How Investors Fall Into Bias Traps with Economists Richard Thaler & Alex Imas

Barry speaks with Richard Thaler and Alex Imas award winning economists and co-authors of "The Winner's Curse: Behavioral Economics Anomalies". They discuss the psychology of spending at auctions, and the effects of draft picks on NFL team spending. They also discuss the anomalies of human behavior and decision making that challenge classical economic theories. 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.

• 0:00Speaker 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.

• 0:34Speaker 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 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

• 1:16Speaker 01

  and hiring practices, but according to recruiters, 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 "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.

• 1:59Speaker 02

  Bloomberg Audio Studios, podcasts, radio, news.

• 2:07Speaker 02

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

• 2:14Barry Ritholtz?

  This weekend on the podcast, two extra special guests, Alex Emes and Richard Thaler. Took Richard's book, The Winner's Curse, and really completely rewrote it and updated it for 2025. I've been privileged to speak with Dr. Thaler a number of times over the past few years. He's been a guest both here and live in Chicago a number of times. Always a fascinating conversation. And Alex Emes is this really interesting professor, who I had no idea I have used and relied on his previous research. Selling Fast and Buying Slow is a chapter in my book. Just an amazing coincidence. Both fascinating people, and

• 2:58Barry Ritholtz?

  I thought this conversation was a lot of fun, and I think you will also. With no further ado, Alex Emes and Richard Thaler on The Winner's Curse.

• 3:07Speaker 04

  Thanks, Barry. Great to be back.

• 3:09Barry Ritholtz?

  Yes, it's so great to have you. So you started, you wrote this book, it's 30 years ago already. We're going to get to this in a bit. Before we do, I want to just talk about both of your backgrounds and how you began collaborating. Richard, you've been called the godfather of behavioral economics. Take us back to the beginning when you were a young economist. How did you become interested in psychology and decision making?

• 3:40Speaker 04

  So when I was in grad school and I was learning standard economics, I kept pausing and saying, really? Because the models that we were being taught.

• 3:56Speaker 04

  The peop- well, there are no people. And there are agents. And there are firms. And there are things they call consumers. But they're not really people. Homo economists. Homo, yeah, homo economicus. And I started making a list of dumb stuff people do. And but that was just to annoy my friends. And but then somebody introduced me to the work of two Israeli psychologists, Danny Kahneman and Amos Tversky.

• 4:37Speaker 04

  And when I read their papers, I had this big aha moment. Because what their research showed was not just that people make mistakes. Of course, we all make mistakes. And can't remember where we left our keys or what have you. What they showed was that behavior is predictably different from the model that economists use. And that was an aha moment for me because it meant I could say, "Look, the model is wrong and in this direction."

• 5:19Speaker 04

  And you can think about that from an investment point of view. It's fine to say stock prices are wrong. That's fine, but useless. If you can say which ones are too high and which ones are too low, then all of a sudden, you're a very rich man. So if we could say how people are different than this artificial model, then we could be in business. And Then the, so I was doing that for a while. Managed to get tenure at Cornell University.

• 6:03Speaker 04

  And spent a year with Kahneman and Tversky and then a second sabbatical with Kahneman. And in 1985, the year Alex was born, I came back from sabbatical and decided to start writing a series of columns in a new economics journal called the Journal of Economic Perspectives. That journal, by the way, here's a free tip. That journal is available free to anyone. And the articles are written to be understandable.

• 6:48Barry Ritholtz?

  Mm hmm.

• 6:49Speaker 04

  And people don't know about it. If you're really interested in economics, go and read some papers.

• 6:56Barry Ritholtz?

  And, and the column you were writing was called anomalies, which were all of these things that were supposed to not be possible, given traditional economic theory. You mentioned Kahneman and Tversky. When you think of psychologists, you don't think of quantitative, data-driven, rigorous models, but really that was at the heart of what they were doing, wasn't it?

• 7:22Speaker 04

  Well, eventually, the, the, their earlier work, you're thinking of prospect theory, which was 1979, the work they did in the seventies, leading up to that, was on predictions or judgments. And the, the models weren't very quantitative. They, they were.

• 7:46Speaker 04

  Typically, a little scenario and almost like a thought experiment. You know, there's a famous experiment about Linda. And they give you a description of Linda. She was an undergraduate, active in social movements, went to lots of demonstrations, blah, blah, blah. She's now, and now you get a list of occupations. And you're asked to say, uh, which is most likely? And one of the ones is bank teller. And another one is feminist bank teller.

• 8:28Speaker 04

  And people think she's more likely to be a feminist bank teller than a bank teller. Now, obviously, that cannot be true. I shouldn't say obviously, because many people are now listening and saying, what does he mean, obviously? Obviously, she's a feminist bank teller. She couldn't just be a bank teller, but that's, you know.

• 8:50Barry Ritholtz?

  Do the number theory, there are going to be more bank tellers than feminist banks.

• 8:53Speaker 04

  Think of a Venn diagram, right? There's a, a, a big circle of, uh, bank tellers. And then the small one with feminist bank tellers. So that was the kind of things they were doing. There was a little bit of theory. So like they had, uh, the idea was that life is hard. And so people used what they called heuristics, rules of thumb, uh, to make judgments. One is called the availability heuristic, which is if it's easier to think of examples of something, it's more likely.

• 9:34Speaker 04

  So if you ask people, what's the ratio of homicides to suicides? People think maybe two or three to one, that homicides are more likely. It's just the opposite. No, twice as many suicides.

• 9:51Speaker 04

  Think about this before you buy a gun.

• 9:53Barry Ritholtz?

  Right.

• 9:54Speaker 04

  The most likely person to get killed with that gun is a family member. So, but again, notice this is a predictable mistake. And because, why? Well, there's lots of stories in the newspaper about homicides. Suicides tend to be quieter.

• 10:16Barry Ritholtz?

  There's a wonderful graphic from Our World in Data, which was Hans Rosling's work that shows here's how things are reported in the media. And then here's their actual percentage in real life. Very little reporting on cancer, heart disease, high blood pressure, diabetes. You're 50,000 times more likely to suffer from that than homicide, terrorism, or shark attacks, which they love to.

• 10:47Speaker 04

  Right, shark attacks, don't worry about them.

• 10:50Barry Ritholtz?

  Especially in Chicago, it's probably not a big.

• 10:54Speaker 04

  Yeah, there are very few.

• 10:56Barry Ritholtz?

  So let's, let's bring Alex in. So when Richard started out in the field, there really wasn't any such thing as behavioral economics. You have an advantage a few decades later of entering the field of behavior, of economics, where behavioral economics is a thing. Tell us a little bit about what brought you into the field and how you found your way over to Booth.

• 11:22Speaker 05

  Well, so behavioral economics was a thing out in the economics journals. And, you know, there are people certainly doing it in various departments, but it wasn't a thing at, as an undergrad. Like, I don't think there was a single behavioral economics course offered at Northwestern University. And this was 2003 through 2007. So even though, you know, people were publishing behavioral economics papers, it was all over the journals, people generally in the field knew about it. As an undergraduate, it still had not made it into the curriculum.

• 11:53Barry Ritholtz?

  03 to 07, Danny was 2002 on the Nobel, is that right?

• 11:57Speaker 05

  Still no classes.

• 11:58Barry Ritholtz?

  So you would have thought someone might have picked up on that, and yet.

• 12:01Speaker 05

  No, I mean.

• 12:01Barry Ritholtz?

  And Northwestern is a big school.

• 12:03Speaker 05

  You open up a microeconomics textbook, it's the same textbook from 1973, basically.

• 12:08Speaker 04

  And that's still true today.

• 12:10Barry Ritholtz?

  Come on, really? I would have assumed at this point.

• 12:13Speaker 05

  No, open up a textbook.

• 12:14Barry Ritholtz?

  Uh, Danny Kahneman, Bob Shiller, Richard Thaler. How many, how many Nobels have to come into space before?

• 12:23Speaker 05

  Starts with perfect competition.

• 12:24Barry Ritholtz?

  Uh huh.

• 12:25Speaker 05

  Uh, then at the end, maybe you learn something about monopolies. Uh, and that, that's pretty much it. So it's a, I actually, I was pre-med. I was, I'm an immigrant kid from Moldova. So my parents are like, well, it's, you're going to the medical school or you're gonna fail. Basically, so I got, I had one option on the table. So I was pre-med. Organic chemistry was real hard and it was eight, eight o'clock in the morning. Uh, so I took econ to kinda just boost my GPA. I thought it was kinda fun.

• 12:50Barry Ritholtz?

  Right.

• 12:51Speaker 05

  And you know, I didn't, and it was interesting because I was taking these psychiatry, abnormal psychology classes, learning about human behavior. I was taking economics, which is the study of human behavior. And these were like two completely different worlds.

• 13:03Barry Ritholtz?

  Mm-hmm.

• 13:04Speaker 05

  Right? Economics is these hyper rational, uh, utility maximizers, had never made any systematic mistakes. And no, I didn't learn about a single deviation from that principle in the entire four years I was there. And so I was, I was thinking, this is kind of, you know, this is fun, but not something I wanted to do. I'm interested in human beings. Uh, and then afterwards, I was applying to medical school and I was doing a cross-country road trip, uh, with one of my friends to Los Angeles. And we were listening to, I think it was NPR. And, uh, it turned out, ex post, I figured this out, Richard was on the radio.

• 13:40Barry Ritholtz?

  Right.

• 13:40Speaker 05

  Talking about something called behavioral economics. And I was like, what is this? And as soon as I got to Los Angeles, you know, I, I went on the internet and I was like, I gotta find out more about this field. So I, within two weeks, I had, you know, talked to my advisors at Northwestern. I'm, I, I wanna get an econ PhD. If I can do something like this, where I could combine my interest in economics and bring in human behavior into it, this is what I wanted to do.

• 14:08Barry Ritholtz?

  So, so let's talk about that. There's something in the book and we'll get to that shortly. Where you describe, Richard, you describe an economist developing a new model, a new calculation for how consumers should behave in response to certain price incentives. So, the first time ever, someone creates this calculation and then immediately afterwards, and therefore, this is how all consumers are or should be behaving, when nobody had thought of this previously. How do you square that circle? How do you square the model-driven, "this is the right way to do it, I just figured this out, and therefore, everybody should be doing it this way"?

• 14:49Speaker 04

  Yeah, you know, maybe just a tiny bit of history will get us there. So, economics didn't use to be that extreme. If you go back and read Adam Smith, he talks about self-control problems and overconfidence. People think of him as the father of right-wing economics. That's not the guy. He did talk about the invisible hand, but he was a behavioral economist at heart. And economists were pretty reasonable until about World War II. And then what happened

• 15:27Speaker 04

  was, people started writing math, doing math. And they wanted to write down models. And if you want to write down a model, the easiest one to write down is a rational model. And that's because anybody, if you've taken high school calculus, you know, you can maximize, you set the first derivative equal to zero, and that's the model, right? So, writing down a model of some-ish is hard. Then, during the 70s and 80s, people started to get ideas

• 16:12Speaker 04

  for even smarter behavior.

• 16:16Speaker 04

  And a norm kind of developed in economics, which is if the agents in my model are smarter than the agents in your model, then my model's better than your model. And that's kind of crazy. But that was the way the field was going. And there was no real stopping it. So around the time that Alex was thinking about going to grad school, there were troublemakers

• 16:55Speaker 04

  like me pointing at certain body parts of this naked emperor. But the field was rushing toward an extreme version of homo economicus, where homo economicus is a genius.

• 17:15Barry Ritholtz?

  So we were talking a little earlier about the so-called wealth effect, which is something that the economists at the Federal Reserve love. The higher the market goes, the wealthier people supposedly feel, and they all go out and spend money. That's like just such a perfect example of a model that doesn't reflect the real world. A huge amount of stocks are owned by the top 10%. It's something like 52% of stocks. The average person doesn't really have a whole lot at stake in the market. And the reality is people are spending more money because the economy is doing well.

• 17:58Barry Ritholtz?

  They have jobs, they're getting raises, which by the way, all helps the market. How often do we run into these correlation causation issues in economics?

• 18:08Speaker 04

  Well, we run into them all the time. Look, the big problem with that, with the wealth effect, there's a lot of discussion of that in this book. One thing economists leave out is what I call mental accounting. And if you look at an economic model of the wealth effect, there is some big W for wealth. And that's it. And wealth will include your house and your retirement money and money you've set aside for your kid's education and then money that you intend to give to charity. And your future expectation. And, right. Of all of the money that you stand to learn. Right.

• 18:53Speaker 04

  So, now, the people at the Fed, if they're just saying, "Well, W goes up, then people spend more." No. It turns out, for example, if the value of your house goes up, how much more do you spend? Approximately zero. Really? Approximately zero. Whereas if some stock you own gets bought and you get a check, you spend a lot of that. If you win a lottery, you spend like half of it. And go bankrupt.

• 19:31Speaker 04

  So, where the money sits has a big effect on how much of it you spend.

• 19:39Barry Ritholtz?

  Your response to somebody's question, "How are you gonna spend the windfall from the Nobel Prize?" was one of my favorite answers. You said, do you recall?

• 19:51Speaker 04

  Yeah, well, I recall. I mean, this was at four in the morning. They call you and wake you up and then say, "Go get some coffee because you have a press conference in half an hour." And I had heard enough of these interviews to know that somebody was likely to ask me that question. And my instinct was to say, "Well, you know, to a real economist, this is a stupid question." Because how am I gonna know? You know, suppose I go out and buy some fancy new car. Barry likes fancy cars. I don't. I like fancy wine. So, suppose I go and buy a case of fancy wine.

• 20:36Speaker 04

  How do I know that's the Nobel money? As opposed to the money I got from selling a book.

• 20:43Barry Ritholtz?

  All dollars are fungible.

• 20:44Speaker 04

  All dollars are fungible and you know, I I've realized later that what I should have done is opened up a special account.

• 20:55Barry Ritholtz?

  The Nobel Prize money account.

• 20:56Speaker 04

  Nobel Prize money and a credit card that's linked to that. And when I want to go buy something stupid, just take out the Nobel card and life would be more fun.

• 21:10Barry Ritholtz?

  You but the line that you said was as irrationally as I can.

• 21:14Speaker 04

  Yeah, I said, I'll just spend it as irrationally as possible. Just I knew it would be a memorable line.

• 21:20Barry Ritholtz?

  So it's so funny because that line led to a conversation with my CFO about the difference in all of these, um, you know, the Chase Sapphire card or the Amex Platinum card where you get these points. And the rational CFO says, hey, I want the money back each month. And my response is always, it's a hundred, $200, it's lost in your bank account. You don't see it. When I get the points and want to buy a fancy cappuccino maker that my wife is going to yell at me, why are you spending $2,000 on a cappuccino maker, you idiot? My answer is, oh, no, it's points, it's free. And she's like, okay, go, go get it.

• 22:05Barry Ritholtz?

  It's the exact same concept. If it if you have that silo, that mental accounting, you could do as much irrationality as you'd like.

• 22:13Speaker 04

  So, you know, but watch out if she listens to this podcast.

• 22:18Barry Ritholtz?

  She listens to the first five minutes and that's it.

• 22:20Speaker 04

  Oh, yeah, so you're safe.

• 22:21Barry Ritholtz?

  I'm okay.

• 22:22Speaker 04

  Because so I'll tell you a story about, um, my daughter Maggie lives in Rhode Island and one of her neighbors grew up to be a pitcher for the Mets.

• 22:33Barry Ritholtz?

  Mm hmm.

• 22:34Speaker 04

  And the Mets were playing in the playoffs, the first round.

• 22:37Barry Ritholtz?

  So this is a long time ago.

• 22:38Speaker 04

  Yeah, this is an old story. And this guy was gonna pitch. So I call Maggie, hey, would you guys wanna go to the game? Let me see if I can get tickets. And she says, oh, that'd be great. So I go online, the game is like tomorrow. And I find some tickets. And there were a bunch, you know, on StubHub or something, you could get tickets. So I text her back and said, look, here, here's the website. It looks like there are lots of tickets to choose from. How about, the tickets were about 300 bucks. I said, how about I'll text, I'll send you a thousand dollars.

• 23:21Speaker 04

  Buy the tickets you want, spend the rest on hot dogs.

• 23:24Barry Ritholtz?

  So you're, you're doing an experiment on your daughter to see if she buys the cheap tickets or the expensive tickets?

• 23:29Speaker 04

  So she texts me back and says, lol, this is just like in your book. If you send me a thousand dollars, I'm not gonna use it on baseball tickets. So I've learned my lesson. Recently, she wanted to go to a concert. David Byrne is on tour. And he was in Providence where she lives. And she wanted to go. And she says, there's some way you could get me tickets. I sent her the tickets.

• 24:00Barry Ritholtz?

  Instead of the money, that's so funny. Let's talk a little bit about the book, The Winner's Curse. And I wanna start with Alex. So this book has been out since you were a young kid. You go to college, you eventually figure, let me get a PhD in behavioral economics or finance and economics. How did you first discover this book? What was your initial response to it?

• 24:26Speaker 05

  So I discovered it, there's not really any textbooks in behavioral economics. So you kinda get here through the grapevine, oh, you should read this, you should read that. You mostly read journal articles. Like with, if you're thinking about doing game theory or something like that, there's like a Five or six textbooks that you can read. With behavioral economics, there's not a whole bunch. Winner's Curse was one of those books that almost everybody recommends because the anomalies columns are just very, very accessible. And then you read the anomalies columns, they got a bunch of references, you look through the references. So I had read the original Winner's Curse, I think, second or third year grad school. And then I got my first job at Carnegie Mellon, I had already known Richard for a while at that point. We met in graduate school.

• 25:11Speaker 05

  His office was, happened to be right next to mine in San Diego. And at some point, I joined Booth. And he called me up, I think like four or five months into my first year and said, hey, you know, I got this opportunity, we want to, the publisher asked us to update the book. I'm thinking of doing a little bit more than just an update. You know, the book's from 1992, there's been 30 years of research. Are you interested in working together on this? So I, I mean, I jumped on the opportunity. One, you know, I get to work with Richard, which is super fun. But two, I mean, you know, I've been doing behavioral economics research for a while, and I know how much demand there is for a book that people can pick up and read and say, hey, these are the original anomalies, here's the 30 years of research that has

• 25:55Speaker 05

  happened since. Now, I think at that point, we were thinking like, you know, six months, do a little update. This was 2020. This conversation happened in 2020, the book is coming out now. We, you know, basically, two-thirds of the book ended up being brand new. We wrote, we rewrote slightly each anomalies column as kind of the bedrock, but you know, 30 years of research has happened since, and it took a while to put all of that together. And essentially, what we showed is, look, the original anomalies, when you read them, most of the experiments, most of the findings are from, you know, college students, sometimes,

• 26:36Speaker 05

  you know, after a bad night out in the lab for, you know, making decisions over a dollar. And the big kind of pushback from economists was, look, we don't really care about these people. We care about, you know, institutional investors, CEOs, we care about people who are in the market with money on the line, making all these big decisions. And so what, why has behavioral economics become a success? Honestly, largely because of behavioral finance. Because of the fact that behavioral economics, behavioral economists said, look, we got access to this amazing data on people making consequential decisions day in and day out, and they're still making mistakes.

• 27:11Barry Ritholtz?

  Coming up, we continue our conversation with Richard Thaler and Alex Emes, discussing the book they have recently updated, The Winner's Curse: Behavioral Economics Anomalies Then and Now. I'm Barry Ritholtz, you're listening to Masters in Business on Bloomberg Radio.

• 27:37Speaker 00

  At Brookfield, we believe you can own wealth that's measured in generations because true ownership looks beyond today and beyond cycles. For 125 years, we've built long-term wealth through expertise, discipline, and a clear vision for the future, providing investors access to alternative strategies built for what's next. Brookfield, own what's next. Learn more at Brookfield.com/own. This is not an offer to sell or investment advice. Investing involves risks, including loss of capital. Past performance is not indicative nor a guarantee of future results. Please review performance and offering materials before investing.

• 28:15Speaker 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 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

• 28:57Speaker 01

  and hiring practices, but according to recruiters, 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.

• 29:42Barry Ritholtz?

  I'm Barry Ritholtz. You're listening to Masters in Business on Bloomberg Radio. My extra special guests this week are Richard Thaler and Alex Emes, both of the Chicago Booth School of Business at the University of Chicago. I love what Danny Kahneman once said is, "I suffer from all the same behavioral biases that I've identified." You mean to tell me that we have 30 years of data, all this research, a handful of books? People still make the exact same behavioral mistakes they used to? Has there been any change in behavior?

• 30:16Speaker 04

  Essentially, no. And that's not that surprising because the stuff we're talking about has been true as long as there have been humans. Right? So we talk about self-control problems. It's in the Bible. Right? You know, Homer talks about Odysseus tying himself to the mast. That's like agreeing to have money taken out of your paycheck and put into a retirement plan. So, human beings, yes, there's evolution, but evolution takes thousands of years.

• 31:00Speaker 04

  And 30 years is the blink of an eye.

• 31:03Barry Ritholtz?

  Since you mentioned retirement accounts, let's talk a little bit about Choice Architecture and Nudge. Before I arrived here, I looked up what was the impact of the default setting that you helped change through Choice Architecture. People used to get a new job, sign up for a 401K, and the money would come into that account and it would sit there in cash. And rather than have the default be cash, we Through your work, created a default as a, either a target date fund or a balance fund, something like that, so it's not sitting in cash. And it turns out, there's about 4.7

• 31:47Barry Ritholtz?

  trillion with a T, trillion dollars, in those funds, of which 40%, according to recent research, was the default setting. So, you get credit for about $2 trillion in retirement savings, that might have otherwise just been sitting around in cash. How does the concept of, people aren't learning from their mistakes, so choice architecture is so important to help people make better decisions, how significant is that?

• 32:18Speaker 04

  Well, if you think about what was going on in the, in the early 80s, these defined contribution plans, like 401Ks, were real new. Our parents, if they, if you worked at a big firm, you had a defined benefit plan. My father worked for Prudential Insurance, you know, and his pension was number of years worked, times some function of his final salary, no decisions to make, kinda like social security. And we bring in these defined

• 33:02Speaker 04

  contribution plans, you have to decide whether to join, and if so, how much to defer, and then how to invest it, and people had no clue. And a lot of people just didn't even join, which is about the dumbest mistake you can ever make.

• 33:20Barry Ritholtz?

  If you have a company with a match, you're basically turning down free money.

• 33:24Speaker 04

  Right.

• 33:25Barry Ritholtz?

  Which, what economic model says that's rational?

• 33:27Speaker 04

  No, well, right. So I would say to economists, look, you would predict, no one would make this mistake, but...

• 33:36Speaker 04

  One early study, half the employees at a company are not joining in the first year. It's amazing. So, how do we fix that? Well, the simplest thing was to change the default. So, we say, it used to be, you'd get a form to fill out, a piece of paper in those days. And if you want to be in the plan, fill out this form and say, you want to join in How to Invest. Change that to, you're, you're welcome to Riddlets Management.

• 34:16Speaker 04

  You're, we have a pension plan, we're going to enroll you unless you opt out. And we're going to enroll you into the default fund unless you choose otherwise. So, all of that was not possible in the early 90s. Because there were, companies were afraid to do automatic enrollment because they didn't have permission. And target date funds weren't legal. Ironically, in the George W. Bush administration, on one side, they were campaigning to partially privatize

• 35:01Speaker 04

  social security. But their Labor Department was forbidding companies from investing in anything that could go down. So, there was a bill passed in 2006. The, uh, said, okay, um, you're allowed to automatically enroll and have a, uh, and automatically escalate what we used to call Sabre Tomorrow. And invest in some prudent funds. And what was, what, you have to give something up to get that?

• 35:46Speaker 04

  So what I suggested to, there was a Republican Senator from Utah who was the running the relevant committee, I said, how about if companies agree to do all three of those, they're exempt from some burdensome paperwork of nondiscrimination rules. And so that's what the Republicans got, was less paperwork, and people who cared about the workers got something, and

• 36:20Barry Ritholtz?

  And the workers got something.

• 36:22Speaker 04

  And the workers got something, and if they just do nothing, then they're in, and their contributions are going up, and they're in a sensible investment product.

• 36:38Barry Ritholtz?

  So this is kind of, Nudge is kind of fascinating, because in The Winner's Curse, you talk about things very much related to what happens in investing. So there's loss aversion, and the status quo bias, and a variety of different things. Let's talk about what are the issues that most relate to, as Alex said, behavioral finance, as opposed to behavioral economics. What do we think are the biggest factors that explain irrational human behavior in stock and bond markets?

• 37:15Speaker 05

  So I think there's a few things that kind of people documented in the late 90s, early 2000s, that have just replicated, and just became bigger, if anything. So the disposition effect is one of them. So the disposition effect, this is Sheffron and Statman, they came up with a paper in 1985 documenting it originally. Terry O'Dean has this giant data set that he published in 1999 documenting it, a bit of a larger sample. And then now it's been replicated in Finland, all over the world. And it's this tendency for people, you know, when I buy a stock, It goes up in price. What do I do? I sell it. I want to realize my gains. Same stock goes down in price.

• 38:00Speaker 05

  You know, this is now a loss. What do I do? Hold on to it. So it's this tendency to realize your gains and hold on to your losses.

• 38:07Barry Ritholtz?

  Peter Lynch, by the way, forty years ago, used to call that cutting your flowers and watering your weeds. That was his expression for it. So it was visible to a guy running a fund at Fidelity in the 1980s.

• 38:21Speaker 05

  Yes, and this is just talking about like, are people learning? I mean, apparently not, because it's like, it's again, I bet you, you download Robin Hood data from today, you're gonna see it show up. So that's the, and this is kind of the tendency, you know, what feels good when you're, when you own a stock? Selling it at a gain and, you know, telling your friends, hey, you know, I bought that thing for 90. It's 120, I just, I just made a lot of money. You know what feels worse telling your friends? I bought at 90 and I sold it at 60. So you just kind of hold on to it, hoping something happens. Maybe some people even double up, buy more shares, just to break even. So the disposition effect, this kind of tendency for individual behavior to,

• 39:05Speaker 05

  you know, realize gains, avoid losses. The other thing is, in my view, this is kind of the bigger, the bigger principle is limited attention. So, you know, there's a lot of stocks out there. Which ones are people buying? And this is not just retail investors, this is, this is bigger institutional investors too. It's the ones that are covered in the news. We were talking about availability bias earlier. What are the things that are coming to mind? Things that have recently been covered? Maybe you heard an earnings announcement call or something like that. These attention grabbing stocks that are much more likely to go into people's portfolios. It's because people don't, you know, aren't evaluating the entire, the entire universe of stocks whenever they think, they're thinking about something to buy.

• 39:48Barry Ritholtz?

  So, so let's address that because the United States happens of, of all countries, not only has such a large stock market, but the home country bias is so acute here.

• 40:02Barry Ritholtz?

  You don't hear a lot about foreign companies all that often. You mostly hear about local companies, local CEOs, local products. How significant is that sort of bias in people's portfolios being not only overloaded with their own country? But hey, if you're in New York, you can have more finance companies. If you're in San Francisco, you have more tech companies. If you're in the Midwest, you can have more manufacturing companies.

• 40:28Speaker 05

  It's more extreme than that. If I'm working for a specific company, I have more of that stock.

• 40:33Barry Ritholtz?

  When if anything, you should have less.

• 40:35Speaker 05

  You should be diversifying.

• 40:35Speaker 04

  Right. Yeah, I think one campaign that has been moderately successful is I think fewer companies are foisting stock of their own company onto the workers. It used to be the match was often paid in company stock.

• 40:54Barry Ritholtz?

  Mm-hmm. Well, GE was notorious and they lost half a trillion dollars of employee investments because of their match.

• 41:04Speaker 04

  Well, and Enron.

• 41:06Speaker 05

  Enron. So my, one of my, one of my friends, their, their, their father, he was working at Enron. He was a risk manager.

• 41:15Speaker 05

  FYI. And.

• 41:17Speaker 04

  Oops.

• 41:17Barry Ritholtz?

  Just not a very good one.

• 41:19Speaker 05

  Huge, huge percentage of his portfolio was Enron.

• 41:22Barry Ritholtz?

  Although I could be the greatest risk manager there, the bosses were not listening to you.

• 41:26Speaker 04

  Right, but they compounded it by putting their employees' money in the 401K into Enron stock. So they get fired and their retirement money goes poof.

• 41:40Barry Ritholtz?

  Right, unbelievable.

• 41:41Speaker 05

  But you know, looking back at what people were owning, I mean, there is that, you know, people in the 401K element, but people who were working there were freely buying Enron stock, right? According to economic models, you should be diversifying. You already have a bunch of Enron stock in your 401K. You shouldn't be taking your discretionary spending and buying more Enron stock. And that's exactly what was happening.

• 42:04Barry Ritholtz?

  Really?

• 42:05Speaker 04

  This home bias applies all around the world. At least the US is a big country. I wrote a paper once about the Swedish social sort of 401K plan. This was a risky move because I was making fun of it and there was some award that might happen, but. Um, anyway, Sweden is 1% of world GDP.

• 42:34Barry Ritholtz?

  Tiny, tiny GDP, tiny.

• 42:36Speaker 04

  And they weren't putting most of their money in Swedish stocks. It's crazy.

• 42:41Barry Ritholtz?

  They ignored the other 99% of the world, but that that just goes to show you the bias. So the obvious question is, if you two were advising a portfolio manager, what sort of behavioral principles would you emphasize for them to build a robust portfolio?

• 42:59Speaker 04

  Well, as you know, I, one hat I have is I'm involved in a company that does this.

• 43:08Barry Ritholtz?

  That has, also has your name on the door.

• 43:10Speaker 04

  It also has my name on the door, Fuller and Thaler Asset Management. And now let me say, I cannot name a single stock we own.

• 43:23Speaker 04

  And no one at the firm would think it's a good idea for me to be making suggestions. We buy small cap stocks, so it's, you know, if we owned Apple or Tesla, I might know it, but we don't buy any big stocks. So they're mostly companies you've never heard of, and I've never heard of them.

• 43:44Barry Ritholtz?

  But this is because you've identified a behavioral issue that is now reflected in the model that you, they use to purchase.

• 43:52Speaker 04

  Right. So we're not, uh, we're not a quant shop, which is a little unusual for a firm that's run by some academics. But each strategy is based on a bias. So there's one that's based on overreaction. There's one that's based on underreaction. So we are, we try to find stocks that we think the rest of the market is making a mistake about. And then we forbid the portfolio managers from forecasting earnings.

• 44:31Speaker 04

  Because that they're gonna be, you know, do we think with our 30 employees that we're gonna make better forecasts than fidelity?

• 44:41Barry Ritholtz?

  Mm-hmm.

• 44:41Speaker 04

  It's crazy. But we think we have an advantage because we're trying to predict something else. We're trying to predict the mistakes. It's like, you're a baseball fan. If there's a pitcher that is a sinkerball pitcher, uh, so the, Alex, this means the ball goes down as it approaches the plate. He's foreigner. But, you know, uh, if there's a sinkerball pitcher, you and I can predict batters are gonna hit ground balls because they are fooled. The ball drops, and if you hit it slightly above center, the ball goes down.

• 45:22Speaker 04

  So you don't have to be able to hit a ball to know it's gonna go down. And so we don't have to be able to forecast earnings to predict that other people are gonna be predicting too high.

• 45:35Barry Ritholtz?

  I want to bring this, this back to the book because one of the concepts underlying the book was, hey, there's a reproducibility issue in, in social sciences. How well have these anomalies and the theories you built around them? How well has this held up? How robust and reproducible are these findings? And it turns out, very. Talk to us about what, what you guys discovered when you were revisiting all of these principles that were first written about 20, 30 years ago.

• 46:06Speaker 05

  Yeah, so as you mentioned, there's a, there's a, some I call a crisis of reproducibility in social science more broadly. So this is psychology, some sociology, uh, et cetera. And the worry is that, you know, these anomalies that were published in, in the eighties and nineties, these are the bedrock of the entire field of behavioral economics. And- You might be worried, like, look, maybe these things don't reproduce. And there's two ways that they can't, they don't reproduce. One, you run the same experiment again and it doesn't work. It was p-hacked, as I said, like, small sample sizes, no incentives. The second way it might not reproduce is that it literally only reproduces in the exact conditions it was run originally, with college students at low stakes.

• 46:48Speaker 05

  You go out in a different population with people who are a bit more sophisticated, know what's going on, and, you know, it doesn't work. So what we did in the book was to say, look, first, let's take the exact same experiments and run them again. Everybody knows about, you know, the original anomaly, so maybe they don't work because people are like, ah, this is a loss aversion experiment. I know what's going on, I'm not gonna do this. This is the endowment effect. I'm not gonna do this. So we just replicated them directly on a completely different platform, so we used an online crowdsourcing platform called Prolific. Basically, everything works. Everything works. And we, you know, you don't have to take our word for it. We, if you go on the website of the book, we posted all of the results of our replications,

• 47:32Speaker 05

  but also instructions on how you can do it yourself. So if somebody's like, ah, I don't, I don't know about these guys, run them yourself. And, you know, people are still loss avers, they still have the endowment effect, things like the conjunction fallacy, the Lynda problem that, that Richard was talking about, all works still. The second part is this external validity part. Does anybody other than college students display these, these effects? And that's kind of the updates part of the book, and the answer is yes. You know, the loss aversion has been, and the myopic loss aversion part that's been used to explain the equity premium puzzle, that's still reproducible. We also do a bunch of out-of-sample tests of the, of the anomalies that didn't use

• 48:17Speaker 05

  experimental data, and, you know, that replicates out-of-sample too. So people aren't learning. The psychology is the same.

• 48:25Speaker 04

  You know, one of, one of the columns was about the equity premium puzzle. We didn't include this in the book, because it's a little wonky. But the equity premium is just the difference in returns between stocks and bonds. The equity premium puzzle is how big it is. And theory says it should be like less than 1%. And historically, it was about 7%.

• 48:49Barry Ritholtz?

  Wow.

• 48:50Speaker 04

  And the article about that was in the early 80s. So we've had 40 years of data since the puzzle was announced. The equity premium, exactly the same. It's maybe 1% lower. So, and that's what we see basically everywhere. Everything's the same.

• 49:10Barry Ritholtz?

  So, so one of the concepts that people have challenged as not being very reproducible has been the concept of priming. To some, sometimes anchoring is, is similar, but that seems to be more reproducible. But when I hear Linda, the bank teller story, that feels like the framing of that is very much a priming. When you hear about her as politically active and being involved in what? How do you distinguish when you have these theoretical overlapping biases that all kind of interact with each other?

• 49:48Speaker 05

  So priming is actually a huge literature in cognitive psychology. Basic priming is very robust. So it's the idea of, you know, I say a bunch of words that start with a K. What comes to mind? A word that starts with a K? That's going to reproduce any day of the week. There's a special subset of priming research that was done kind of in the 90s, early 2000s that kind of took this to an extreme, which is, so here's an example. Let's say you're doing word search and there's a bunch of words that have to do with like oranges, palm trees, hot weather, like vaguely related with Florida, right? And then that's supposed to prime in your brain, old people. And the result, the dependent variable was that those subjects who had those words,

• 50:33Speaker 05

  they walked a little slower out of the lab. Right? I mean, that's, it's a little crazy.

• 50:38Barry Ritholtz?

  Right. Kind of tough to, to measure also.

• 50:41Speaker 05

  Yeah. So, I mean, it relied, there's a lot of degrees of freedom. The researcher can be looking in a certain direction, you know? And those tend to, tend to not reproduce. The sort of priming that

• 50:53Speaker 05

  Something like Linda, the Linda problem, for example, has, that's more in the kind of cognitive psychology wheelhouse of like, what do you think about when I describe a person who takes part in radical rallies? What comes to mind? This is, this is a basic concept in memory. Right? So, um, the, and the second part that, that I wanted to, to say is that priming, as far as like looking at the behavioral economics research, priming is a really small part. It was actually not really featured much in the book. Um, but, but the type that is, uh, that was used by, uh, you know, uh, Twersky and Kahneman, it's much more in the wheelhouse of just basic cognitive psychology.

• 51:32Barry Ritholtz?

  More like anchoring? Does anchoring still hold up?

• 51:35Speaker 05

  Oh, yeah.

• 51:35Barry Ritholtz?

  Very well.

• 51:36Speaker 05

  Oh, yeah.

• 51:36Speaker 04

  Yeah, yeah.

• 51:37Speaker 05

  Yeah.

• 51:37Speaker 04

  And look, one of the things, when, when I was writing those columns, the, I could pick anything.

• 51:46Barry Ritholtz?

  Mm-hmm.

• 51:46Speaker 04

  I picked big effect sizes. And some of the prob, you know, we talked earlier about the norm in economics to make models smarter and smarter. I think there was a norm in psychology for results to get cleverer and cleverer.

• 52:06Barry Ritholtz?

  Well, I thought Alex's paper where you randomly sell versus what was actually sold, that was a very clever setup for, for a paper.

• 52:14Speaker 04

  It was clever, but it wasn't, uh, the, what I was deriding is a norm that the models assume people are being clever, as opposed to designing a clever paper.

• 52:27Barry Ritholtz?

  Gotcha.

• 52:27Speaker 04

  We're all for clever papers.

• 52:29Barry Ritholtz?

  Okay.

• 52:30Speaker 04

  We, we like clever papers. So when I was choosing to, what columns to write about, I picked big stuff. And think about, uh, there's a well-known company that makes, uh, cinnamon buns and has the strategy of pumping the smell of that out into the airport.

• 52:54Barry Ritholtz?

  Mm-hmm.

• 52:55Speaker 04

  Now, uh, let's say you're on a low carb diet, just hypothetically.

• 53:00Barry Ritholtz?

  Hypothetically.

• 53:01Speaker 04

  You know, if you walk by that thing, that's, that's priming and that works.

• 53:08Barry Ritholtz?

  Mm-hmm.

• 53:09Speaker 04

  And it, it's not.

• 53:11Barry Ritholtz?

  It's not clever.

• 53:12Speaker 04

  It's not.

• 53:13Barry Ritholtz?

  It just works.

• 53:14Speaker 04

  Right. It's a big effect size.

• 53:15Barry Ritholtz?

  Yeah.

• 53:16Speaker 04

  So there are, and so everything I wrote about. Was big. And it's because I wanted to pick things that I thought were well established. And so, you know, I think if I had looked for cute little things, then some of them would have failed to replicate.

• 53:39Speaker 05

  You also pick things that people were actively attacking and adversarially trying to replicate at the time that you were writing it.

• 53:47Speaker 04

  Yeah, I mean, look, take the ultimatum, yeah.

• 53:51Speaker 05

  Okay.

• 53:52Speaker 04

  That's one of the original columns and one that we include in the book. The game is very simple. I give Barry a hundred dollars. I say, share it with Alex. You can give whatever proportion of the hundred you want to Alex. He says yes or no. If he says yes, he gets whatever you offer and you get the rest. If he says no, you both get nothing. Now, the standard economic model at the time predicts that Alex will accept anything because something is better than nothing.

• 54:34Speaker 04

  Barry knows that Alex will accept anything. And so he offers him a dollar and Alex accepts. Now, real people, only an economist would think that that's a really good prediction. Anybody who's not an economist is gonna say, what are you kidding? I'm not gonna take a dollar and give you ninety-nine. You didn't do anything to deserve that ninety-nine. So if you run that experiment, if you offer less than twenty percent, you're gonna get rejected. And the profit maximizing offer is about forty percent.

• 55:19Speaker 04

  And most people offer half.

• 55:20Speaker 05

  Mm-hmm.

• 55:21Speaker 04

  Okay? Now, there were big fights. There was a professor from Brit who, yeah, who was saying this was challenging game theory. And no, it wasn't challenging game theory. It was challenging the idea that the agents.

• 55:50Speaker 04

  Only care about money and don't care about being treated fairly.

• 55:55Barry Ritholtz?

  So let's address that because I love the evolutionary biology of this. Humans were cooperative, social primates. We have neither fangs nor claws, so we had to come up with some way to stay alive. And it turns out cooperating in a tribe is very useful survival tactic. It seems that an inherent sense of fairness is somewhat built into all of us as well as social status seeking. So how much of this issue in economics derives from not understanding a little bit of evolutionary history?

• 56:38Speaker 04

  You know, it's a tricky thing. Obviously, we have evolved to be who we are. There are some people who then say, well, that means whatever we do is optimal.

• 56:52Barry Ritholtz?

  Well, maybe, maybe not.

• 56:53Speaker 04

  No, that's stupid. I mean, we evolved on the savanna.

• 56:58Barry Ritholtz?

  Right.

• 56:59Speaker 04

  Right?

• 57:00Barry Ritholtz?

  Nothing about picking muni bonds from a large assortment.

• 57:03Speaker 04

  You know, Amos Tversky was famous for one-liners. And he had a one-liner about loss aversion. Which was, there may have been species that did not exhibit loss aversion, and they're now extinct. Right? So if you're a subsistence, it's really smart to be worried about losing.

• 57:28Barry Ritholtz?

  It's an existential threat.

• 57:30Speaker 04

  Right? But, you know, none, the three of us, we could go several days without eating. Some more, more days than others.

• 57:41Barry Ritholtz?

  Right.

• 57:41Speaker 04

  Right? So we're, we're not a subsistence. And yeah, we, managing our own portfolios is something people have been doing for 30 years. Right? Yeah, the rich people, but they had their broker do it, right? So there's no evolutionary history of how to manage a portfolio. And even saving for retirement.

• 58:11Speaker 04

  People didn't live long enough to worry about that. And if you were unlucky enough to reach my age, then you hoped your kids would take care of you, and they lived nearby. You know, then people started scattering and penicillin and, you know. So now we live long and our kids are scattered, and they have no interest in having us move in with them. So people had to learn a very new thing, and they needed some help.

• 58:49Barry Ritholtz?

  Really, really fascinating. So we didn't talk about where, from whence the title of The Winner's Curse comes from. Why don't, before we get to the future of behavioral finance, let's, let's talk about The Winner's Curse. Tell us where the name comes from.

• 59:06Speaker 04

  The concept, I should say, the title of the book comes from the title of one of the chapters. And I picked it as the title back then because it's sort of a fun phrase and a bit intriguing. And the concept itself is interesting and important. The idea is this. Suppose you have a lot of people bidding for some object that's worth the same to everybody. And it could be, when you do this as a demonstration in the class, you fill up a jar of jelly beans or coins, and say it's 10 cents for each jelly bean,

• 59:48Speaker 04

  and it's $100 in the jar. Now, we're going to auction it off. High bidder wins the $100, but they don't know what.

• 59:58Barry Ritholtz?

  They don't know it's worth $100.

• 1:00:00Speaker 04

  All they see is a lot of coins or jelly beans. What happens? Well, the average bid is less than $100 because people are risk averse. But the winning bid is always above $100.

• 1:00:17Speaker 04

  If you have enough people, because the most optimistic forecast is likely the highest bid, and it's too high. Now, this was not discovered by psychologists in the lab. It was discovered by engineers at Atlantic Richfield, Arco.

• 1:00:38Barry Ritholtz?

  The energy company.

• 1:00:39Speaker 04

  The energy company, who discovered they were bidding for oil leases in what I continue to insist on calling the Gulf of Mexico. And they realized that the leases they won had less oil than they expected. And they said, gee, we thought we had world-class geologists. What's going on? Are they dummies? And then they realized that it's quite subtle that

• 1:01:15Speaker 04

  the, what you're trying to do is make a bid that will make you money if you win. And the if you win part, if there's 100 people bidding, gee, do I really want to win? Because maybe I misunderstood something, right? So that's the winner's curse. And it was found and replicated on bidding for oil leases. It's relevant in book publishing.

• 1:01:51Barry Ritholtz?

  When they're bidding contests for books.

• 1:01:54Speaker 04

  Yes, yes.

• 1:01:55Barry Ritholtz?

  So let me, let me see if I can clarify the, the, the way you're describing the winner's curse. So we're bidding for oil leases. We don't know exactly how much oil is going to come out of this hole for, or, or area for the next 10, 20 years. And when there's many people bidding, all of which are advised by geologists, if you make a conservative bet, the odds are you're going to lose. But if you make a bet that's high enough that you're going to win, the odds are it's not going to be a moneymaker. Coming up, we continue our conversation with Richard Thaler and Alex Emes discussing the book they have recently updated, The Winner's Curse: Behavioral Economics Anomalies

• 1:02:39Barry Ritholtz?

  Then and Now. I'm Barry Ritholtz. You're listening to Masters in Business on Bloomberg Radio.

• 1:03:00Speaker 01

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• 1:04:29Barry Ritholtz?

  I'm Barry Ritholtz. You're listening to Masters in Business on Bloomberg Radio. My extra special guests this week are Richard Thaler and Alex Emes, both of the Chicago Booth School of Business at the University of Chicago. I shared with you an article I saw recently. Some real estate group did a study of tens of thousands of home transactions where there was a bidding war, and they found something very similar. The winners of the bidding war ended up paying much more than the subsequent home value was determined by looking at comparable homes in the neighborhood. So, is the purpose of an auction to identify something at a

• 1:05:13Barry Ritholtz?

  fair value where it's profitable for you, or is the purpose of an auction to win at any cost?

• 1:05:20Speaker 04

  Well, so there are two interesting aspects of that. One is, suppose you're these engineers, and you've discovered this. What should you do? And if you're losing money every time you win an auction, you could not bid, but then you don't have any places to drill. And what did they decide to do? It's really clever. They decided to write a paper.

• 1:05:45Barry Ritholtz?

  In order to get people to stop overbidding?

• 1:05:49Speaker 04

  Yeah. Now, that's different than what the owners of Major League Baseball did.

• 1:05:56Barry Ritholtz?

  I was gonna say, why didn't they just moneyball it? Why didn't they just start looking at ugly but productive?

• 1:06:03Speaker 04

  Well, what the Major League Baseball owners did is they colluded.

• 1:06:09Barry Ritholtz?

  Right.

• 1:06:10Speaker 04

  And they said, "Look, let's not bid anymore."

• 1:06:12Barry Ritholtz?

  Well, the salary caps that are in all these...

• 1:06:15Speaker 04

  No, no. There was just outright collusion. When baseball players first became free agents, the owners said, "Hey, we're losing money on these crazy auctions. Let's just not bid." And then they got slapped down.

• 1:06:29Barry Ritholtz?

  Right.

• 1:06:30Speaker 04

  So, what can you do? You can try to... A good strategy is to bid very low on every site. And in the data, there were lots of sites that you could have gotten for a dollar.

• 1:06:52Barry Ritholtz?

  Really?

• 1:06:53Speaker 04

  And

• 1:06:54Barry Ritholtz?

  Cause, cause the consensus was there's no there.

• 1:06:58Speaker 04

  And

• 1:06:59Barry Ritholtz?

  Were any of them productive? Did any of these?

• 1:07:01Speaker 04

  Some of them will be.

• 1:07:02Barry Ritholtz?

  Really? So now let's bring this back to sports because you've written papers on NFL drafts.

• 1:07:10Speaker 04

  So the, the, the NFL draft, every year there's, uh, they have a draft for new players. The first pick is given to the team with the worst record the previous year. With the idea that that's going to be a big advantage to them and will help them improve. Cade Massey, one of my former students, he and I wrote a paper showing that the first pick is actually not the most valuable because the league has a salary. He, the first player gets paid the most.

• 1:07:51Speaker 04

  And you can trade the first pick for the seventh and eighth picks or for five second round picks. And what we showed is if, if you trade the first pick for lower picks, you get more value.

• 1:08:11Barry Ritholtz?

  So now this is known like the Arco engineers publishing that paper. And yet there still seems to be this frenetic war for top, top one, top three, top five picks. Has the NFL learned any lessons from the research?

• 1:08:29Speaker 04

  Almost nothing. They, so they have learned that you should, they only trade up to get the first pick to pick a quarterback.

• 1:08:42Speaker 04

  So that's smart because the quarterbacks are more valuable than any other player.

• 1:08:49Barry Ritholtz?

  Well, of course, you want that first pick so you could get a Tom Brady.

• 1:08:52Speaker 04

  Yeah.

• 1:08:53Barry Ritholtz?

  Except.

• 1:08:53Speaker 04

  Except Tom Brady was taken with 199th pick. And all the listeners who are football fans can have their list of people who were taken with the first pick and turned out to be busts. The Chicago Bears seem to specialize in that, although let's hope this current guy is the new one.

• 1:09:17Barry Ritholtz?

  So how much of this, like I'm seeing this through the lens of my book, which I don't want to talk about. But how much of this is just how difficult it is to predict the future, to, to have truly expert judgment about these very complex, very variable. So selecting quarterbacks, identifying oil leases, like it seems that supposed expert advice ain't all that expert. How much of this is, aren't we better off just being a little more humble about our, let's give up the top pick and have five second round. Somebody in that five is likely to be half decent, right?

• 1:10:00Speaker 04

  So let, let, let me stick to the sports for one second because there's one statistic from our paper. And we've just, we're coincidentally, we've been in a process of replicating that study. So I have the new data, but here's the statistic. Take all the players at a given position, say quarterback or cornerback or running back. Rank them in the order in which they're picked. And now ask the fourth guy, what's the chance he's better than the fifth guy? So for the, for the whole thing, so what's the chance the earlier player is better than the next one?

• 1:10:42Barry Ritholtz?

  One over two, 10 over 11, five over six.

• 1:10:45Speaker 04

  Now, if they're perfect, it'll be a hundred percent. If they're coin flipping, it'll be 50%.

• 1:10:54Speaker 04

  What do you think it is?

• 1:10:55Barry Ritholtz?

  I think it's less than 50%. I think it's negative.

• 1:10:57Speaker 04

  They know less than nothing.

• 1:11:00Barry Ritholtz?

  Right, that's right. I think it's in the 30s or 40s.

• 1:11:02Speaker 04

  Well, they're not that bad.

• 1:11:05Barry Ritholtz?

  All right.

• 1:11:05Speaker 04

  I mean, because if they were, then you could just, you know.

• 1:11:09Barry Ritholtz?

  Flip a coin.

• 1:11:09Speaker 04

  No, no. You'd want it, what the George Costanza, you want to do the opposite.

• 1:11:15Barry Ritholtz?

  The opposite.

• 1:11:16Speaker 04

  Right?

• 1:11:16Barry Ritholtz?

  That's right.

• 1:11:17Speaker 04

  So, so no. They don't have negative knowledge. They have a tiny little, it's 53%.

• 1:11:23Barry Ritholtz?

  Okay.

• 1:11:24Speaker 04

  So, but that's your point, really, which is, they think they know this guy is the next Tom Brady. And there's only a 53% chance that he's better than the next one. And, you know, Patrick Mahomes, Josh Allen, think, none of these were first picks.

• 1:11:47Barry Ritholtz?

  Right, that's right.

• 1:11:48Speaker 04

  Right?

• 1:11:48Barry Ritholtz?

  And this Mahomes kid is gonna be pretty good one day.

• 1:11:50Speaker 04

  I think he might make it.

• 1:11:52Barry Ritholtz?

  Yeah, he's got some potential.

• 1:11:53Speaker 04

  Right. So, and I think that is, so getting off of sports, I think that your general point is exactly right, that people are, look, overconfidence. Danny Kahneman used to say, that's the mother of all biases. And we fall into these traps because we think we know more than we do. And if we had some humility, maybe if we listened to our spouses more often. Because, at least in my house, my wife doesn't think that I know anything.

• 1:12:37Speaker 04

  So, she's always bringing me back to 50%. And she's usually right.

• 1:12:43Barry Ritholtz?

  My, my wife is from the same, cut from the same cloth. So, so, I want to bring Alex back into this. So, when we're thinking about the future of behavioral economics and, and what this means for investors or regular people making financial decisions or insignificant decisions, what direction are we moving in? Are, are we learning from all of this knowledge that's been accumulated? Or are we just destined to make the same mistakes over and over again?

• 1:13:18Speaker 05

  I don't think we're destined to do anything. I think it's a choice to take, you know, read papers and look at papers on kind of published in financial journals where people are making mistakes and then to choose to say like, "Look, I actually can correct this by having a particular decision aid or asking my spouse what to do," or something like that. So, you know, a paper you mentioned earlier, we published this actually just last year called "Selling Fast and Buying Slow." And in that paper, basically, we look at institutional investors. So, thinking about who in the economy are least likely to be exhibiting behavioral biases. You know, maybe retail traders, they're like, you

• 1:14:00Speaker 05

  know, drinking beer in their basement while trading stocks on Robinhood. Maybe this is not the sophisticated people we want to be looking at. But, you know, institutional investors, the average portfolio in the data set was like 600 million, 700 million dollars or something like that. We had a data set where we actually saw every single thing they did over something like a 12 or 13-year period, as far as what they're buying and what they're selling. And what we found is because the data is so rich, we can actually construct these counterfactual portfolios. We can say, "Look, I see what you're buying. What if you bought something else?" So, it could be something else from your portfolio. You can top something up, or you can buy something new from the universe. On the other

• 1:14:41Speaker 05

  hand, we could say, "Look, same thing for selling. I saw you sold Apple. I saw you sold Samsung. Let me sell something else instead. How would that perform relative to what you actually did?" And what we found is that on the buying side, people actually did really well. I mean, these guys are... Really well, but better than random.

• 1:15:02Barry Ritholtz?

  Fund managers create some value in their stock selection when they're making purchases.

• 1:15:08Speaker 05

  Yes.

• 1:15:08Barry Ritholtz?

  But the flip side of that, not so much.

• 1:15:10Speaker 05

  No, not so much. We had a... We really wanted to be conservative. We didn't want to, you know, say, compare them to the benchmark or something like that. We said, "Let's throw a dart at your portfolio and sell that instead of what you actually..."

• 1:15:22Barry Ritholtz?

  So, instead of selling what the manager wants to sell, you would sell something else randomly from the rest of the portfolio?

• 1:15:29Speaker 05

  Yeah, a random selling.

• 1:15:30Barry Ritholtz?

  And the performance difference was how significant?

• 1:15:33Speaker 05

  Basically, same difference, but in the opposite direction. So they were losing a ton of money.

• 1:15:40Barry Ritholtz?

  So 100, 200 basis points on a random sell. Better performance.

• 1:15:44Speaker 05

  Exactly.

• 1:15:45Barry Ritholtz?

  And, you know, the way, when I read that paper and wrote about it, the way I rationalized it, or tried to conceptualize it was, they're bringing a very objective quantitative approach to the stock selection issue, but it seems that their sells are filled with biases and squishy decision-making. Is that a fair description?

• 1:16:08Speaker 05

  Yeah, exactly. So that we found no evidence for heuristics on their buying decision. Like, we couldn't find anything. Like, they just seemed to be very disciplined and principled about what they're buying. But on the selling side, we found literally the same biases that we found in the lab.

• 1:16:23Barry Ritholtz?

  Has there been any evolution or improvement in this recently? That's the question that I keep coming back to. It seems that, Richard, you figured a lot of these things out 25, 35 years ago. Are we any better at making unbiased decisions? Or are we still subject to the same foibles?

• 1:16:46Speaker 05

  I think you need something extra, right? You can't just say, "I'm not gonna do this, and I have decided not to listen to my psychology." That's what it would look like to be better.

• 1:16:54Barry Ritholtz?

  Well, choice architecture, or building in some guardrails and defaults.

• 1:17:00Speaker 05

  This is where overconfidence comes in. When you read a paper about somebody doing something silly, your first reaction is, "Not me." Right?

• 1:17:07Barry Ritholtz?

  The blind spot.

• 1:17:09Speaker 05

  This is called the bias blind spot. Exactly. So this is a well-replicated finding. When you ask people, "To what extent do you exhibit a bias?" I don't, obviously. I'm a smart person. But to what extent? To other people, of course. You know, other people are bad at selling, I'm really good. But in order to adopt choice architecture to help you out when making decisions, you actually have to be, have some, you have to have a lot of humility to say, "Look," these institutional investors, to say, "Look, looks like I'm not really doing so well on selling." I'm gonna adopt some choice architectures so I don't suffer from these biases. Maybe I'll hire somebody else to help me out. Maybe I'll think longer or use the same sort of research technology for my selling as I'm doing for my buying.

• 1:17:54Speaker 05

  And because that requires humility, which most people don't have a lot of, that's really hard to do. So I think that's why we're seeing a lot of these biases just be perpetuated forward to the point where we're, you know, running the same analyses now as we did 30 years ago and finding the exact same thing.

• 1:18:11Barry Ritholtz?

  So the question that, since we're talking about sports and lack of knowledge, and then you mentioned Robinhood. One of the things that's a little concerning is how some companies are putting our knowledge of biases and bad behavior to work for their own profit. So when we see the gamification of investing with Robinhood, or just the incredible rise, not just of sports books and gambling, but you could bet on every play. It's reached a point where it's ridiculous. And there is robust evidence that especially young men are having all sorts of...

• 1:18:51Barry Ritholtz?

  How can we, how can we deal with what seems to be not a good use of choice architecture, but a bad use of choice architecture, at least as far as the public is concerned?

• 1:19:04Speaker 04

  Yeah, it's a very good question, Barry, and one to which I don't have a pat answer. I mean, it's tempting to say, look, all these sports betting apps and the gamification of investing are bad for people. On the other hand, people like doing it. They're mostly adults. And, you know, prohibition basically didn't work. So I think some disclosure would help. It's difficult to find out what the odds are in a lot of these things.

• 1:19:49Speaker 04

  But it's a tough question. I had a conversation on this book with Nate Silver a couple of weeks ago, and we talked a lot about sports gambling. He's a professional gambler, and he spent a year betting on NBA games and basically broke even.

• 1:20:10Barry Ritholtz?

  Right.

• 1:20:11Speaker 04

  So, you know, if Nate can't make money doing this, chances are you can't. And, you know, my advice would be, look, if you really think you like doing this, do it on a small scale, you know?

• 1:20:29Barry Ritholtz?

  Don't bet the house, literally.

• 1:20:30Speaker 04

  Don't, right. And the same with weekly options or daily.

• 1:20:35Speaker 05

  That's one of the most popular, one of our colleagues at University of Chicago, she did an analysis of what retail traders are actually doing on Robinhood. And one of the most popular products, which because it's pushed by Robinhood, is weekly options.

• 1:20:49Barry Ritholtz?

  And there's now end of day options where it expires, you have till four o'clock to either make money or not.

• 1:20:56Speaker 04

  So, you know, if you want to risk one month's pay on that, fine.

• 1:21:03Barry Ritholtz?

  Not, just not every month?

• 1:21:04Speaker 04

  No, and yes, yeah, that's your lifetime budget. And when it goes to zero, switch to something else.

• 1:21:14Barry Ritholtz?

  I'm a big fan of the cowboy account where you take three or 4% of your portfolio. And if you want to fool around with options, whatever, knock yourself out. And if it makes money, great. But like we've seen, you mentioned Apple, if it was your whole portfolio, you would never have been able to ride it to be a 5X or a 10X. You would have taken, I'm up 20 bucks, I'm taking the money off the table.

• 1:21:36Speaker 04

  Yeah, yeah. So, you know, people long ago would adopt the strategy of bringing a certain amount of money to the casino.

• 1:21:46Barry Ritholtz?

  Right.

• 1:21:47Speaker 04

  And then, of course, the casinos put ATMs on the floor. So it's a battle. But mental accounting, you have a gambling account.

• 1:21:58Barry Ritholtz?

  But that's it.

• 1:21:59Speaker 04

  Yeah, I mean, it would be better if it were zero.

• 1:22:02Barry Ritholtz?

  Right.

• 1:22:03Speaker 04

  But otherwise, set it up that's something you can afford to lose. And when you've lost it all.

• 1:22:10Barry Ritholtz?

  You're out.

• 1:22:10Speaker 04

  Stop.

• 1:22:11Speaker 05

  Don't go to the ATM.

• 1:22:12Barry Ritholtz?

  That's right. So, so I only have you for a few more minutes. I want to ask two of my favorite questions that I want to ask each of you that I ask all of my guests. Starting with, what sort of advice would you give a recent college grad interested in a career in either behavioral finance or economics? Alex, you're the more recent grad. What would you, what would your advice be?

• 1:22:34Speaker 05

  Uh, get tech'd up.

• 1:22:35Barry Ritholtz?

  Really?

• 1:22:36Speaker 05

  Get tech'd up. Uh, I think that's the biggest kind of difference between even when I was in graduate school and what I'm seeing hiring pre-docs and RAs. The sort of work that you're doing in modern behavioral economics, modern finance, it just requires a different level of analysis.

• 1:22:51Barry Ritholtz?

  So is this learning to code or is this becoming a prompt engineer for AI?

• 1:22:56Speaker 05

  What? I think you still got to learn to code. I think, you know, we're, I, I, I work in the applied AI group at Booth. You know, you still got to learn to code. And a lot of this sort of modern analyses that people are doing, particularly as behavioral finance, behavioral econ has moved out of the lab into the field. These data sets are huge, uh, machine learning, AI tools. The type of people who are getting hired are doing sophisticated analysis.

• 1:23:21Barry Ritholtz?

  So it's still basically STEM groups, science, technology, engineering and math for people who don't know the acronym, but applied specifically to the field.

• 1:23:32Speaker 05

  Yeah. And like, you know, you take your economics courses, you take your finance courses, take some CS courses on the side. Those are, uh, this is what I wished I would have done, right? When I was getting my PhD, it wasn't on my radar to take, you know, a coding class in the CS department. People coming out now, the ones who are really successful, you have to have good ideas. That's a necessary condition. Uh, it's not a sufficient condition. Uh, you still, you got, you, you need to be tech'd up to a level that I, I don't think we were seeing back when I was graduating.

• 1:24:02Barry Ritholtz?

  Really interesting.

• 1:24:03Speaker 04

  And I'll reinforce that with the following. I think you need some practical experience.

• 1:24:09Speaker 05

  Yeah.

• 1:24:09Speaker 04

  Because the part that you don't learn in a textbook is you, you get this gigantic data set and it's noisy and there are errors and.

• 1:24:22Speaker 04

  So, learning how to clean up a data set.

• 1:24:28Speaker 04

  You gotta learn that through experience.

• 1:24:31Barry Ritholtz?

  Really interesting. And our final question, what do you know about the world of behavioral economics today? Would have been useful back in the 1970s and 80s when you were getting started? And in the 2000s when you were getting started?

• 1:24:47Speaker 04

  So I think if we go back, we talked about the changes that I helped make in the retirement plans. And what I wish I had been able to accomplish more of is making retirement saving at the workplace available to the possibly 40% of American workers whose firms don't offer that option. And there were plans around and they didn't get passed. I think the system they have in the UK is a reasonable model, which is

• 1:25:31Speaker 04

  there's a requirement that any firm with more than, I'm not sure the number, say 20 employees, has to offer a plan and automatically enroll people into the plan. And the government has like a generic plan they can use, like the government thrift program. So, and this is useful because big firms like Fidelity and Vanguard don't really want tiny accounts.

• 1:26:03Barry Ritholtz?

  Right.

• 1:26:04Speaker 04

  So, make it easy for an employer. They don't have to do anything, they just have to let their employees enroll in this. And then, when they change jobs, they can keep it there. Because the real problem is, they go to work for a while at this firm, and they work there for a year and they've saved $600, and then they leave and they take the cash out. So we need automatic rollover. So, that's the piece of the puzzle that...

• 1:26:42Speaker 04

  I don't know whether I could have done anything about, but it's what I wish we could work on now.

• 1:26:46Barry Ritholtz?

  So, related to that, what do you think of these new baby accounts? Every newborn in America next year gets a thousand dollar, has to be invested domestically, which, you know, we can have an argument, we were talking about home country bias, but still, you're starting every infant off with a portfolio. What are your thoughts on that?

• 1:27:06Speaker 04

  I don't know the details of how that's gonna work. You could, uh, my friend and sometime colleague when I'm in Berkeley, Ulrika Malmondier, has made a similar proposal in Germany, where she's on the German Council of Economic Advisors. I think the idea is to give kids some experience with the stock market, and I think that could be useful. Um, I, I don't know how this is gonna wash out, and all of these things end up being tilted toward the rich.

• 1:27:48Speaker 04

  I mean, there were big reforms made recently to the retirement plans. One of the reforms was to let you wait longer to start making withdrawals. Who do you think that helps?

• 1:28:03Barry Ritholtz?

  People who are wealthy, healthy, and gonna have a longer lifespan.

• 1:28:07Speaker 04

  Right. So, most people start taking the money out at 59 and a half. Raising the data which you have to start from 70 to 72 doesn't help anybody that's in any trouble.

• 1:28:24Barry Ritholtz?

  Yeah, that makes a lot of sense. Alex, what do you know today about behavioral finance that you wish you knew when you were getting started?

• 1:28:31Speaker 05

  Um, I think what I, when I was getting started, I wasn't really thinking about kind of being able to target these big institutional investors, and thinking about getting data sets on

• 1:28:46Speaker 05

  Smart money in the economy. So I think when I was starting out, I was really focused on lab experiments. I was really focused on kind of the data that was available. And if I was starting out now, I would start my PhD trying to get data sets that I eventually was able to get. Because the types of, as far as like looking at my research, what has had the largest impact? What has had, you know, people in finance, in the professional world, calling me up and saying, hey, what do you think about this or that? It's been looking at the population that people are actually interested in, which are, you know, the smart money in the economy. So I think, and this is, I think, you know, you have

• 1:29:27Speaker 05

  this analogy of looking under the streetlight. Where is a lot of behavioral finance?

• 1:29:33Barry Ritholtz?

  For the missing car keys?

• 1:29:34Speaker 05

  Yeah, exactly.

• 1:29:35Barry Ritholtz?

  The junk on the streetlight.

• 1:29:36Speaker 05

  You know, where are you looking? Oh, it's where the data sets already are. So, you know, Terry O'Deen had this genius idea in 98 when he published his paper. What did he do? He made that data set available. Now it's easy to just, oh, I got an idea. Why don't I look at Terry's data set? Terry's data set is great, but it's three years in the 90s with, you know, a couple hundred retail traders. And that tells you about that specific population, but you can't have a field evolve looking at three years of retail traders with $10,000 portfolios. So I think if I was going into the field now and thinking about, you know, what have I learned? It's the power of getting data sets and running analyses on populations that are important for the economy and for

• 1:30:21Speaker 05

  finance.

• 1:30:22Barry Ritholtz?

  Really, really fascinating. Gentlemen, thank you so much for doing this. We have been speaking with Richard Thaler and Alex Emes, both of the Booth School of Business, about their updated version of The Winner's Curse. Strong recommendation. If you enjoy this conversation, well, check out any of the 592 we've done over the past 12 years. You can find those at iTunes, Spotify, Bloomberg, YouTube, wherever you get your favorite podcasts. And be sure to check out my new book, How Not to Invest, the idea Ideas, numbers and behavior that destroys wealth and how to avoid them. I would be remiss if I did not thank the crack team that helps put these conversations together.

• 1:31:04Barry Ritholtz?

  Each week Alexis Noriega is my video producer. Sean Russo is my researcher. Anna Luke is my producer. Sage Bowman is the head of podcasts here at Bloomberg. I'm Barry Ritholtz. You've been listening to Masters in Business on Bloomberg Radio.

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