Category Archives: Social Science

Michael Mauboussin rocks!

From Knowledge@Wharton: “How do we know which of our successes and failures can be attributed to either skill or luck? That is the question that investment strategist Michael J. Mauboussin explores in his book “The Success Equation: Untangling Skill and Luck in Business, Sports, and Investing”. Wharton management professor Adam M. Grant recently sat down with Mauboussin to talk about the paradox of skill, the conditions for luck and how to mitigate against overconfidence.”

I also recommend Mauboussin’s book entitled “Think Twice: Harnessing the Power of Counterintuition”. Mauboussin does a wonderful job explaining how to use modern social science findings (particularly behavioral finance) to become a better decision-maker when facing risk and uncertainty.

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The game theory behind the new NBC show called "Take it All"

Take it All which recreates a well-studied problem in game theory called the Prisoner’s dilemma.   According to the Prisoner’s dilemma Wikipedia article, a “classic” example of this game is as follows:

“Two men are arrested, but the police do not have enough information for a conviction. The police separate the two men, and offer both the same deal: if one testifies against his partner (defects/betrays), and the other remains silent (cooperates with/assists his partner), the betrayer goes free and the one that remains silent gets a one-year sentence. If both remain silent, both are sentenced to only one month in jail on a minor charge. If each ‘rats out’ the other, each receives a three-month sentence. Each prisoner must choose either to betray or remain silent; the decision of each is kept secret from his partner until the sentence is announced. What should they do?”
This game is called the Prisoner’s dilemma because the solution to the game involves joint betrayal rather than joint cooperation, even though joint cooperation is the better outcome for both.  To see this, consider the following “payoffs” (in terms of prison time) that Prisoner 1 and Prisoner 2 associate with the strategies “Betray” and “Keep Silent”.

 

Prisoner 2

Prisoner 1

Betray

Keep Silent

Betray

A) 3 months in jail, 3 months in jail

C) Go free, 1 year in jail

Keep Silent

B) 1 year in jail, Go free

D) 1 month in jail, 1 month in jail


Suppose Prisoner 2 decides to betray Prisoner 1.  Under the “Prisoner 2 Betrays Prisoner 1” scenario, Prisoner 1 will only have to spend 3 months in jail if he betrays Prisoner 2 (corresponding to cell A above), and a full year in jail if he keeps silent (corresponding to cell B above).  Now suppose Prisoner 2 decides to keep silent.  Under the “Prisoner 2 keeps silent” scenario, Prisoner 1 goes free if he betrays Prisoner 2 (corresponding to cell C above), and spends 1 month in jail if he keeps silent (corresponding to cell D above).  So no matter what Prisoner 2 does, Prisoner 1 always spends less time in jail if he betrays Prisoner 2.  By symmetry, no matter what Prisoner 1 does, Prisoner 2 always spends less time in jail if he betrays Prisoner 1.   Thus the dilemma… Now, let’s consider how Take it All recreates the Prisoner’s dilemma.  The show begins with five contestants playing a first round, four contestants playing a second round, and three contestants playing a third round.  The final two contestants after round three advance to the “Prize Fight” which mimics the Prisoner’s dilemma game shown above.  In the Prize Fight, the strategy pair for each contestant is “Keep Mine” (i.e., keep my winnings from Rounds 1–3) and “Take it All” (i.e., keep my winnings from Rounds 1–3 and also take my opponent’s winnings from Rounds 1–3).  If both contestants choose to “Keep Mine,” they will each keep the prizes they have won in the prior rounds (this is analogous to ending up in cell D in the Prisoner’s dilemma payoff matrix shown above). If one contestant chooses “Keep Mine” and the other chooses to “Take it All,” the contestant that chose “Take it All” will go home with all the prizes — theirs and their opponents (this is analogous to ending up in either cell B or cell C D in the Prisoner’s dilemma payoff matrix).  But if both choose “Take it All,” they both go home with nothing (this is analogous to ending up in cell A in the Prisoner’s dilemma payoff matrix).  If one were to play this game purely on the basis of self-interested action, then the obvious strategy would be to always “Take it All”, in which case NBC doesn’t have to pay out at all.  However, the interesting (and somewhat creepy and provocative twist) here is that the show’s host (Howie Mandel) gives both contestants time to try to convince each other that they won’t betray each other.  Thus, the “suspense” is whether one’s opponent follows through on his or her verbal “promise” to “Keep Mine”. Now consider what happened earlier this week on a “Take it All” episode: From a business perspective, I think that it is quite clever to produce a game show based upon a prisoner’s dilemma game.  The production costs for a show like this are nominal, and most of the time the production company won’t have to pay out a jackpot.  It doesn’t take a game theory expert to figure out that the incentive structure of the game is incompatible with a (Keep Mine, Keep Mine) outcome.  The  likely outcome is (Take It All, Take It All), in which case no prize is paid.  Occasionally one can expect a (Keep Mine, Take It All) outcome, as was the case earlier this week.  This also works to the NBC’s benefit; the “drama” of the game creates a buzz and possibly more viewership (thus bringing in more revenue from commercials).  In all likelihood, NBC also manages the risk of a (Keep Mine, Take It All) outcome by purchasing an insurance policy covering the cost of the jackpot from Lloyds of London… Let me make one final point about Prisoners Dilemmas and television shows.  The next time you watch a Law and Order re-run, keep in mind that virtually every Law and Order episode is organized around some variation of a Prisoners Dilemma game.  The downside of realizing this is that this makes Law and Order much less interesting to watch, since you can often deduce what will likely happen just a few minutes into each episode!  ]]>

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The game theory behind the new NBC show called “Take it All”

There’s a new NBC game show called Take it All which recreates a well-studied problem in game theory called the Prisoner’s dilemma.   According to the Prisoner’s dilemma Wikipedia article, a “classic” example of this game is as follows:

“Two men are arrested, but the police do not have enough information for a conviction. The police separate the two men, and offer both the same deal: if one testifies against his partner (defects/betrays), and the other remains silent (cooperates with/assists his partner), the betrayer goes free and the one that remains silent gets a one-year sentence. If both remain silent, both are sentenced to only one month in jail on a minor charge. If each ‘rats out’ the other, each receives a three-month sentence. Each prisoner must choose either to betray or remain silent; the decision of each is kept secret from his partner until the sentence is announced. What should they do?”

This game is called the Prisoner’s dilemma because the solution to the game involves joint betrayal rather than joint cooperation, even though joint cooperation is the better outcome for both.  To see this, consider the following “payoffs” (in terms of prison time) that Prisoner 1 and Prisoner 2 associate with the strategies “Betray” and “Keep Silent”.

 

Prisoner 2

Prisoner 1

Betray

Keep Silent

Betray

A) 3 months in jail, 3 months in jail

C) Go free, 1 year in jail

Keep Silent

B) 1 year in jail, Go free

D) 1 month in jail, 1 month in jail

Suppose Prisoner 2 decides to betray Prisoner 1.  Under the “Prisoner 2 Betrays Prisoner 1” scenario, Prisoner 1 will only have to spend 3 months in jail if he betrays Prisoner 2 (corresponding to cell A above), and a full year in jail if he keeps silent (corresponding to cell B above).  Now suppose Prisoner 2 decides to keep silent.  Under the “Prisoner 2 keeps silent” scenario, Prisoner 1 goes free if he betrays Prisoner 2 (corresponding to cell C above), and spends 1 month in jail if he keeps silent (corresponding to cell D above).  So no matter what Prisoner 2 does, Prisoner 1 always spends less time in jail if he betrays Prisoner 2.  By symmetry, no matter what Prisoner 1 does, Prisoner 2 always spends less time in jail if he betrays Prisoner 1.   Thus the dilemma…

Now, let’s consider how Take it All recreates the Prisoner’s dilemma.  The show begins with five contestants playing a first round, four contestants playing a second round, and three contestants playing a third round.  The final two contestants after round three advance to the “Prize Fight” which mimics the Prisoner’s dilemma game shown above.  In the Prize Fight, the strategy pair for each contestant is “Keep Mine” (i.e., keep my winnings from Rounds 1–3) and “Take it All” (i.e., keep my winnings from Rounds 1–3 and also take my opponent’s winnings from Rounds 1–3).  If both contestants choose to “Keep Mine,” they will each keep the prizes they have won in the prior rounds (this is analogous to ending up in cell D in the Prisoner’s dilemma payoff matrix shown above). If one contestant chooses “Keep Mine” and the other chooses to “Take it All,” the contestant that chose “Take it All” will go home with all the prizes — theirs and their opponents (this is analogous to ending up in either cell B or cell C D in the Prisoner’s dilemma payoff matrix).  But if both choose “Take it All,” they both go home with nothing (this is analogous to ending up in cell A in the Prisoner’s dilemma payoff matrix).  If one were to play this game purely on the basis of self-interested action, then the obvious strategy would be to always “Take it All”, in which case NBC doesn’t have to pay out at all.  However, the interesting (and somewhat creepy and provocative twist) here is that the show’s host (Howie Mandel) gives both contestants time to try to convince each other that they won’t betray each other.  Thus, the “suspense” is whether one’s opponent follows through on his or her verbal “promise” to “Keep Mine”.

Now consider what happened earlier this week on a “Take it All” episode:

From a business perspective, I think that it is quite clever to produce a game show based upon a prisoner’s dilemma game.  The production costs for a show like this are nominal, and most of the time the production company won’t have to pay out a jackpot.  It doesn’t take a game theory expert to figure out that the incentive structure of the game is incompatible with a (Keep Mine, Keep Mine) outcome.  The  likely outcome is (Take It All, Take It All), in which case no prize is paid.  Occasionally one can expect a (Keep Mine, Take It All) outcome, as was the case earlier this week.  This also works to the NBC’s benefit; the “drama” of the game creates a buzz and possibly more viewership (thus bringing in more revenue from commercials).  In all likelihood, NBC also manages the risk of a (Keep Mine, Take It All) outcome by purchasing an insurance policy covering the cost of the jackpot from Lloyds of London…

Let me make one final point about Prisoners Dilemmas and television shows.  The next time you watch a Law and Order re-run, keep in mind that virtually every Law and Order episode is organized around some variation of a Prisoners Dilemma game.  The downside of realizing this is that this makes Law and Order much less interesting to watch, since you can often deduce what will likely happen just a few minutes into each episode!

 

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US Birth Rate Hits New Low – A Nation of Singles – Forecasts & Trends

US Birth Rate Hits New Low – A Nation of Singles – Forecasts & Trends According to this article, “the fertility rate needed to maintain the current US population is 2.1 children born to women of child-bearing age… the US fertility rate among women is now only 1.9 children and falling.” Apparently the US is in much better shape in this regard than Europe; e.g., according to a recent Forbes article entitled “What’s Really Behind Europe’s Decline? It’s The Birth Rates, Stupid“, the fertility rate among women in Spain presently stands at 1.4 children and falling.  This and similar “birth dearths” in other Mediterranean countries such as Greece, Italy and Portugal are contributing significantly to the economic malaise in Europe.  The above referenced Forbes article notes,

“Essentially, Spain and other Mediterranean countries bought into northern Europe’s liberal values, and low birthrates, but did so without the economic wherewithal to pay for it. You can afford a Nordic welfare state, albeit increasingly precariously, if your companies and labor force are highly skilled or productive. But Spain, Italy, Greece and Portugal lack that kind of productive industry; much of the growth stemmed from real estate and tourism. Infrastructure development was underwritten by the EU, and the country has become increasingly dependent on foreign investors. Unlike Sweden or Germany, Spain cannot count now on immigrants to stem their demographic decline and generate new economic energy. Although 450,000 people, largely from Muslim countries, still arrive annually, over 580,000 Spaniards are heading elsewhere — many of them to northern Europe and some to traditional places of immigration such as Latin America. Germany, which needs 200,000 immigrants a year to keep its factories humming, has emerged as a preferred destination.”
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US Birth Rate Hits New Low – A Nation of Singles – Forecasts & Trends

US Birth Rate Hits New Low – A Nation of Singles – Forecasts & Trends

According to this article, “the fertility rate needed to maintain the current US population is 2.1 children born to women of child-bearing age… the US fertility rate among women is now only 1.9 children and falling.”

Apparently the US is in much better shape in this regard than Europe; e.g., according to a recent Forbes article entitled “What’s Really Behind Europe’s Decline? It’s The Birth Rates, Stupid“, the fertility rate among women in Spain presently stands at 1.4 children and falling.  This and similar “birth dearths” in other Mediterranean countries such as Greece, Italy and Portugal are contributing significantly to the economic malaise in Europe.  The above referenced Forbes article notes,

“Essentially, Spain and other Mediterranean countries bought into northern Europe’s liberal values, and low birthrates, but did so without the economic wherewithal to pay for it. You can afford a Nordic welfare state, albeit increasingly precariously, if your companies and labor force are highly skilled or productive. But Spain, Italy, Greece and Portugal lack that kind of productive industry; much of the growth stemmed from real estate and tourism. Infrastructure development was underwritten by the EU, and the country has become increasingly dependent on foreign investors.

Unlike Sweden or Germany, Spain cannot count now on immigrants to stem their demographic decline and generate new economic energy. Although 450,000 people, largely from Muslim countries, still arrive annually, over 580,000 Spaniards are heading elsewhere — many of them to northern Europe and some to traditional places of immigration such as Latin America. Germany, which needs 200,000 immigrants a year to keep its factories humming, has emerged as a preferred destination.”

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Did the Community Reinvestment Act (CRA) Lead to Risky Lending?

Did the Community Reinvestment Act (CRA) Lead to Risky Lending?

by Sumit Agarwal, Efraim Benmelech, Nittai Bergman, Amit Seru  –  #18609 (AP CF)

Abstract:

Yes, it did.  We use exogenous variation in banks’ incentives to conform to the standards of the Community Reinvestment Act (CRA) around regulatory exam dates to trace out the effect of the CRA on lending activity.  Our empirical strategy compares lending behavior of banks undergoing CRA exams within a given census tract in a given month to the behavior of banks operating in the same census tract-month that do not face these exams.  We find that adherence to the act led to riskier lending by banks:  in the six quarters surrounding the CRA exams lending is elevated on average by about 5 percent every quarter and loans in these quarters default by about 15 percent more often.  These patterns are accentuated in CRA-eligible census tracts and are concentrated among large banks.  The effects are strongest during the time period when the market for private securitization was booming.

http://papers.nber.org/papers/W18609

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Are You Brilliant, or Just Lucky?

Are You Brilliant, or Just Lucky? – WSJ.com.

This article applies insights from Michael Mauboussin’s new book entitled “The Success Equation: Untangling Skill and Luck in Business, Sports and Investing” to investment decision-making. I particularly like the author’s description of a classic experiment in which “… people guessed the outcome of a coin toss. When told they got the first four tosses correct, they concluded on average that they would be able to guess 54 of the next 100 coin flips.” In other words, people often fool themselves into attributing skill to pure luck.

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Mulligan on Redistribution, Unemployment, and the Labor Market

Mulligan on Redistribution, Unemployment, and the Labor Market | EconTalk.

I am looking forward to listening to this EconTalk podcast on my daily walk today.  Here are the program notes for this podcast:

“Casey Mulligan of the University of Chicago and the author of The Redistribution Recession, talks with EconTalk host Russ Roberts about the ideas in the book. Mulligan argues that increases in the benefits available to unemployed workers explains the depth of the Great Recession that began in 2007 and the slowness of the recovery particularly in the labor market. Mulligan argues that other macroeconomic explanations ignore the microeconomic incentives facing workers and employers.”

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