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Confessions of

a Value
Investor: A Few
Lessons in
Behavioral
Finance

Sanjay Bakshi

17 March, 2010
Indian Institute of Management
Lucknow
Direct Experience
Vs.
Vicarious Experience
VICARIOUS EXPERIENCE

Extreme Mediocrity Extreme


Failure Success

Most Learning Comes from


Extremes
VICARIOUS EXPERIENCE

Copy,
All I want to Paste,
know is where Emulate
I’m Going to Extreme
Extreme Mediocrity
Die So I never Failure Success
Go There

Ignore
Instead of
focusing on
becoming too
smart, i urge
you to focus on
avoiding
foolish
behavior
I urge you to learn from
mistakes of others
Reflexive vs.
Reflective Brain
Reflexive Brain is
effortless, automatic, fast,
can lend itself to errors
Reflective
Brain is
effortful,
reasoned,
slow,
logical, and
less prone
to error
confession # 1
I fell for the
Availability
trap
Human brains tends to drift into
working with what’s easily
available to it.
“When I’m not near
the girl I love, I love
the girl I’m near.”
The brain can’t
use what it
can’t
remember...
...or what it is
blocked from
recognizing
under the
influence of
certain
psychological
tendencies
The result? Mind tends to over-
weigh what’s easily available to it
“People assess the
frequency,
probability, or
likely cause of an
event by the degree
to which instances
or occurrences of
that event are
readily “available”
in memory.”-Daniel
Kahneman
“An event that
evokes emotions
and is vivid, easily
imagined, and
specific will be
more available than
an event that is
unemotional in
nature, bland,
difficult to imagine,
or vague.”-Daniel
Kahneman
What sort of
things tend to be
more available
in our minds
than others?
Vivid Events
Recent Events
First Conclusions
Direct Experiences
Anchors
Easily Measurable Data
Information Overload
What are the consequences of over-
weighing most available information?

People’s estimates of probabilities


will go wrong, so their estimates of
value will go wrong resulting in
misjudgments.
Key Word: Vivid
Approximately
3,000 people died
in september 11
attacks
An additional
1,500 died due to
increased ROAD
Travel because of
dread risk
What
caused the
dread risk?

Key Word:
Vivid
We under-weigh
rich and
concrete data
because it does
not evoke vivid
images.
Physicians response to
Surgeon General’s report
linking cancer to smoking
The probability that
a physician will
continue to smoke
is directly related
to the distance of
the physician’s
specialty from the
lungs!
What does
vividness do to
People’s Perception
of Risk?
We over-react to recent events

Recency + vividness = lethal


combination
Recency

Our most recent experience tends


to carry more weight in our heads
than old experiences.
First-conclusion bias
The human mind
is like the
human egg. Out
of a billion
sperms racing
towards the
egg, only one
succeeds in
entering and
fertilizing it.
As soon as the fastest swimming
sperm enters the egg, the egg
immediately shuts down to stop
any other sperm from entering
We answer
questions which
start with the
word “why” by
grabbing the first
answer that
comes to mind.
When our minds
jump to
conclusions, we
push aside other
reasons and
latch on to the
first explanation
which comes to
mind
EXample: Steel
Price Hike
Impact on Auto
Stocks
“Nothing is more
dangerous than
an idea, when
it's the only one
you have.”

Émile Auguste Chartier


The human mind
seeks easy
answers to the
questions which
start with the
word “why”
Why should I buy this stock?

Because its cheap!

Well, so what? Under what


circumstances would this be a
mistake?

Can you think of three reasons


why you could be wrong?
Reason 1: Fraud
Reason 2: value trap
Reason 3: Bubble market
“I followed a
golden rule,
namely that
whenever a new
observation or
thought came
across me,
which was
opposed to my
general
results, to
make a
memorandum of
it without fail
and at once...
“for I had
found by
experience
that such
facts and
thoughts were
far more apt
to escape from
the memory
than
favorable
ones.” -
Charles
Darwin
We overweigh direct experience
and under-weigh vicarious
experience
What we see for ourselves with
our own eyes, hear from our
own ears, has a greater impact
than what we see or hear
through others
I saw it with my OWN Eyes!
“Man who” syndrome

“But I know a man who smoked


three packs of cigarettes a day
and lived to be 99!”
Problem of Silent Evidence

You only see the winners!


“We have never seen anything like
this,” said analyst Glenn Schorr, who
covers the investment banks for UBS
AG. “There have been tough situations
like Long-Term Capital Management and
the crash of 1987, but the problem
here is there is leverage in the
securities under the microscope and in
the banks that own them. And to try
and unwind it all at once creates a one-
way market where there are only
sellers, and no buyers.” - WSJ,
September 14, 2008
“What we learn from history, is
that we don’t learn from
history.” Benjamin Disraeli
Anchoring
Money lost
in wallet
Anchors
Par value
52 week low
All time high
Low absolute price
Sunk-costs
Stock price itself
Overweighing what can be counted

“You’ve got a complex system and it spews out


a lot of wonderful numbers that enable you to
measure some factors.
“But there are other factors that are terribly
important, [yet] there’s no precise numbering
you can put to these factors...
“You know they’re important, but you
don’t have the numbers.Well practically
everybody (1) overweighs the stuff that
can be numbered, because it yields to
the statistical techniques they’re taught
in academia...
“and (2) doesn’t mix in the
hard-to-measure stuff that may
be more important. That is a
mistake I’ve tried all my life to
avoid, and I have no regrets
for having done that.”
“To a Man with a Hammer,
everything looks like a nail.”
“The first step
is to measure
what can be
easily
measured. This
is okay as far
as it goes.

John Bogle
“The second step
is to disregard
that which
cannot be
measured, or give
it an arbitrary
quantitative
value. This is
artificial and
misleading.
“The third
step is to
presume
that what
cannot be
measured
really is
not very
important.
This is
blindness.
“The fourth
step is to say
that what
cannot be
measured does
not really
exist. This is
suicide.”
“Not everything
that counts can
be counted, and
not everything
that can be
counted, counts.”
Albert Einstein
Example Beta as a
measure of risk
“People calculate too much and
think too little.”
Example 1
Cost of machinery:
Rs 10 cr.
Expected life of
machine: 10 years
Annual savings: Rs
2.50 cr. p.a.
Expected residual
value of the
machine: Rs 1 cr.
Cost of capital: 15%
p.a.
Accept or reject?
Accept or reject?
How did
he Solve
this
Problem?
Warren Buffett
He shut down the
textile business of
Berkshire
Hathaway!
Huh?
“The domestic textile industry
operates in a commodity business,
competing in a world market in
which substantial excess capacity
exists.
“Much of the trouble we experienced
was attributable, both directly and
indirectly, to competition from
foreign countries whose workers are
paid a small fraction of the U.S.
minimum wage...
“Over the years we had the option of
making large capital expenditures in
the textile operation that would have
allowed us to somewhat reduce
variable costs... Each proposal to do so
looked like an immediate winner...
“Measured by standard return-on-investment
tests, in fact, these proposals usually
promised greater economic benefits than
would have resulted from comparable
expenditures in our highly-profitable candy
and newspaper businesses...
“But the promised benefits from
these textile investments were
illusory...
“Many of our competitors, both domestic
and foreign, were stepping up to the
same kind of expenditures and, once
enough companies did so, their reduced
costs became the baseline for reduced
prices industrywide...
“Viewed individually, each
company’s capital investment
decision appeared cost-effective
and rational..
“Viewed collectively, the decisions
neutralized each other and were irrational
(just as happens when each person watching
a parade decides he can see a little better
if he stands on tiptoes)...
“After each round of investment,
all the players had more money in
the game and returns remained
anemic.”
“Thus, we faced a miserable choice:
huge capital investment would have
helped to keep our textile business
alive, but would have left us with
terrible returns on ever-growing
amounts of capital...
“After the investment, moreover, the
foreign competition would still have
retained a major, continuing advantage
in labor costs...
“A refusal to invest, however, would
make us increasingly non-competitive,
even measured against domestic textile
manufacturers...
“[Buffett] knew that the huge
productivity increases that
would come from a better
machine introduced into the
production of a commodity
product...
“would all go to
the benefit of the
buyers of the
textiles. Nothing
was going to [come
to us] as owners...
“That’s such an obvious
concept – that there are all
kinds of wonderful new
inventions that give you
nothing as owners...
“except the
opportunity to
spend a lot
more money in a
business that’s
still going to
be lousy...
“The money still won’t come
to you. All of the
advantages from great
improvements are going to
flow through to the
customers...
“Conversely, if you own the only
newspaper in [town] and they
were to invent more efficient ways
of composing the newspaper...
“then when you got
rid of the old
technology and got
new, fancy
computers and so
forth, all of the
savings would
come right
through to the
bottom line...
“In all cases, the
people who sell the
machinery – and even
the internal
bureaucrats urging
you to buy the
equipment...
“show you
projections
with the
amount you’ll
save at
current prices
with the new
technology...
“However, they
don’t do the
second step of
the analysis –
which is to
determine how
much is going to
stay home and
how much is just
going to flow
through to the
customer…
“I’ve never seen a
single projection
incorporating
that second step
in my life. And I
see them all the
time...
“Rather, they
always read:
“This capital
outlay will save
you so much
money that it will
pay for itself in
three years…”
“So you keep
buying things
that will pay for
themselves in
three years…
“And after twenty years of doing it,
somehow you’ve earned a return of
only about four percent per annum.
That’s the textile business...
“And it isn’t that
the machines
weren’t better.
It’s just that the
savings didn’t go
to you...
“The cost reductions
came through all
right. But the
benefit of the cost
reductions didn’t go
to the guy who
bought the
equipment...
“It’s such a simple idea. It’s so
basic. And yet it’s so often
forgotten.”
“People calculate too much and
think too little.”
Example 2
Assume today is 27 March
2009 i.e. there are only
five days left in the
financial year ending on 31
March 2009. One of your
friends has approached you
to advice him on his
investments. He presents
you with the following data
about his current
portfolio:
In addition, your friend also tells you that
during 2008-09, he has already realized short-term
capital gains of Rs 27 lacs. He now needs Rs 73
lacs by selling part of his portfolio. Which
stocks should he sell?
Selling Hersheys and Godiva
could be very silly mistakes!

Why?
“People calculate too much and
think too little.”
Overreaction
Noise
to what you
see
Quantity not
as important
as quality
Information
Overload =
Noise

I saw it with my OWN Eyes!


My experience with Goldman Sachs
Price is readily available and precise
and is also recent and vividly shown on
TV etc.
Value is not readily available and is
necessarily an estimate

Is it any wonder people overweigh


price?
Antidotes
Look for
disconfirming
evidence – killing
your own ideas
Under-weigh extra-
vivid experience and
overweigh less vivid
experience.

Same with recent


events; i.e. cool off.
“Remember the lesson: “An
idea or a fact is not worth
more merely because it is
easily available to you.””
confession # 2
I let
Perceptual
contrast
misguide me
Two types of
contrast effect
high contrast
low contrast
Scene from Tin Men
Dan Airely
Dan Airely
Decoy
What will happen if you put this in
your mouth and then...
and then you put this in your
mouth?
Buying a Lamp

Buying a Car
Is a Rs 15 stock really cheaper
than a Rs 500 stock?
Ignoring the role of transaction
costs and taxes on long-term
returns
How would the Buy-and Hold Strategy do?
Blind averaging down- “Its fallen
so much, how much lower can it
go?”
Answer: 100%
Throwing good money after bad
If you put a frog in
boiling hot water, it
will instantly jump
out and escape
But if you put a frog in lukewarm
water and slowly boil it, it will
slowly boil to death!
Boiling frog effect is a
frequent cause of business
failure
“Cognition, misled by tiny
changes involving low
contrast, will often miss a
trend that is destiny.”
What did
digital camera
do to the
photographic
film business?
What did the mobile phone do to
the fixed line telephony
business?
What did the Audio CD do to the
audio cassette business?
Slow change goes unnoticed

Example: SAIL 2003 vs. SAIL


2007

Learn to focus on a few key


factors which may be
changing slowly
confession # 3
Failure to
promptly
resolve
cognitive
dissonance
Cognitive
Dissonance as
the Engine
Behind Self
Justification
How do Smokers Rationalize?
“The medical evidence is
inconclusive”
“Other smart people do
it so it can’t be all
that bad!”
“But I know a man who smoked
three packs of cigarettes a day
and lived to be 99!”
“It’s needed for my relaxation- I
might have a shorter life but it
will be more enjoyable!”
Man is not a rational animal
He is a rationalizing one
Lesson?

Ask if you
are
inventing
new
reasons to
rationalize
your
behavior?
Confirmation
Bias:
Overweighing
evidence that
confirms
your prior
notions and
under
weighing
evidence that
contradicts it
Its in the nature of things,
that if you look hard enough
for evidence that support
your belief, you will find it.
And that will intensify your
belief...
Francis Bacon
“What a man believes, he prefers to
be true.”
Proposition: All Swans are
White

How will you prove it?


Proposition: All Swans are
White
Confirmation
Bias:

Role of
Surprise
People are too slow to change an
established view

Importance of Surprise
Need to change
your mind in
light of new
facts which
change the
odds
John M Keynes
“When facts change, I
change my mind. What
do you do Sir?”
The
Justification
of Effort
“If a person works
hard to attain a
goal, that goal
will be more
attractive to the
individual than it
will be to someone
who achieves the
same goal with
little or no
effort.” - Elliot
Aronson in “The
Social Animal
Sunk cost fallacy - I have
too much invested in this
situation to walk away now
I can’t afford to write this
off.

Maybe you can


Capital (mis)
allocation decisions
Traditional Budgeting
vs. Zero based
budgeting
The
Endowment
Effect
Possessions are over-valued-
once owned they suddenly
become worth more to the
owner than he would pay for
them if he did not own them
already – Endowment Effect
One Man’s Ceiling is Another Man’s Floor
Man’s decisions are suddenly
regarded by him as better than
was the case just before he
made them
confession # 4
I gave into
social proof
Video Clip on Salomon Asch Experiment
WE RELY
HEAVILY ON
PEOPLE
AROUND US
FOR CUES ON
HOW TO
THINK, FEEL,
AND ACT
Video Clip on Elevator Experiment
Social proof most
influential under
two conditions
Uncertainty and
doubt – when
people are unsure,
when the situation
is ambiguous, they
are more likely to
copy others
Similarity-
People follow
the lead of
“similar others”

Of Suicides and
Lost Wallets
PERSUASION VERY EFFECTIVE IF IT
COMES FROM PEERS
PEOPLE FOLLOW LEAD OF “SIMILAR
OTHERS”
TESTIMONIALS
FROM “SIMILAR
OTHERS”
Video Clip on Safety in Numbers
Hardwired to HERD
Real pain and social pain are
felt in the same parts of the
brain.
Eisenberger Lieberman study
Eisenberger Lieberman study
Similar
Others
Herding in
Money
Management
“Zebras have the same problems as
institutional portfolio managers.
First, both seek profits. For
portfolio managers, above-average
performance; for zebras, fresh
grass...
“Secondly, both dislike risk.
Portfolio managers can get
fired; zebras can get eaten by
lions...
“Third, both move in herds. They
look alike, think alike and stick
close together...
“If you are a zebra, and live in a
herd, the key decision you have to
make is where you stand in
relation to the rest of the herd...
“ When you think that the conditions
are safe, the outside of the herd is
the best, for there the grass is fresh,
while those in the middle see only
grass which is half-eaten or trampled
down...
“The aggressive zebras, on the
outside of the herd, eat much
better...
“On the other hand – or other hoof –
there comes a time when lions
approach. The outside zebras end up
as lion lunch, and the skinny zebras
in the middle of the pack may eat
less well but they are still alive...
“A portfolio manager for an institution
such as a bank’s [wealth management]
department cannot afford to be an
Outside Zebra. For him, the optimal
strategy is simple: stay in the centre of
the herd at all times...
“As long as he continues to buy the
popular stocks he cannot be faulted.
To quote one portfolio manager, “It
really doesn't matter a lot to me what
happens to Johnson & Johnson as long
as everyone has it and we all go down
together.”...
“But on the other hand, he
cannot afford to try for large
gains on unfamiliar stocks which
would leave him open to
criticism if the idea fails...
“Needless to say, this
Inside Zebra philosophy
doesn't appeal to us as
long-term investors.. We
have tried to be Outside
Zebras most of the time,
and there are plenty of
claw marks on us."
John Templeton

“People are always asking me


where is the outlook good,
but that’s the wrong
question...
“The right question is: Where
is the outlook the most
miserable? I call this the
Principle of Maximum
Pessimism...
“Let me explain how it works.
In almost every activity of
normal life people try to go
where the outlook is the
best...
“You look for a job in an
industry with a good future, or
build a factory where prospects
are best. But my contention is if
you are selecting publicly
traded investments, you have to
do the opposite...
“You’re trying to buy a share
at the lowest possible price
in relation to what that
corporation is worth...
“And there is only one reason
a share goes to a bargain
price: Because other people
are selling. There is no other
reason...
“To get a bargain price, you’ve
got to look for where the
public is most frightened and
pessimistic.”
“You pay a very high price in
the stock market for a
cheery consensus.”
confession # 5
I became a
dope addict
Video on Dopamine
Cocaine causes dopamine
increase resulting addictive
pleasure.

Operant Conditioning: It feels


so good, I want more more
more!!!
Neuroecon
omics:
There is
no
difference
between a
man who
who just
made a
killing in
the
markets
and a man
who is
high on
cocaine
Dot Con Video Clip - Dope Addicts?
Getting
what you
expected
produces
no
dopamine
kick
However,
an
unexpected
gain fires
up the
brain
(neurons
go from
firing 3
times a
second to
40 times a
second)
If expected
reward
fails to
materialize,
dopamine
dries up
Unexpected pleasant surprises
make people ecstatic because of
the dopamine surge they produce
If lab rats are wired up to receive
tiny pulses of electrical stimulation
in the dopamine centers of the brain
when they press a lever...
...they often begin tapping it nonstop
to the exclusion of other activities,
including eating and drinking...
They would rather starve to death
than live without that dopamine
surge inside their brains.
The human equivalent of this Lab
Rat is there in all of us...
Dopamine
system
loves
novel
stimuli.

Glamor
stocks
Variety is
the spice
dope of
[market]
life

IPOs
New Hot
Stocks e.g.
dotcoms
“Severe change and
exceptional returns
usually don't mix. Most
investors, of course,
behave as if just the
opposite were true...
“That is, they usually
confer the highest price-
earnings ratios on exotic-
sounding businesses that
hold out the promise of
feverish change...
“That prospect lets
investors fantasize
[THINK DOPAMINE]
about future
profitability rather
than face today's
business realities.
For such investor-
dreamers, any blind
date is preferable
to one with the girl
next door, no
matter how
desirable she may
be.”
“We make bricks in Texas
which use the same process as
in Mesopotamia.” - Charlie
Munger
Just like in video games, vivid stock market
screens and real time charts offer
frequent change (i.e. volatility) and
sometimes unexpected good surprises,
thereby producing surges of dopamine
which results in addiction
“Investment success will not
be produced by arcane
formulae, computer
programs or signals flashed
by the price behavior of
stocks and markets....
... Rather an investor will
succeed by coupling good
business judgement with an
ability to insulate his thoughts
and behavior from the super
contagious emotions that swirl
about the marketplace.”
Monetary gains have narcotic
power
Addicted gamblers
chain themselves
to slot machines
Using adult
diapers
“People are most credulous when
they are most happy”- Walter
Bagehot
They become extremely suggestible
and will believe almost anything
confession # 6
I became
foolishly
overconfident
A person in a manic state is impulsive,
turbocharged with euphoria, often unable
to sleep, and endowed with a grand ability
to “perceive” the underlying significance
of everything around him
I am on a roll- I can see the
future, nothing can stop me - I am
the master of the universe
Elevated levels of dopamine of a man
in a hot state makes him
overconfident.
One-time gains start looking like
perpetuities, luck becomes skill, and
“early retirement” is just around the
corner...
Normal human
tendency
90% of drivers
think that they
are better than
average drivers
Why do people buy lottery tickets?
Or indulge in day trading?
74% of investors in a survey
said that their own funds
will consistently
outperform the market
Reality? Only a handful
actually do
Only 37% of managers
believe that mergers create
value for buyers. But when
it came to their own mergers
and acquisitions, 58% said
their deals will create value
Overoptimism in Predictions
Our track record in making
predictions is very bad

The future is very


unpredictable
Oil at $140?
Oil at $10?
The value of ONGC when Oil
is at $10 will be VASTLY
different from its value
when its at $140
“We do not have an opinion
about where the stock market,
interest rates, or business
activity will be a year from
now. We've long felt that the
only value of stock forecasts
is to make fortune tellers
look good. We believe that
short-term market forecasts
are poison and should be kept
locked up in a safe place, away
from children and also from
grown-ups who behave in the
market like children.”
“If I taught a
course in
investments, my
final exam would
be to value this
Internet stock.
“And if they came
up with an
answer, they'd
flunk. And if
they came up with
a blank sheet of
paper, I'd
probably give
them a B.
“And if they said
how the hell
could you ask
something so
dumb? I’d give
them an A.”
“There are
two classes
of
forecasters:
Those who
don't know
and those
who don't
know they John Galbraith
don't know.”
I have never seen a research
report which says:
“The value of this is 1,000 if this
happens and 50 if something else
happens, and I have no clue what
will happen.”
Importance of Plausible Range
of Values
Financial modelers use
scenario analysis and then
apply subjective
probabilities to each
scenario to arrive at the
“expected value”
That’s the functional equivalent of
the statistician who drowned in
water which was, on average, only 4
feet deep!
He forgot that the RANGE of
depth was between 2 feet and
10 feet!
Nassim Taleb
“The worst case scenario is
often more consequential
than the forecast itself.”
Two very
different
reactions to
worst case
scenarios
“Available”
worst case-
scenarios
results in
ignorance of
frequency and
overweighing of
magnitude.

Consequence:
Excessive
Overreaction
“Available” worst case-
scenarios results in ignorance
of frequency and overweighing
of magnitude.

What is most “available?”

Personal vs. Vicarious


experience
Recency
Vividness
e.g. Terrorism vs Climate Change
Immediately after a horrible
scenario (e.g. terrorist attack,
major market crash), people’s
perception of risk goes through
a major change.
If worst case
scenario is
“unavailable”
there is a tendency
to assume that the
frequency is as
good as zero

Consequence:
Utter Neglect
e.g. Terrorism vs
Climate Change
“It hasn’t
happened for a
long time, so it
won’t happen”
Earthquake and
volcano
eruptions

LTCM
“In all my
experience,
I’ve never
been in an
accident of
any sort
worth
speaking
about. I have
seen but one
vessel in
“I never saw a
wreck and have
never been
wrecked nor was
I ever in any
predicament that
threatened to
end in disaster
of any sort.”-
E.J. Smith, 1907,
Captain, RMS
Titanic
The Expected Value Frame of
Mind
“Take the probability times the
amount of possible loss from the
probability of gain times the amount
of possible gain. that is what we are
trying to do. its imperfect, but that's
what it is all about.”
Frequency-Magnitude

Much of humanity focuses on


frequencies and not magnitudes
and expected values
When odds of success are low
(and for entrepreneurs they are
ALWAYS low)
“OMG, this is too tough!”
“I can’t do it!”
But, what are the consequences,
if you succeed?
Understand the
importance of
black swans
“Along the hilly slopes of the bell
curve, most values are clustered
around the middle. The average
value is also the most common value.
“The points along the far extremes of the
curve contribute very little statistically.
If 100 random people gather in a room and
the world's tallest man walks in, the
average height doesn't change much.
“But if Bill Gates walks in, the average net worth
rises dramatically. Height follows the bell curve
in its distribution. Wealth does not: It follows an
asymmetric, L-shaped pattern known as a “power
law,” where most values are below average and a
few far above. In the realm of the power law, rare
and extreme events dominate the action.”- David
Shaywitz
Bell curve driven models under-estimate
the importance of black swans - positive
(windfalls), as well as negative
(disasters).
“If its not worth doing at all its
not worth doing well.” - Charlie
Munger
“It is not given to human beings to have
such talent that they can just know
everything about everything all the time.
But it is given to human beings who work
hard at it – who look and sift the world
for a mispriced bet – that they can
occasionally find one.
“And the wise ones bet heavily
when the world offers them
that opportunity. They bet big
when they have odds. And the
rest of the time, they don't.
It's just that simple.”
“You only have to get rich
once.”
- Warren Buffett
facing your first failure
But failure is a just a stepping
stone and not a stumbling block,
isn’t it?
How many successful
entrepreneurs got it right the
first time?
So you embrace failure
Michael Jordan Commercial

26 times I’ve been entrusted to


And that
I’ve failed over,isand
why,over,
I succeed
and
I’ve
take
I’ve lost
the
missedalmost
game-winning
more 300 games
than shot.
9,000
over again in my life
And
shots inmissed
my career
Some people just don’t give up
confession # 7
I did not think
carefully
about losses
Rules:

1. Highest
bidder wins

2. 2nd
Text
highest
bidder also
has to pay
his bid price
to the
auctioneer.
HUH?
Deprival Super
Reaction Syndrome
(DSRS)
If you deprive
me, I’ll have a
super reaction!
“The quantity of a man’s pleasure from
a ten-dollar gain does not exactly
match the quantity of his displeasure
from a ten-dollar loss.”
Video on Loss Aversion
People tend to accept more
risk to avoid losses than to
obtain equivalent gains
DSRS also takes place when you
almost have something you love
and you “lose it” [“near-misses”]
What happens to our risk assessment
ability when, as we approach, the green
light turns yellow?

We become crazy gamblers!


People feel
considerably
more pain after
incurring a
financial loss
than they feel
pleasure after
achieving an
equivalent gain
In the extreme
case, desperate
fears after
losing a lot of
money induces
people to take
enormous risks
with the rest of
their money -
Gambler’s ruin
Countdowns make
people go crazy!
Closing Bell Effect

I am gonna miss it!


Neuroeconomics
shows that
financial losses
and mortal
danger are
processed in
the same part of
the brain:
Amygdala Basic
Instinct
3 types of subjects were chosen
to play a game: normal brains,
damaged amygdalas, brains
damaged in areas other than
amygdala (controls)
Each player was given a starting
capital of $20 and was then
offered a choice to play a game or
not. The game involved a coin
toss. To play the game one had to
invest $1
Heads, you lose$1
Tails, you win $2.5
Total number of rounds: 20

What would you do?


Damaged amygdalas played 84% of the
rounds

Normals played 63%

Controls played 61%


Damaged amygdalas did much
better than the other two
groups!

Why?
Fear of losing our MTM
profits makes us sell out of
good decisions too early.

The stupidity of “you can’t


go broke taking a profit.”
confession # 8
I became a
pavlovian dog
How to Create a Misassociation?
The human equivalent of pavlovian
dog is there in all of us
Restaurants stopped serving
tandoori items and sale of
tandoors plunged...
High price
associated
with high
quality
e.g.
Nakshatra
diamonds
made by De
Beers
Advertisers demonstrate the power of
positive associations by constantly
connecting their products with the things
we like.
=

In a world where for many the


acquisition of money is difficult...
the possession of it in large amount
seems a miracle. Accordingly,
possession must be associated with
some special genius.”- Galbraith
Mis-associating good outcomes
with skill (stock market swindle,
massively outperforming fund
etc.)
Mis-associating bad outcomes with
bad process
Under-appreciation of role of
luck
You see success, and you ask what caused
it?
You read success stories and you
look for what they have in common
You don’t learn about
winning by only looking
at winners!
Stock market
Predictions SCAM

Lotteries
You don’t learn about
success by only looking
at successful people
“When people tend to like what
other people like, differences in
popularity are subject to what is
called “cumulative advantage,”
or the “rich get richer” effect.
This means that if one object
happens to be slightly more
popular than another at just the
right point, it will tend to become
more popular still...
Darwin’s Theory of Evolution
“As a result, even tiny, random
fluctuations can blow up,
generating potentially enormous
long-run differences among even
indistinguishable competitors...
“Thus, if history were to be somehow
rerun many times, seemingly
identical universes with the same
set of competitors and the same
overall market tastes would quickly
generate different winners:
Madonna would have been popular in
this world, but in some other
version of history, she would be a
nobody, and someone we have never
heard of would be in her place.”
Parallel Universes
Web-based experiment.
More than 14,000 participants
registered at Music Lab
(www.musiclab.columbia.edu), and
were asked to listen to, rate and,
if they chose, download songs by
bands they had never heard of.
Some of the participants saw
only the names of the songs and
bands, while others also saw how
many times the songs had been
downloaded by previous
participants. This second group —
“social influence” condition —
was further split into eight
parallel “worlds” such that
participants could see the prior
downloads of people only in
their own world.
All the artists in all the worlds
started out identically, with
zero downloads — but because
the different worlds were kept
separate, they subsequently
evolved independently of one
another.

Darwin’s Theory of Evolution


At the same time, however, the
particular songs that became hits
were different in different
worlds, just as cumulative-
advantage theory would predict.
Introducing social influence
into human decision making, in
other words, didn’t just make the
hits bigger; it also made them
more unpredictable.
Summary
confessions:

1.Availability
2.Perceptual
Contrast
3.Cognitive
dissonance
4.social proof
5.Dopamine addiction
6.Overconfidence
7.Losses
8.Pavlovian
Misassociation
Instead of
focusing on
becoming too
smart, i urge
you to focus on
avoiding
foolish
behavior
I urge you to learn from
mistakes of others

After all...
“You don't have
to pee on an
electric fence
to learn not to
do it.”- Charlie
Munger
Thank You