 04

  Right? There were other things where we see, you know, like one, within one hour, markets are repricing

• 1:25:57Barry Ritholtz?

  Mm-hmm.

• 1:25:58Speaker 04

  really well. But despite this Jensen article, the hostility to behavioral finance was ferocious.

• 1:26:08Barry Ritholtz?

  Ferocious, that's a big word.

• 1:26:09Speaker 04

  At that time.

• 1:26:10Barry Ritholtz?

  It was that, so late seventies, early eighties?

• 1:26:12Speaker 04

  Late seventies, early eighties. And so that's when I was kind of deciding, do I want to stay in finance or mix it with it? And I remember having a discussion, I don't know if Gene remembers it the same way, with, I had to write a paper for Eugene Fama's course, who was also kind of a mentor in the sense that even though I didn't end up doing work that was close, you know, he was, he was really relentless and very empirically driven, and he had a really good idea. When he started, people thought he was crazy.

• 1:26:36Barry Ritholtz?

  Right.

• 1:26:37Speaker 04

  Because there was all this stuff on, you know, there was even, he wrote some papers on dividends, like, well, the optimal dividend payment policy. And of course, Miller and him was like, why pay dividends in a hole? You just like take money from one pocket and put it in the other.

• 1:26:51Barry Ritholtz?

  Well, back in the early days of widows and orphan stocks, you, people lived on their dividends.

• 1:26:56Speaker 04

  Yeah, exactly. Because of the liquidity.

• 1:26:57Barry Ritholtz?

  Right. You don't want to sell, you want to hold on to it.

• 1:27:00Speaker 04

  Right. And then the dividends is, you know, is enough to live on.

• 1:27:03Barry Ritholtz?

  Now, the theory has shifted towards, it's more efficient return of capital to shareholders doing buybacks than dividends, but that's only total return. If you're looking for that income stream, buybacks don't necessarily help you.

• 1:27:18Speaker 04

  Right, right. Exactly. So that's, and that's also where the behavioral economics comes in with, you know, why can't you just like create whatever income stream you want by borrowing and selling?

• 1:27:27Barry Ritholtz?

  Right, that's right.

• 1:27:28Speaker 04

  And if, you know, if you're really liquidity constrained or credit constrained, you can't. But for most people, that's not a big deal. Anyway, so, so if I had known behavioral finance would... It didn't take off quickly. So from 1978, which is Jensen, 1981, I graduated. 1985 was the Thaler and DeBont paper about January FX. And even that was published as a, it was in the proceedings issue, which meant that the president of the, of the AFA could pan pick papers. So the proceedings issue had the most radical papers that were the foundation of Aver economics. Fisher Black wrote a paper called Noise Traders. In fact, it might have just been called Noise.

• 1:28:12Speaker 04

  And then Dick Roll wrote a paper called R Squared. And he said, you know, if only news moves the market, right, then the R squared on days with no news, you know, you shouldn't have any volatility. And of course, days with big news and small news, similar to the story you were telling at the beginning, days with big news, big obvious news and hardly any news move about the same.

• 1:28:37Barry Ritholtz?

  The assumption being by the time it's in the front page of the New York Times, it's already reflected in the price.

• 1:28:44Speaker 04

  But also there may be things that are not newsy at all, like in October 87 crash, you know, the Bundesbank moved rates by a quarter of a point or something.

• 1:28:53Barry Ritholtz?

  Who cares?

• 1:28:53Speaker 04

  That was the big news.

• 1:28:54Barry Ritholtz?

  But, right, but you know, you never know when that last straw breaks the camel's back.

• 1:28:59Speaker 04

  Correct. But, but so all those ideas now that, that we, we, you know, we feel like we have an understanding and examples. There was a lot of hostility to that. So I, I remember asking Gene, I'd like to study market psychology. Like, what do you know about market psychology? And he said, what's that? Market psychology? This Boston accent. You know, I think it's just a word they use on the news, like on Bloomberg. It's just a word they use on the news when the market moves and they don't know why.

• 1:29:30Barry Ritholtz?

  Right. Well, no one wants to admit it's a fairly random day to day. We're very, humans are very, I know that, humans are very uncomfortable.

• 1:29:38Speaker 04

  And we're good at pattern sense making.

• 1:29:40Barry Ritholtz?

  Right. We make up patterns. We come up with a narrative to explain it. I recall Dick Thaler quoting, maybe it was Max Planck, who was talking about physics.

• 1:29:53Speaker 04

  Science progressives.

• 1:29:54Barry Ritholtz?

  One funeral at a time. Thaler said the same thing about behavioral finance. And he also said, I'm bypassing the current generation and going right to the kids. So they'll adapt it wholesale. And literally, he said, I'm teaching grads and undergrads this, so we don't even have to wait for the funeral. And it seems to have worked.

• 1:30:14Speaker 04

  Oh, yeah. No, absolutely.

• 1:30:16Barry Ritholtz?

  Colin, thank you so much for being so generous with your time. This has been absolutely fascinating. I'm glad we finally managed to do this. We have been speaking with Professor Colin Cammera of California Institute of Technology. If you enjoy this conversation, well, check out any of the 500 previous interviews we've done over the past 10 and a half years. You can find those at iTunes, Spotify, YouTube, Bloomberg, wherever you find your favorite podcasts. And be sure and check out my new short form podcast, At the Money, short, single-subject conversations with experts about issues that affect your money, earning,

• 1:30:58Barry Ritholtz?

  spending, and investing it. At the Money in the Masters in Business podcast feed, or wherever you find your favorite podcasts. I would be remiss if I did not thank the crack team that helps put these conversations together each week. John Wasserman is my audio engineer. Anna Luke is my producer. Sean Russo is my researcher. Sage Baumann is the head of podcasts at Bloomberg. I'm Barry Ritholtz. You've been listening to Masters in Business on Bloomberg Radio.

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