Thursday, August 25, 2016

Are we too risk averse?

Yes.  At least according to a clever natural experiment run by Freakanomics author, Steven Leavitt.
He made a website and asked listeners of his podcast, readers of the Financial Times and Forbes, and Reddit users to help him out by visiting it. They were invited to give details of a big decision they were struggling with, then witness a coin toss to help them make up their mind. Mr Levitt then followed up with them twice, after two months and after six months, to ask whether they had made the change, and how happy they were.
Those who made the change, away from the status quo, were happier.
For policymakers, the lesson is that the status quo is a powerful thing. And for those tired of hearing their friend obsess over whether to dump a disastrous boyfriend, they have a new weapon in their armoury—in their wallet.

4 comments:

  1. Very nice article and very useful to understand a bit more all this things, thanks for share Luke

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  2. While the study was not statistically well grounded, what I think we are seeing here are people deciding the opportunity cost of a particular decision process. As Froeb states in his text book Managerial Economics on page 32, “Costs and decisions are inherently linked to one another.” Perhaps what we are seeing here is that for the sample set, the cost of inaction of making the decision was greater than that of making the decision. Once the decision was made, the “cost” of the time analyzing (and/or agonizing over) the decision that was chosen was in turn minimized. These are what can be construed as adding to the real costs of the decision and not just one of monetary reward or loss. The idea to let a coin choose a decision and thus minimize the time or effort lost to the decision making should be included as part of the opportunity cost.

    That said, an important decision should always consider all the facts, pros and cons of said decision. For most rational people, to even consider using a coin toss, the outcome of the decision would have to be so equally weighted that the outcomes would be the same regardless of the choice made. This especially holds true if either outcome is a “win” regardless of which choice was made.

    For example, if one was to like apple and pears equally but could only choose one fruit, the opportunity cost would be the time wasted in choosing which one to consume. In this simple case, flipping a coin would minimize the opportunity cost lost in the decision making process. In turn making the person happy with the outcome. If the outcome of a decision leans heavily in favor of one direction or another (or if the gains or losses are substantial), then it would be assumed someone making a choice would have no need or desire to flip a coin in the first place.

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  3. I believe that in general people are more risk averse than risk adverse. The fear of losing money is much hire that gaining it, especially is they have no warning or control in the loss of their money. A recent example is the effects of the United States recession in the mid-2007. Retirees and those that were close to retirement did have the necessary time to recover from job losses, falling home prices, and loss in their investment portfolio (Brandon, 2011). Therefore many of them had to go back to work, invest in a less aggressive retirement plan, dip into their remaining savings to survive and become more conservative with their spending (Josephson, 2015). Therefor the fear of taking risks are forcing people to live in the existing state of affairs also known as the status quo (Merriam-Webster, 2016).
    However, there is a down side of being risk adverse and living the status quo. The main downside is missing out on a great opportunity such as a new job and purchasing a home. The main reason for risk aversion is the uncertainty a person may face do to their choice. A way to reduce risk aversion to uncertainty is to become informed about the risk (Froeb, McCann, Ward, & Shor, 2015). If the information demonstrates that risk has minimal to no negative impact, then take the risk. In the end the benefits of your choice has to outweigh the negative impact.

    Bibliography
    Brandon, E. (2011, May 27). 10 Ways the Recession Has Changed Retirement . Retrieved from usnews.com: http://money.usnews.com/money/blogs/planning-to-retire/2011/05/27/10-ways-the-recession-has-changed-retirement
    Josephson, A. (2015, January 26). Top 5 Signs You’re Too Risk-Averse. Retrieved from smartasset.com: https://smartasset.com/life-insurance/top-5-signs-youre-too-risk-averse
    Merriam-Webster. (2016, December 4). Definition of Status Quo. Retrieved from merriam-webster.com: https://www.merriam-webster.com/dictionary/status%20quo

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  4. When I read this post, I think about what we learned about risk versus uncertainty. Perhaps we seem risk averse because it’s about uncertainty. Froeb et al (2014) tells us that understanding the difference between risk and uncertainty is critical. Risk can be quantified while uncertainty is more complicated to deal with. It is recommended to combat uncertainty by gathering more information.

    Grant (2013) shares according to 20 years of research conducted by Columbia University’s Tory Higgins, it might be more accurate to say that some of us are particularly risk-averse, not because we are neurotic, paranoid, or even lacking in self-confidence, but because we tend to see our goals as opportunities to maintain the status quo and keep things running smoothly.
    I like how Froeb et al (2014) reminds us that uncertainty can never be eliminated and we must learn to fight despite it. Interestingly, further research conducted by Harvard’s Francesca Gino and Joshua Margolis, indicates that prevention-focused people are more likely than the promotion-focused to behave ethically and honestly — not because they are more ethical per se, but because they fear that rule-breaking will land them in hot water (Grant, 2013).

    References
    Froeb, L. M., McCann, B. T., Shor, M., & Ward, M. R. (2014). Managerial economics: A problem solving approach (4th ed.). Boston, MA: Cengage Learning.
    Grant, H. (2013, July 2). The Hidden Danger of Being Risk-Averse. Retrieved December 10, 2017, from https://hbr.org/2013/07/hidden-danger-of-being-risk-averse

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