The Romans thought that all swans were white, but the Australians knew better, and Europe was amazed around 1700 when they shared their secret. Now we use the term Black Swan event to describe a surprise that we hadn’t predicted. In 1690 would you have invested in a company trying to raise swans that were black?
If we are looking over our investment portfolio, we try and play safe when our paper gurus in the press mutter about possible disasters. If we are told something is risky, we avoid it and choose the certain gain. We all nod wisely and mutter the old proverb about “a bird in the hand etc.” Faced with a falling market, many of us will take the risk of a bigger loss on the off chance when we read that an investment might buck the trend.
Later, when we’re sitting in the bar drowning our sorrows and agreeing with our fellow nouveau– pauvreté, we tell each other that it wasn’t our fault, it’s just our lack of experience. Next time, hmm… next time. Ludvig and Spetch from Princeton U (1) decided to pin down what the decisions would be when things weren’t so risky. They carried out experiments in which the participants could choose an easy win or take a risk of increasing it or loosing it. In addition they also had decisions to make in losing situations where they could accept a small loss or take the risk of a bigger loss or maybe none.
Here is the interesting bit though. The experiments were designed so that they were just given the choices or that they were trained on the frequency of particular events occurring. As the authors put it making decisions based on ‘contemplating the future or reflecting on the past.’
Our alcoholic driven epiphany in the bar was correct. Experience would lead us to be less risk averse when it comes to gains and not to throw good money after bad when losses are on the menu. One wonders if there is a lot of poker played around the Princeton campus.
