Tuesday, April 29, 2008

Penny for your Thoughts: Revisited

Here is a paper that might put a new lens on the previously discussed Alter and Oppenheimer money familiarity study (or perhaps vice versa). In "The Dishonesty of Honest People: A Theory of Self-Concept Maintenance," Nina Mazar, On Amir, and Dan Ariely discuss the results of a series of cheating experiments. In the experiments students are paid 50 cents for each question they get right on a test. Some of the experimental conditions provide an opportunity to cheat by allowing students to self report their scores. The surprising finding is that cheating dramatically increases when tokens are given to students instead of cash, even though these tokens can be exchanged for cash at a station only a few feet away. The authors of the Dishonesty study believe there is something special about cash. It is why people might take home a few office supplies but they are much less likely to take the equivalent value out of petty cash. Moral ambiguity is erased.

Perhaps there is a related effect at play in Adam Alter and Daniel Oppenheimer’s research. $2 bills, Susan B. Anthony dollars, and altered bills play the role of tokens. Like the tokens in the Dishonesty study people rationally know they have equivalent value to cash (ironically a token of value in its own right). However, in practice tokens and cash are not the same since people behave differently by say, increasing their cheating or having a willingness to part with a token at a discount. Of course we beg the question of why $2 bills are tokens and $1 bills are not. We may be back to familiarity.

Another take is that familiarity is playing a role in the Dishonesty study. There could be a discounting of the unfamiliar tokens taking place. People are cheating the same “amount” but they need more of the discounted tokens to steal the equivalent perceptual value.

Sunday, April 20, 2008

Penny for your Thoughts

Into the growing body of research on “predictably irrational” behavior comes a new study from Adam Alter and Daniel Oppenheimer of Princeton, to be published in the Psychonomic Bulletin & Review. Like others before it, this study examines the great plasticity of perceived value. In their experiments, Alter and Oppenheimer’s subjects value a $1 Susan B Anthony coin less than they do a traditional $1 greenback bill. Similarly, subjects also seem to value $2 bills less than they rationally should as compared to the more frequently encountered “ones.” The authors argue that this is a result of familiarity which subjects value more than they rationally should.

Initially, the authors’ explanation of the results did not strike me as correct. Generally rare things are the most valuable. Even with money, the units we see the least frequently (like $100 bills) are more valuable than those we see all the time ($1 bills). However, I have tried to think of alternative theories and I have not hit on anything that holds together as well as the familiarity explanation.

One alternative explanation is that subjects are using touch stone categories as heuristics to determine value. Imagine that we place amounts we encounter into one of three buckets valued lowest to highest: pocket change, wallet, and bankable. These categories are formed around how people use money, where they physically store it, and perhaps some kind of “purchase ambition.” Subjects would place a Susan B. Anthony coin into the pocket change bucket. The $1 bill would be placed in the higher category of “wallet” and thus be valued more. Of course the $2 bill falls into the same “wallet” category as well yet subjects value the $2 bill significantly less than two $1 bills. Something else must be going on.

Perhaps there is a glass half full or half empty framing effect with value. Here are some possible subconscious monologues. I have a single coin and I feel poor because you can’t get much for a coin (half empty). I have a dollar bill and I feel relatively wealthy because one dollar is a psychological threshold to having something of real value (half full). The same effect may happen with two $1 bills. I separate the money into two units and frame each on the threshold of value and feel even wealthier (half full). On the other hand, the $2 bill may inspire visions of higher value bills. I now frame on the wish that I had a $20 bill and I then feel poor (half empty).

Neither of the two theories I put forward can account for a third experiment run by the authors but it does prompt a new alterative. In the third experiment subjects effectively compare the value of one real $1 bill and one that has been slightly altered by reversing the image of George Washington’s head (the fake). The fake should appear less “familiar” than the real bill and therefore be valued less, which indeed was the case.

Is it possible that subjects are not valuing the familiar itself but instead discounting the unfamiliar? Unfamiliar money could somehow make subjects less comfortable, perhaps because they fear that it could be fake? They may worry it will be more difficult to trade it to others in the future even if they understand that it is the equivalent to the more frequently encountered money. Maybe, but to risk a bad pun this is probably just the other side of the same coin. I think I will stick with the authors on this one after all. They present the simplest explanation to all the observations.

Friday, April 18, 2008

Neuroeconomics: Testosterone and Trading

The Wall Street Journal recently published an article on the possible impact of testosterone on stock traders. The study is by John M. Coates, a senior research fellow at Cambridge. His general finding is that higher levels of testosterone are correlated with higher levels of risk taking and (during the course of the study anyhow) better trading results. Increased risk taking behavior seems intuitive; however, the one percentage point gain in financial performance is not as clear cut. One could dig into the original study to see how Coates tried to account for this but I do not see a clear way to determine if the trading decisions were good or bad ones based only on the outcome. Taking really risky bets can sometimes yield high returns. However, could those same returns be generated (on average) with more certainty and less risk? Would they have a higher risk adjusted rate of return?

The more interesting study mentioned is that of MIT Sloan’s Andrew Lo. He wired up traders to monitor their psycho-physiological state in real time while executing real trades. It seems he would have much tighter paring of the independent variable to the actual decision making moment. However, this study may suffer the same issues with the outcome measure. Some time ago Professor Lo presented his experimental design in a class I was taking at the MIT Media Lab (Sandy Pentland’s Digital Anthropology Class). I was an MBA student at the time and playing a lot of Texas Hold’em with buddies from the Muddy Charles -- so perhaps that was the inspiration but I suggested he run a similar experiment on Black Jack players. Unlike with the stock market, the expected value of given Black Jack hands can be precisely quantified. On a hand by hand basis you could determine if the subject made the decision that maximized his or her expected value from playing the hand. I would guess that a higher testosterone level and/or greater excited psycho-physiological state would cause subjects to make suboptimal decisions, even if on occasion they got lucky and won.