Jul

7

I found this interesting piece of research:

Ergodicity transformations predict human decision-making under risk

Decision theories commonly assume that risk preferences can be expressed as utility functions, which vary from person to person but are stable over time. A recent model from ergodicity economics reveals that if people want their wealth to grow at the fastest rate they need to adjust their utility functions depending on the dynamics of their wealth. Here, we ask whether humans make such adjustments by exposing them to different wealth dynamics….Together, these results provide evidence that human risk-taking behaviour is sensitive to the dynamical context in which decisions are made and that long-term wealth maximization is an important explanatory principle.

It's about two things concerning the psychology of gamblers. First, is the attitude of risk towards bets that entail absolute returns & absolute losses. An absolute return from a bet is when:
- a gambler is given say $10 if they win
- and if they loose the outcome is -$5
What amount they loose or gain is absolute i.e in dollars terms, $10 or -$5.

Second is a group of gamblers whose risk is phrased in relative terms. A relative return on a bet is when:
- a gambler gains 10% if they win
- and if they loose the outcome is -5%
Rewards & gains are framed as percentages.

The conclusion of the research is that people that gamble in absolute terms take more risk than people that gamble in relative terms. People do change their risk appetite if you present gambles to them differently.

So I have a question for you specs: Which statement would make you more likely to buy Nvidia's stock?
a) $1,000 invested in Nvidia stock at IPO ($0.04) would become about $3,200,000 ( i.e absolute terms)
b) $1,000 invested in Nvidia stock would grow by 327,000% (i.e relative terms)

Personally a) would do a better job at baiting me to buy some stock (the research is true for me). What about you?

Here is a twitter thread by one of the authors with a more simplified explanation.


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