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Friday, August 31, 2012

What Tiger Woods and New York Cabbies Have in Common

More wisdom from Daniel Kahneman ("Thinking Fast and Slow," Chapters 26-28). Consider the following question:
  • You are offered a gamble on the toss of a coin. 
  • If the coin shows tails, you lose $100. 
  • If the coin shows heads, you win $150. 
  • Is this gamble attractive? Would you take it?
To take this gamble, you have to choose between the potential of winning $150 against the potential of losing $100. Although the gamble's expected value is positive, most people dislike and reject it because for most, the fear of losing $100 is more intense than the hope of winning $150. When people were asked what the smallest gain they'd need to balance an equal chance of losing $100, most answered $200, twice as much as the loss. This loss aversion ratio has been measured in several experiments and been found to range between 1.5 and 2.5 although it tends to increase as the potential loss increases. In practical terms, what this means is that we fear losing something that we have more than we do getting something that we don't have.

Our aversion to loss is often in reference to short-term goals that we set for ourselves. Take New York cabdrivers, for instance ("Labor Supply of New York City Cab Drivers: One Day at a Time"). They probably have a daily target income, which is easier to achieve some days than on others. For example, "on rainy days, a New York cab never remains free for long, and the driver quickly achieves his target; not so in pleasant weather, when cabs often waste time cruising the streets looking for fares. Economic logic implies that cabdrivers should work many hours on rainy days and treat themselves to some leisure on mild days, when they can 'buy' leisure at a lower price. The logic of loss aversion suggests the opposite: drivers who have a fixed daily target will work many more hours when the pickings are slim and go home early when rain-drenched customers are begging to be taken somewhere" (Kahneman, p. 303).

Perhaps the most interesting study of loss aversion involved professional golfers (Kahneman, pp. 303-304).  The economists Devin Pope and Maurice Schweitzer reasoned that if people are truly more adverse to loss than they are hopeful for a gain, then professional golfers would more adverse to missing a putt for par than they would be to missing a putt for a birdie "("Is Tiger Woods Loss Averse? Persistent Bias in the Face of Experience, Competition, and High Stakes"). Why? Because when gauging loss and gain, we typically do so in relation to some reference point or baseline, and in golf the baseline is par.
For the uninitiated, every hole on the golf course has a number of strokes associated with it, and par is the number of strokes that indicates good (but not outstanding) performance. For a professional golfer a birdie (one stroke under par) is considered a gain, and a bogey (one stroke over par) is considered a loss.
Pope and Schweitzer analyzed more than 2.5 million putts and compared those where the golfer was putting to avoid a bogey and those where he was putting to achieve a birdie. What did they find? Regardless of the difficulty and distance of the putt, the players made more putts when putting for par than they did when putting for a birdie. The difference in the success rate was 3.6%, which although it may appear small, it isn't. Evidently, Tiger Woods was one of those whose putting results were included in the study, and Pope and Schweitzer determined that if in his best years, Woods had putted as well when putting for birdies as he did when putting for pars, his average tournament score would have improved by one stroke and his earnings by almost $1 million, which even in Tiger Woods's world is nothing to sneeze at.

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