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September 19, 2005

John Quiggin and the Equity Premium.

John Quiggin of Crooked Timber has a new paper out about the Equity Premium. Serious science of course and thus not only not understandable but also not available to mere mortals like myself.

Larry Elliott in The Guardian has a note on the same subject. John’s paper is about what the implications of the existence of the premium are, the newspaper bit more about how it comes about:

Those who believe successful financial speculators are somehow different from the rest of us could well be right, according to research.

A study by Baba Shiv, associate professor of marketing at Stanford University, found that emotions get in the way of making prudent decisions. Shiv gave 41 participants $20 each at the start of a 20-round gambling game. Players could either bet $1 on the toss of a coin in every round or pass. If they called correctly, they won $2.50, if they called incorrectly they lost their dollar. If they decided not to play they kept their dollar.

The most profitable approach was to play every round. Why? Because with a 50-50 chance of calling right, the expected value of playing would be $1.25 a round, while the expected value of not playing was $1. Those who had suffered damage in the areas of the brain that affected emotions took the profitable approach.

The "normal" participants became more cautious as the game went on, with their decision to play or not affected by what had happened in the previous round. They played less and won less money. Researchers said the experiment helped to explain why investors favoured low-risk bonds when equity returns have been historically much higher. According to the researchers those who made a mint by controlling their emotions are "functional psychopaths".

So now we know the truth about Warren Buffett and George Soros.

September 19, 2005 in Economics | Permalink

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Comments

Well, I'll just have to settle for being a functional psychopath then...

http://infinitivesunsplit.blogspot.com/2005/09/mathematics-and-sociology.html

Posted by: The Pedant-General | Sep 19, 2005 11:45:21 AM

I'm used to seeing people who understand basic math being belittled, but implying that they are "functional psychopaths" is a bit much, no?

Posted by: maor | Sep 19, 2005 12:16:51 PM