Special Edition: Nobel Prize Winner Richard Thaler Live from the Economic Club of New York

On this special edition of Masters in Business, Barry speaks with Nobel Prize winning economist Richard Thaler, along with Alex Imas, Professor of Behavioral Science, Economics, and Applied AI at the University of Chicago Booth School of Business about their book, "The Winner's Curse: Behavioral Economics Anomalies, Then and Now". Recorded live on stage at the Economic Club of New York. 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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  This is the Bloomberg Tech Minute brought to you by ChatGPT. I'm Carol Muster. Getting hired at SpaceX requires exceptional ability and may include having Elon Musk review a candidate's resume. So writes Bloomberg Business Week's Lauren Grush. She reports that the company culture is defined by Musk and job candidates must understand that a commitment to SpaceX means adhering to this culture and exhibiting loyalty to Elon Musk. To get hired, candidates must demonstrate their achievements from past jobs and hands-on experience matters more to recruiters than advanced degrees, with the company looking for people with raw innate intelligence. A spokesperson for SpaceX didn't respond to a request for comment on its recruiting and hiring practices.

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• 2:37Speaker 02

  Bloomberg Audio Studios, podcasts, radio, news. This is Masters in Business with Barry Ritholtz on Bloomberg Radio.

• 2:53Barry Ritholtz?

  Hey, it's a bonus Masters in Business live. One of my favorite economists, Richard Thaler, and his colleague at the Booth School of Business, Alex Emes, were going to give a presentation at the New York Economic Club. And they said, hey, why don't we make this a live conversation? And literally said, hey, how do you feel about being our interlocutor? And any opportunity I have to spend time with Thaler, I jump at. So sure, let's do that. And so a few weeks ago, I sat down with Professor Richard Thaler and Professor Alex

• 3:36Barry Ritholtz?

  Emes, both of the Booth School of Business at the University of Chicago, live at the New York Economic Club, talking about their new version of the book, The Winner's Curse. It was about 30, 40 minutes of conversation. We had some questions from the audience. It was fabulous. In fact, it was so good, we're going to have them back in the studio for a full Masters in Business, which is now already recorded. It won't be out for a couple of weeks. But in the meantime, to give you a taste of what that full interview is like, here is our live Masters in Business conversation at the New York Economic Club.

• 4:23Barry Ritholtz?

  I'm kind of fascinated by not only this book, but Richard's entire history. And a lot of what I know about him really came to the public eye through the anomalies columns that began so long ago. Tell us a little bit about the genesis of what the anomalies columns were and how that led to this book.

• 4:53Speaker 04

  Sure. So about 1986, somebody at the American Economics Association decided it would be a good idea to start a new journal in which the articles would be accessible to at least all economists and grad students and even undergrads because articles have become more and more specialized. So that was the idea. I had a friend, I have a friend named Hal Varian, who has been the chief economist at Google. He was a mere professor at the time and on the advisory board of this journal.

• 5:37Speaker 04

  And they were planning some pieces that would appear in every issue, which is once a quarter. And Hal and I cooked up the idea of having a feature on anomalies. So what's an anomaly in economics? An anomaly is something that cannot easily be explained using the standard assumptions that people are really smart, unemotional, selfish, no self-control problems, basically not like anybody you know. And...

• 6:20Speaker 04

  So, as a result of that, there were lots of anomalies. And I did this for almost four years. When it looked like, a pile of them looked like a book, I stapled them together and that was the original version of The Winner's Curse, published in 1992.

• 6:44Barry Ritholtz?

  So, the book comes out in 92. I was curious how it was received by traditional economists. You're challenging core theses that they deeply believe in. And did the lay public take any interest in this?

• 7:00Speaker 04

  So, you know, I'm very good friends with Steve Levitt and Stephen Dubner. They basically invented a bestselling economics book. Before Freakonomics, there was no such thing. So this is pre Freakonomics. It was read, but the profession had read the articles in the journal. And the book was an attempt to reach out. But, you know, I've often said that, you know, I'm a professional heretic and troublemaker.

• 7:40Speaker 04

  And I didn't change anybody's mind over the course of my career. And after realizing that, I decided instead to have a strategy of corrupting the youth. And Alex is... I used to be young. So, yeah, I'll let Alex tell his version of the story. But, you know, the book sold better than expected and was around. It was still in print, but for various boring reasons, it was going to go out of print.

• 8:23Speaker 04

  And the publisher asked me if I wanted to freshen it up. And that turned into a... Well, we first talked about that five years ago. So, you can see how long it took. But that's the story of the book.

• 8:42Barry Ritholtz?

  So Alex, how did you get corrupted by Dr. Thaler?

• 8:47Speaker 05

  I didn't need much pushing. So I was a neuroscience undergrad major. So I was already kind of interested in how human minds actually worked. I took a bunch of abnormal psychology and things like that. But science, like STEM classes, were really, really hard. And so I took economics as kind of a way to boost my GPA.

• 9:09Speaker 05

  So, and I thought it was fun. The algebra was interesting. And, but I didn't, you know, I didn't think much of it. And then, at some point, I was like, I was moving, and I was applying to medical school, by the way. I was pre-med, good immigrant kid. And I was driving cross-country and I was listening to the radio. And Richard was on the radio. This was 2008. I had no idea who Richard was. I didn't know what Nudge was. He was on NPR talking about Nudge. And it was about this field called behavioral economics that I've never heard about before. And I was like, wait, I could take this and combine it with that?

• 9:47Speaker 05

  And it'll, that's amazing. I got to Los Angeles, went online, applied to econ PhD programs right away. Didn't end up going to medical school. And I ended up going to UC San Diego for my PhD. And low and behold, Richard was not on the roster, but he spent his winters in San Diego in the office next to me. And, you know, I would come out-

• 10:13Speaker 04

  It was corruption at first sight.

• 10:17Speaker 05

  You corrupted me just way earlier.

• 10:20Speaker 05

  And so I was, you know, we started chatting. Then I got a job at Carnegie Mellon afterwards. We kept in touch. And then I got a job offer at University of Chicago. And I think like, I got there in July 2020. I think within like a few months, you gave me a call and said, "Hey, my publisher is asking I should freshen up the book, maybe to give it a new preface. But I want to do something a little bit more ambitious than that." And, you know, we can play around with- That add some new things. It'll take about six months. Easy, easy work. We get to, we get to hang out. And I was, I jumped at the opportunity and then we kept talking and then it grew and grew and grew. And the book is about two thirds new content at this point. So it took five years of writing and going back and forth.

• 11:05Speaker 05

  And, you know, there's been 30 years of research since 1992. And so that's kind of the, the book, the, the, the original winner's curses in there, a little bit rewritten and freshened up. But the 30 years of research are now in there too. So every single anomalies column, there were new anomalies that were added to it that Richard had written afterwards, but also every single chapter comes with an update, basically reviewing everything that's happened in the last 30 years of behavioral economics.

• 11:33Barry Ritholtz?

  So, so I'm going to circle back to the book in a moment, but for people who are unfamiliar with Alex, this wasn't just a random kid next door. He wrote what could be one of the most cited finance papers of recent years called, I'm going to get this wrong, Selling Fast and Buying Slow. Is that right? Selling Fast and Buying Slow. It's a chapter in my book. I've written about it. And you describe how professional fund managers are really, really good buyers of stocks. What it turns out, they're terrible sellers of stock. Nobody had discussed this in this sort of detail. And that's one of the reasons that paper has become so highly regarded.

• 12:17Barry Ritholtz?

  But I just wanted the audience to be aware of, of who you were.

• 12:23Barry Ritholtz?

  Tell us what it was like working on the book with Richard.

• 12:28Speaker 05

  It was just a lot of fun. I mean, we would get on the phone and, you know, why don't we talk about this topic?

• 12:36Speaker 05

  A lot of the research, you know, I kind of wrote, I took lead on the updates and we kind of went back and forth on them. And then it was, you know, just a lot of, a lot of conversations over the phone during COVID. It was a lot of Zoom. Then it moved on to, you know, we were colleagues at the University of Chicago coffees.

• 12:56Speaker 05

  Just kind of going back and forth on what should be included, what, what. A lot of it was about framing of where the field has come. And what we kind of found out, I don't think this was obvious when we first started the book, is that where the field has come is really gone from these lab experiments that were in the original columns in The Winter's Curse, where it was college students, low stakes, maybe not even any stakes at all. And the pushback from the economics profession was, look, we don't really care about students. We care about market participants. The updates are all about, look, all of these anomalies, as you mentioned, replicate in some of the most sophisticated economic participants out there, such as institutional investors, in the case of my paper.

• 13:37Barry Ritholtz?

  So there are some ideas in the book, endowment effects, status quo bias, The Winter's Curse, that are today are everyday vocabulary, but back then, people really didn't know about it. The whole book has aged fairly well. What do you think about those original ideas, Richard, and how they present in the modern world?

• 14:03Speaker 04

  Well, I mean, one of the motivations for writing the book is the so-called replication crisis. It's not really a crisis, but there has been several papers and several fields where the original experiments cannot be reproduced. And some of those papers are, let's say, adjacent to behavioral economics. And I was worried that some of that bad aroma would rub off on us.

• 14:46Speaker 04

  And I think the reason why things replicate so well is when I was choosing what topics to write about, I was picking big stuff. I wasn't picking some little minor thing. I was picking something with a very big effect size. And topics, there had already been several papers. So, you know, it's not when we started this that we...

• 15:22Speaker 04

  Realized there really wouldn't be any problems. But we were pleasantly surprised not to find any, anything in the attic, so to speak.

• 15:35Barry Ritholtz?

  Nothing aged poorly?

• 15:37Speaker 04

  No, not really.

• 15:39Barry Ritholtz?

  What has persisted, or if anything have become more widely accepted today? That was a pleasant surprise amongst the chapters in the book.

• 15:54Speaker 05

  The endowment effect now, so, you know, back then, back in the 92 book, it was about mugs and pens. So the endowment effect is this phenomenon where, you know, buyers and sellers are in a market. The idea is that if you assign a good to a buyer or seller, there's a theorem in economics that underlies, basically, it's one of the fundamental theorems in economics called the Coast theorem. Basically, it means that it doesn't matter who's assigned property rights. There's going to be transactions where people, the person who wants it the most or values it the most is going to end up with it. And what Richard showed in a paper with Jack Netch and Danny Kahneman is that, basically, you know, have, let's say, Barry, you are sitting in a classroom, I'm sitting in a classroom.

• 16:38Speaker 05

  The professor gives me a mug and doesn't give you a mug. You have some money in your pocket. And he's asking, what is the lowest amount that you would be willing to sell the mug? And he's asking you, what is, how, what's the most you'd be willing to pay for the mug? Because it doesn't matter, we were randomly assigned, we should have basically the same average valuation. But it turns out, just because I own the mug, I start valuing it more. This is called the endowment effect. And what Richard and Danny and Jack showed is that it's about two and a half times more. So this, there's like a breakdown in the market because of this endowment effect. So what have we found, what has been documented thus far? There's a paper in the American Economic Review, the top journal in the profession, showing that there's an endowment effect for houses.

• 17:21Speaker 05

  And you can actually estimate exactly the amount of loss aversion that people have, which drives them to post, if they own the house, they post the house at a higher price. And the number, the actual quantitative number in housing markets, this is the crazy part about it, matches the number that Richard documented in the lab. So there's, there's. Uh, there's obviously a lot of back and forth between uh, different experimentalists, different uh, different experiments and stuff like that. But even most of the quantitative magnitudes have been.

• 17:55Barry Ritholtz?

  It's robust. Let's talk about something that economic theory says shouldn't happen. Um, ultimatums and cooperations. Let's talk about the ultimatum game. Tell us a little bit about that.

• 18:07Speaker 04

  Okay, sure. So the ultimatum game is pretty simple. Uh, let's say I give Barry a hundred dollars. And I tell him that he's got to share it with Alex. He can make Alex an offer for some amount of the hundred. He could give all hundred.

• 18:28Barry Ritholtz?

  Unlikely. Unlikely.

• 18:31Speaker 04

  Alex gets to say yes or no. So it's an ultimatum. Uh, and if he says yes, deal. If he says no, they both get nothing.

• 18:44Speaker 04

  Now, that game was invented. It didn't really surprise us. Um, it was invented because we kind of knew what was gonna happen. Which was, so, but before that, let's say, what does economic theory say? And what does game theory say? Game theory says, people are selfish. And Alex, if you offer him a dollar, don't insult him with a quarter. Or a penny, but if you offer him a dollar, dollars worth something. And he knows dollars worth more than zero, so he'll take it.

• 19:25Speaker 04

  And you know that he knows that. And so he, uh, you offer him a dollar and he takes it. No, no real world person has ever done that.

• 19:37Barry Ritholtz?

  Meaning in the lab experiments, what's the number, under twenty dollars?

• 19:42Speaker 04

  Under, yeah. Offers less than twenty percent of whatever the pie is are more likely, are likely to be rejected. Offers tend to be fifty fifty. Uh, the profit maximizing offer is forty percent.

• 19:58Speaker 04

  So, there are a whole, we have two chapters that are about games sort of like this. The big lesson is that in the world, you're dealing with people. And if you make insulting offers, they may get rejected. And if you want cooperation, you have to be cooperative. Let me, let me tell you a story that's related to this. Years ago, my wife and I were in Thailand. And we needed to take a cab, like a 20-minute ride.

• 20:39Speaker 04

  Like, three blocks here, but it was 10 miles in Chiang Mai. So, and everything is negotiated there. So, I'm negotiating with this cab driver. And after wild negotiations, we agree on some fair, I don't know, $4. And we, we get to the restaurant. And then, um, there was a question of how are we gonna get back? And the cab driver said, "Would you like me to take you back?" And notice, there's a mutual risk of defection. He could not be there when we get done with dinner.

• 21:22Speaker 04

  Or we could get done early and go back with somebody else. He proposed a contract that no economist would ever recommend. The contract was, he said, "Don't pay me anything." Perfect. So, when dinner's over, of course, we went to look for this cab driver. We're not gonna stiff the cab driver. And in fact, he dropped us somewhere else for some other, same thing. Now, uh, what's the lesson there? He knew that by being trusting, he would engender trust.

• 22:06Speaker 04

  And that's like a, a big, important lesson, both in business, and in life, and in politics.

• 22:17Barry Ritholtz?

  Coming up, we continue our live conversation with Dr. Richard Thaler and Dr. Alex Emes, both of the Booth School of Business at the University of Chicago, discussing the newest edition of their book, The Winner's Curse.

• 22:41Speaker 00

  At Brookfield, we invest in the thing behind the thing, behind the next big thing. Our focus across infrastructure, energy, real estate, private equity, and credit is helping to build the backbone of the global economy. We combine deep operational expertise with disciplined long-term investing, uncovering value, and partnering alongside clients to shape tomorrow's economy today. Learn how you can own what's next at Brookfield.com/own. This is not an offer to sell or investment advice. Investing involves risks, including loss of capital.

• 23:16Speaker 01

  This is the Bloomberg Tech Minute brought to you by ChatGPT. I'm Carol Muster. Getting hired at SpaceX requires exceptional ability and may include having Elon Musk review a candidate's resume. So writes Bloomberg Businessweek's Lauren Grush. She reports that the company culture is defined by Musk and job candidates must understand that a commitment to SpaceX means adhering to this culture and exhibiting loyalty to Elon Musk. To get hired, candidates must demonstrate their achievements from past jobs and hands-on experience matters more to recruiters than advanced degrees, with the company looking for people with raw innate intelligence. A spokesperson for SpaceX didn't respond to a request for comment on its recruiting and hiring practices, but according to recruiters,

• 24:01Speaker 01

  advisors, and those who've interviewed for jobs there, it's the space exploration dream that draws people to the company, and Musk invokes that dream regularly to remind workers why they're there. Prospective hires are told that the job will require stamina, including in job ads that candidates, quote, "must be willing to work extended hours and weekends as needed." One major perk for all that hard work? Employees' access to equity, either the right to buy shares or payment in the form of restricted stock units that vest over time. That's the Bloomberg Tech Minute brought to you by ChatGPT. Get started at ChatGPT.com.

• 24:42Barry Ritholtz?

  I'm Barry Ritholtz. You're listening to Bloomberg's Masters in Business. Let's continue our live conversation with Richard Thaler and Alex Emes, discussing the new edition of the book, The Winner's Curse. So let's talk about some other things within the book. The title, The Winner's Curse, is really a fascinating story and leads so many places. Let's start off talking about oil leases. Tell us about The Winner's Curse.

• 25:13Speaker 04

  You want to go, or you want me to go?

• 25:16Barry Ritholtz?

  You can do it.

• 25:17Speaker 04

  So, this is the only chapter in the book that the research, original research, was not done by psychologists or economists.

• 25:30Barry Ritholtz?

  The law of one price.

• 25:32Speaker 04

  Oh, you're not counting financial economists as economists?

• 25:37Speaker 04

  Ooh, and that gets back to Booth. You're gonna be in a lot of trouble.

• 25:41Barry Ritholtz?

  I'm in a different part of the building.

• 25:44Speaker 04

  So, finance is just a branch of economics. It's not its own field. So, we're both dabblers in finance. So, the research in this was done by engineers at Atlantic Ridgefield, ARCO. And here's what they found. They were bidding for oil leases in what I still call the Gulf of Mexico. And what they found was that for the leases they won, there was less oil than they expected.

• 26:27Speaker 04

  And they're thinking, "We have great geologists. How can we be wrong? What's going on?" And then they got an insight. The essence of the insight is that when you're in an auction, the ones you win are not a random sample of your bids. The auctions you win are when you bid high.

• 26:56Speaker 04

  Right now, that sounds like a pretty obvious point. But it's not. Because if there are a lot of bidders, let's suppose that the the version of this that we would run in classrooms is we'd have a jar of coins. And we'd have people bid for the amount of money in the jar, not the coins. And what happens? The average bid is, let's say the jar is worth a hundred dollars. The average bid is much less because people are risk averse. But the winning bid is always more than a hundred. Because it's the most optimistic person, or the person with the worst eyesight, or whatever.

• 27:40Speaker 04

  So this insight by the engineers applies everywhere. And contractors have either learned this or go out of business. Right? Because when they're bidding on a job, the low bid wins. And if you forget the roof or the HVAC, you're going to go massively over. And so one of the interesting follow-up experiments was to take a bunch of contractors and put them into one of these experiments and see what would happen.

• 28:23Speaker 04

  And the experimenters were a little worried that the contractors were going to take them to the cleaners. But they didn't. The reason is, the contractors never understood the math of this. Instead, they had a fudge. So they would figure out what they thought they could build it for, and then they add 25%. And that covers the stuff they forget. But they didn't have that rule for bidding for jars. And so they were no better than the undergrads in the winner's curse.

• 28:58Barry Ritholtz?

  How is this held up since? What is the latest data on the winner's curse look like?

• 29:04Speaker 05

  Well, the winner's curse, as we discuss in the update, it's held up quite well as far as, you know, the experiment replicates, first of all. You know, you run it in Harvard, you go into Econ 101 at Harvard, you auction off a jar of coins, they're going to be overbidding for the coins. It's just, and then, you know, it's held up with NFL teams where you're basically bidding for free agents and things like that. So it shows up in the data. And the big follow-ups to the winner's curse has been the idea, kind of abstracting from the phenomenon of the winner's curse, but thinking about like what leads to the winner's curse in the first place psychologically.

• 29:46Speaker 05

  And psychologically, what leads to the winner's curse is you not taking into account that you're bidding against other people. You're not just kind of bidding alone. Oh, I think this is worth this much. That's how much I'm going to pay shading down a little bit. It's the fact that if I'm bidding with a lot of people, if I end up winning, that's real bad news for me. Because everybody else is just as smart as me and they're bidding with the similar information. And if I'm the one who's winning, I'm making a mistake. So you kind of have to bid down. And so the other follow-up experiments have basically explored where this sort of phenomenon shows up in other places.

• 30:26Speaker 05

  So for example, one setting is, you know, kind of thinking about,

• 30:34Speaker 05

  there's the guessing game, the beauty contest game, which is meant to model-

• 30:37Barry Ritholtz?

  From Keynes.

• 30:38Speaker 05

  From Keynes, exactly. So the follow-up to the idea behind the winner's curse. So Keynes had this model for the stock market where he said that the stock market is a beauty contest in the sense that it's not that the fundamental value of a stock would determine its price. It's what everybody else thinks the fundamental value is. It's all about the belief. So there was this, the reason it's called the beauty contest is newspapers used to run these contests where you had a whole page of faces. And the winner of the contest was the one who chose the face that everybody else chose as well. And so he said the stock market is just like that. And so you run the beauty contest by saying something like, alright, what is, guess a number between one and a hundred.

• 31:21Speaker 05

  The room guesses, everybody submits a guess. And the winner is the one who guesses two thirds of the average. Now again, this game, think about it for a second. This game has an economic solution. And what's the solution? What we can do right now?

• 31:38Speaker 04

  It's the New York Economics Club. Somebody should know the Nash equilibrium.

• 31:43Speaker 05

  Anybody have a guess for the Nash equilibrium?

• 31:47Speaker 05

  Yeah. Yeah. It should be one.

• 31:51Speaker 04

  It should be zero or one.

• 31:53Speaker 05

  If the lowest number is one, it's one. And the reason is the following. Let's say, I think I'm playing against a bunch of, you know, random people. They don't know what they're doing. They're guessing randomly. If everybody guesses randomly, the average is going to be 50. So I should do two thirds of that, right? But then I think, alright, if it's two thirds of that, I guess that. Uh, wait, well, they're probably going to think the same thing. And so they're going to guess two thirds of 50. So I should do two thirds of that. But then I think, wait, no, hold on. Hold on, I'm going to do two thirds of that. And two thirds, two thirds, two thirds, I get to one, right? So that's the Nash equilibrium solution. Would you win guessing one?

• 32:35Speaker 05

  No, you would not win guessing one because other people are not guessing one. So the way that you, when you run this experiment, essentially what you see is the majority of people guess something like 50 times two thirds, times two thirds. So they make it to level two and then they stop.

• 32:58Speaker 04

  I played this game once in the Financial Times with two business class tickets from London to the US as a prize. And the winning guess was 13.

• 33:12Speaker 04

  So there were lots of zero and ones. And they didn't win. There were a, there were a bunch of ninety-nine and a hundred.

• 33:23Barry Ritholtz?

  They didn't understand the game.

• 33:24Speaker 04

  No, they were jerks.

• 33:26Barry Ritholtz?

  Trying to skew the numbers?

• 33:28Speaker 04

  Yeah, and they were all from Oxford. And they, they, they were trying to pull it off. They weren't disguising, they all had the same dorm address, but, but, but, but it was one guess per person. So, my TAs and I were the judges in this. We had thirteen hundred entrants. But, yeah, so again, this is the sort of thing that we can do in class.

• 34:02Speaker 04

  If you do it with MBA students, you're gonna get a number in the teams.

• 34:06Speaker 05

  Like thirteen, eight, something like that. The more so kind of, oh, I've taken economics, they'll, they'll go like eight. Oh, I haven't taken economics, thirteen, sixteen. So it's, it's always above one and it just mattered. You can see these spikes of the data. That's the craziest part about it.

• 34:22Speaker 04

  So you know, I've written, I've written a paper with one of my former students showing that the NFL draft is subject to this.

• 34:30Barry Ritholtz?

  Literally where I wanted to take this into the real world.

• 34:34Speaker 04

  You know, ESP is one of my, one of my skills, Barry. So, the, well, you probably are all familiar with the NFL draft. The, the end of the season, the worst team gets the first pick of the eligible players. What you may not know is there's a, a chart that the Dallas Cowboys first created.

• 34:59Speaker 04

  One of the, one of the owners that plots what somebody thought was the, should be the prices to trade picks. So for example, you can trade the first pick for the seventh and eighth picks or for half a dozen second round picks. And what we show in that paper is the early picks are massively overvalued.

• 35:24Barry Ritholtz?

  And where, where does the value show up? Round two, round three?

• 35:27Speaker 04

  Yeah, round two. Now, even bigger anomaly is you can trade this year's pick for next year.

• 35:37Speaker 04

  And the rule of thumb is if you trade a second round pick this year, you get a first round pick next year. So you move up one round per year. And we calculated that's a discount rate of 137%.

• 35:55Barry Ritholtz?

  Really? Why such a big discount rate?

• 35:58Speaker 04

  Because owners want to win. Now, we have one former franchise owner in the room. And I'm pretty sure he didn't get his money by borrowing at 137%. But NFL teams are even more expensive than NBA teams. But that it's still, they still have that rule. And we're in the process of replicating that study. And it's all exactly the same.

• 36:33Barry Ritholtz?

  So this conversation reminds me of the discussion that took place after Michael Lewis's Moneyball. So everyone's familiar with the book about the Oakland A's and how they brought a essentially behavioral economic approach to selecting players. What happened after that book came out?

• 36:58Speaker 04

  Well, it's interesting. I mean, one thing happened is I got in touch with Michael Lewis. And we didn't know each other at the time, but through his publisher or something, I said, if you're ever in Chicago, let me know. I'm there next week. And we've become very good friends and have come to realize that sports analytics and behavioral economics are the same field. It's trying, why? Well, what was Billy Bean, who also lives in our northern California neighborhood? What was Billy trying to do? He was trying to buy a team more cheaply than others by...

• 37:44Speaker 04

  And it's just like being a portfolio manager. You're trying to buy undervalued stocks. He was trying to buy undervalued players. Michael got so interested in this, he ended up writing the book, The Undoing Project, which is a great book. It's about my mentors, Danny Kahneman and Amos Tversky. He did stick an irrelevant chapter in the beginning about Daryl Morey, but anyway.

• 38:15Barry Ritholtz?

  The line I was looking to pull from you is, not for nothing, Michael, but what you're writing about, these two Israeli psychologists have been writing about and experimenting with for years. Moneyball directly led to your relationship with him and that becoming a book as well.

• 38:35Speaker 04

  Yeah, and I mean, it's about the biases from psychology and it's also about markets, right? So the difference between behavioral economics and psychology is markets. So a psychologist would be interested in the fact that teams are overconfident in their ability to tell good players from bad. That's pure psychology. The fact that it gets reflected in the market for picks, that's economics.

• 39:09Barry Ritholtz?

  So let me push back a little bit on this and the winner's curse in that all the topics that you write about in the winner's curse, oil leases where we don't know what the future oil production will be, first round draft picks where we don't know how that player is going to perform, and in the markets, either picking stocks or picking fund managers to pick stocks, or picking somebody to pick the fund managers in a fund to fund to pick stocks, they all seem to deal with, hey, we really are unaware of how this is going to play out and we're making decisions under uncertainty. All of this comes back to Kahneman and Tversky.

• 39:54Speaker 04

  Well, I'm not gonna, I'm not gonna disagree with that. I mean, my, look, I became a behavioral economist when I discovered them. I claim that was my big discovery, was discovering these two psychologists who were over in Israel that economists hadn't heard of. And I went and spent a year at Stanford where, when I got wind that they were gonna be there, and basically stalked them.

• 40:26Speaker 05

  Well, a lot of the phenomenon, they go away when there's not a lot of uncertainty. The winner's curse needs uncertainty, right? If we know what the value of the plot is, there's no winner's curse. It doesn't matter how many people are bidding. If we know, so there's a famous anchoring effect, right? So if I, the anchoring effect is essentially, you know, you ask a question like how many countries are in Africa before, but before I do it, I spin a big wheel, right? The wheel has nothing to do with the question. And the wheel gets to like seventeen, or eight, or whatever. And it turns out wherever that number gets to affects how, what number people guess about the number of countries in Africa. But if people know the number of countries, they're not gonna be affected by the wheel, right?

• 41:06Speaker 05

  So all of this has to do, almost every single behavioral economic phenomenon has, is bred and fed through uncertainty. And I think the way that people react to that uncertainty and shape their preferences and beliefs, that's where all the biases seep in, in the first place. When experts know what they're doing, when they're, you know, they know the value of the plot, they know what, you know, whether the stock is gonna go up or down, there's not a lot of biases to talk about.

• 41:36Speaker 04

  You know, one aspect of this that surprised me is, in the sports world, teams have learned, but really slowly. I mean, it's like shockingly slowly.

• 41:56Speaker 04

  When the three-point shot was introduced in basketball, Daryl Morey, I always tease him, he's the general manager of the Philadelphia 76ers. I always tease him that he was the first guy who figured out that three is 1.5 times two. So you should take three-point shots because they have a higher expected value. Every team has somebody who can make 40% of their three-point shots, and they make about half their two-point shots. But if you look, Larry Bird was really good at making three-point shots, and he took two or three a game. Steph takes 20. He's a little better than Larry Bird, but the...

• 42:38Speaker 04

  Now, if you look at that trend, it's really shallow. And it's the same as, football teams have learned to punt less, but still...

• 42:52Barry Ritholtz?

  Go for it on fourth down.

• 42:53Speaker 04

  They should go for it on fourth down. They get it right now half the time, and the closer they get to... If they get over the 50-yard line, they're more likely to get it right, but they're still terrible. So, the learning is slow, and the reason is, people don't like to look like fools.

• 43:16Barry Ritholtz?

  There was a Wall Street Journal article about, I don't remember if it was a high school or a college coach, who always went for it on fourth down.

• 43:23Speaker 04

  Yeah, I love that guy.

• 43:25Barry Ritholtz?

  And that was 10 years ago, right?

• 43:27Speaker 04

  Yeah, 20 years ago, probably. He didn't have a kicker. He didn't have any... He didn't have a field goal kicker or a punter. Now, it's, this is obviously the case for high school. Because, think about, you gotta hike it back to some kid, he has to catch it, he has to put it down, and then the other kid has to kick it, and the weather's lousy, so he just had no kickers. And he was winning the state championship in Arkansas, I mean...

• 44:05Speaker 04

  Not some place with lousy football. So, teams will get better, people do learn. But, you know, people are always asking me, what surprised me? What has surprised me is how slowly the learning has taken place in... Look, how long did it take, it's a World Series. How long did it take them to add a pitch clock? Baseball had become unwatchable. They add a pitch clock, it cuts half hour off the game. Oh, you know, that's not a genius. They, they had a 24 second clock in basketball for 40 years. So, they could have figured this out, but sometimes they don't.

• 44:46Speaker 05

  It's not just sports. I think like, the thing that economists push back with behavioral economics, it's, oh, people just don't know have opportunities to learn, right? In the endowment effect, if they, if they trade enough, if people know what they're doing for long, even for a short period of time, they'll figure it out, these biases are gonna go away. That's the whole like, look, these are just confused subjects. They go to the market, they'll get some feedback, everything will be fine. But I think that's the biggest, I think with Richard being surprised, I think not just in sports, everywhere that these anomalies have held up. And the fact that these anomalies are holding up in very, very experienced people. So, the, in the paper with traders, you know, they're, we find that they trade really well when they're buying, but on the selling, they have to do a lot of selling. They sell all the time, they have to sell in order to buy.

• 45:31Speaker 05

  They sell all the time, some of them have years, decades of experience, and they're doing worse than random in their selling.

• 45:38Barry Ritholtz?

  Well, explain that, cuz that was what was so brilliant about that paper. In order to figure out how well they sold, you guys came up with the solution of, let's randomly sell anything else from that manager's holdings and compare it to what they actually sold.

• 45:55Speaker 05

  Right.

• 45:56Barry Ritholtz?

  And what are the results?

• 45:57Speaker 05

  The results are, so we basically said, look, we wanna give these guys the, a large benefit of the doubt. We don't know what their conditions are, so we're just gonna compare them to a very, very easy counterfactual. I don't know what they're facing, I'm just gonna throw a dart in their portfolio and sell that instead. And they did worse than random. And, basically, what we found is that they were, they didn't have, they weren't spending a lot of time on, on the selling decisions. We interviewed them and we said like, what are you guys doing? It's like, ah, selling is not really that important, it's not really an investment decision. And I'm like, you know... All right. I told my friends at the University of Chicago Finance Department, they were very surprised that selling wasn't an investment decision.

• 46:40Speaker 05

  And so they were just not really paying attention to it. So they were just selling the things that were very, very salient on their screens and the things that they were least attached to. So going back to the endowment effect, they were selling the things that they had recently bought. But if you're good at buying, that's not what you should be selling. You should be holding on to that for longer to get that alpha out. And we actually, we have a graph in the paper called like the alpha decay graph. And it was about nine months and they were selling it around six.

• 47:10Speaker 04

  You know, we all have blind spots. And you just wrote a book recently. You have a chapter on selling because of Alex's paper.

• 47:21Barry Ritholtz?

  Exactly, 100%.

• 47:22Speaker 04

  If he hadn't written that paper, you wouldn't have had a chapter on selling.

• 47:25Barry Ritholtz?

  I would have had a different chapter. It wouldn't have been as good.

• 47:28Speaker 04

  Or there are no articles about selling. Basically.

• 47:32Barry Ritholtz?

  Very few, very few.

• 47:34Speaker 04

  So if you look at the Journal of Finance or one of the other top journals, there'll be 100 articles of the form. Use the following three criteria to form a portfolio. Hold for one year, then sell. And these guys said, oh, maybe selling could be interesting. And they could maybe double their alpha if their selling decisions were as good as their buying decisions.

• 48:05Barry Ritholtz?

  Coming up, we continue our live conversation with Dr. Richard Thaler and Dr. Alex Emes, both of the Booth School of Business at the University of Chicago, discussing the newest edition of their book, The Winner's Curse.

• 48:34Speaker 01

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• 50:01Barry Ritholtz?

  I'm Barry Ritholtz. You're listening to Bloomberg's Masters in Business. Let's continue our live conversation with Richard Thaler and Alex Emes discussing the new edition of the book, The Winner's Curse. Well, we talked about this last time we discussed this issue. The buys are very quantitative and rigorous. The sells are just squishy and every emotional bias that comes in, oh, this is starting to falter, it's not doing what I expected. Something else shiny comes along and catches their attention. They need to make room in the poor Portfolio, you mentioned, um, blind spots.

• 50:43Barry Ritholtz?

  Your friend Danny Kahneman used to talk about, I used, asked him on occasion, "How do you avoid all of these biases we all succumb to?" And he's like, "I'm subject to every one of them. We all have a bias blind spot. There's no getting away from it." Is, is there hope for us?

• 51:02Speaker 04

  Well, the only way you can learn anything is feedback. And, and most of us don't bother. So, we don't get the feedback. And, you know, when, when my, uh, friend Cade, my former student that I did the football paper with, we, uh, were hired for a while by one of the NFL teams. And we're, they're showing us around their facility. And we go and there's some room about the size of this, full of file cabinets. And we say, "What's in there?" "Oh, old scouting reports."

• 51:47Speaker 04

  Our eyes are getting big, you know? Like, "Well, have you ever studied those?" "No." Right? So, you know, they're, they have, they're, they have probably 20 scouts going around watching games. They've built a $2 billion Taj Mahal stadium, but do they, uh, invest a little research in improving the process of picking players? No. And I must say, most firms are not that much better.

• 52:23Barry Ritholtz?

  Really?

• 52:24Speaker 04

  Uh, well, firms still do interviews. Interviews.

• 52:31Barry Ritholtz?

  Symphonies are doing blind auditions.

• 52:33Speaker 04

  Yeah, they, but they still listen.

• 52:37Barry Ritholtz?

  Yes.

• 52:38Speaker 04

  So.

• 52:39Barry Ritholtz?

  Arguably.

• 52:41Speaker 04

  Interviews, look, and I think a great musician can hear

• 52:48Speaker 04

  whether you're playing well or poorly. Learning anything useful about how somebody is going to do on the job from the usual job interview is very different.

• 53:01Speaker 05

  One of our postdocs actually has a paper, Brian Jabaryan. So he worked with a company in the Philippines. They replaced all first round interviews with artificial intelligence. And retention ended up increasing. Basically, they were able to extract the signals that they needed to extract at that stage and that humans were missing.

• 53:21Barry Ritholtz?

  So let's talk about this before we're going to open up this up for questions in a minute. But let's talk about that sort of choice architecture. And I just have to share some numbers with people as to how significant this could be. Richard's book, Nudge, described a variety of different ways to affect decision making. Perhaps the most significant was when you open a 401k, there's no obligation for you to participate in the company. When money goes into it, there's no obligation to put that money to work. And Richard convinced the SEC and the government to change that

• 54:03Barry Ritholtz?

  so that the default is that you're assumed to participate and the money goes into some qualified fund, either a balance fund or a target date fund. And to just put some flesh on how significant that is, the US's 401k, not counting today's trading action, is $4.7 trillion. Historically, 40% of that was defaulted to cash, which means there's $2 trillion being invested today that otherwise would have been sitting around in cash for God knows how many years. So given what we know about choice architecture, how should we be addressing choices and options,

• 54:48Barry Ritholtz?

  whether it's in hiring or putting money to work or bidding and auctions? How should, what should we be doing better?

• 54:55Speaker 04

  I mean, there's, so, you know, let.

• 54:59Speaker 04

  On the retirement saving thing, we did three things. One was change the default. And we had to get congressional approval for all of this because companies said, "Oh, if we enroll somebody without their permission, some lawyer is gonna sue us as soon as the market goes down." So we were able to get a bill passed in 2006 that said it was okay to automatically enroll. It was okay to invest in something like a target date fund, even though it could go down. And it was okay to slowly ramp up their contributions,

• 55:43Speaker 04

  what I call "save more tomorrow" because we all have more self-control next week.

• 55:51Speaker 04

  So that, you know, those three ingredients were important. Maybe that four trillion is twice what it would have been without it. It's not easy to just say, you know, "What can you do to solve obesity or some other problem?" My mantra is, "Make it easy." If you want people to do something, make it easy.

• 56:34Speaker 04

  I always say what I would like is a world that's like GPS. I have a terrible sense of direction. And now I don't get lost hardly ever, right? And notice, the GPS doesn't tell you where to go. You had the wrong address coming tonight. So, but I plugged in the right address and, you know, well, I just had to walk down Fifth Avenue, but even I could do that. But, right, so for complicated things, like improving your diet, or exercising more, or whatever problem you're trying to solve.

• 57:20Speaker 04

  You have to figure out what's preventing people from getting it right, and then eliminate that. And, you know, when David Cameron was elected Prime Minister in the UK, he had, get this, they don't have platforms, they have manifestos. And they had told me that they were gonna put in their manifesto that if they got elected, they were gonna create a nudge unit. And I said, "Yeah, yeah," because I'm used to the US. So, but they did it. And they called me up and said, "Hey, we're starting this thing.

• 58:05Speaker 04

  You better come over and figure out how to do this." And the main lesson I learned was, we go to the branch. One of the things we did was, we changed the way they dealt with people who owed money on their taxes. And I said, "What do you do?" "Well, we send a letter." "What does the letter say?" "Oh, well, they showed us the letter." "Oh, I think we can improve the letter." So, and we told them, truthfully, 90% of people paid their taxes on time. That increased the speed, so brought in money very fast. Costs nothing, right? They're sending the letter. It doesn't cost any more to write a good letter.

• 58:52Speaker 04

  But you have to, you have to talk to the experts and understand what it is that's preventing them from doing the right thing, and then make it easy for them to do that.

• 59:07Barry Ritholtz?

  Remove the obstacles, make it easy. All right, so we have a few more minutes. Let's get some questions. Can I see some hands? Wait for the mic. Let's start right up front and work our way back.

• 59:19Speaker 06

  Thank you so much for a super interesting discussion. I'm curious, Robert Auman has a theory that says that reasonable people can't disagree. And I'm curious like how you would relate that to the winner's person if you've ever had a discussion with him about that.

• 59:36Speaker 04

  Reasonable people can't disagree?

• 59:38Speaker 05

  He's never been on long.

• 59:40Speaker 04

  I mean, you know, Alex and I are both extremely reasonable.

• 59:46Speaker 05

  We disagree.

• 59:47Speaker 04

  We disagree on all kinds of things.

• 59:49Speaker 05

  Well, his theorem is basically if you have the same information set, you have to arrive at the same belief.

• 59:55Speaker 06

  Actually, it says you don't even need the same information.

• 59:57Speaker 05

  You need common knowledge.

• 59:58Speaker 06

  You need common knowledge of each other's rationality. You don't need the same information.

• 1:00:05Speaker 05

  But, and then you arrive at the exact same posterior belief, right? But the problem is that people have confirmation bias in the real world, right? So they seek out information that confirms their beliefs. So they end up not only, they basically end up in completely different worlds thinking that they're rational and somebody else who's not agreeing with them is irrational. And that, if you go back to Robert Auman, that breaks that, that condition for being able to agree. So one of the things about the internet age and digital, the digital transformation is that, look, if you read like the texts of what technologists were writing, we're going to be in a utopia, millions of, a library of Alexandrias at our fingertips.

• 1:00:50Speaker 05

  Everybody will have all information at the same time. We should all agree, right?

• 1:00:55Speaker 04

  And we're not there yet.

• 1:00:57Speaker 05

  We have all the information. We are there yet, but what ended up happening...

• 1:01:01Speaker 04

  Yeah, but we are not all agreeing.

• 1:01:03Speaker 05

  But it's because people are seeking information that confirms their priors and confirms the priors of the people that they're, and, and, and because you can't think that your prior is wrong, if you could, if you meet somebody with a different prior or a different belief, you assume that they're irrational. And then we're not going to agree. I'm going to hold on to my belief. You're going to hold on to your belief. And the more this kind of ramps up, the ability to endogenously gather information, and the feeding of that process from the information providers gets worse and worse.

• 1:01:36Barry Ritholtz?

  The fascinating part about the stock market is all the economic data is out there, all the market analysis is out there. Bulls and bears go out and they find what supports their view. They rarely seek disconfirming advice. And hey, trade is where there's a disagreement on value, but an agreement on price. And it's all the same information. People cherry pick.

• 1:02:00Speaker 04

  And perhaps the biggest anomaly in financial markets is the volume of trade.

• 1:02:05Speaker 05

  That people are trading in the first place.

• 1:02:07Speaker 04

  That's the counter example. How can we have a trillion shares traded if everybody agrees? Yeah, right. The mic right behind.

• 1:02:21Speaker 07

  So this is actually a related question. You wrote a paper in 1997 on the equity premium puzzle. You finished it by saying, you have any issues with this, call me in 2017. So in 2017, two fourth years at the University of Chicago who studied economics emailed you, trying to call you on your bluff. You met with them, which me and my now husband do appreciate. But, and we both work in finance now. And I am curious, especially you mentioned like the volume of trading, democratization of trading, Robin Hood traders. As you're refreshing this book more broadly, how has technology changed or magnified some of the behavioral econ effects that you were writing about in 1992?

• 1:03:03Speaker 04

  So of course, I vividly remember this.

• 1:03:08Speaker 04

  And there's a bridge over near Brooklyn.

• 1:03:13Speaker 04

  You know, the, so you're right, there was a chapter, it wasn't a chapter in the original book, but I did write a column on the equity premium puzzle, and then a paper about it, and we talked about whether to include it. Instead, we just have a couple pages saying, the equity premium is within 1% of what it was when the first paper was published. It's gone from seven down to six, or something like that. So it didn't seem worth a chapter.

• 1:03:46Speaker 05

  But it is in the appendix.

• 1:03:48Speaker 04

  But I'll let Alex, who's the now part, talk about the technology.

• 1:03:55Speaker 05

  Yeah, so I think the, you mentioned the democratization of finance, and I think there was this hope that, again, you know, people have access to, basically, there's no transaction fees, you log on to your phone, you have access to these equities and financial products that you didn't have access before. So now, everyday people have, you know, can get a piece of the pie, they can get a piece of the real growth of the economy. So some of our colleagues wrote a paper at the University of Chicago recently, I think it came out this year, doing an audit of what people are trading on platforms like Robinhood. They're trading weekly options, and they're losing billions of dollars. I think within the last

• 1:04:36Speaker 05

  two years, they lost $6 billion, right? And so, and why is that? Well, the same sort of biases that you have, that you're documenting in the lab, that you document in the field, they're on steroids in digital spaces, right? What is Robinhood doing? Where is it making its money? Because Robinhood does make money. It's making it on spreads, right? And the widest spreads are crazy instruments, like options, that generate these lottery-like returns that we know people are really attracted to. And so, it's making money off of behavioral biases, and people are losing a lot of money on it. So.

• 1:05:14Barry Ritholtz?

  It's not even the weekly options, it's the single day options now have become the biggest volume.

• 1:05:19Speaker 04

  Right, and of course.

• 1:05:21Barry Ritholtz?

  Pure gambling.

• 1:05:22Speaker 04

  Sports gambling is even worse odds.

• 1:05:29Barry Ritholtz?

  Where you can bet on every play, not even the outcome of the

• 1:05:32Speaker 04

  Well, and now they're learning that these bets on what a specific player does, they've got to get rid of those because there's just going to be too many scandals.

• 1:05:45Barry Ritholtz?

  That was my live conversation with Richard Thaler and Alex Emes. Be sure and check out the full version of this coming sometime in the coming months. I would be remiss if I didn't thank the crack team that helps put these conversations. Together, a special thanks goes to the Economic Club of New York for hosting this event. My audio engineer is Justin Milner. Anna Luke is my producer. Sean Russo is my researcher. I'm Barry Ritholtz. You've been listening to a bonus live edition of Masters in Business on Bloomberg Radio.

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