“Can you explain behavioural finance to my 14-year-old daughter?”
As the girl’s father was a finance professor, I had the impression that he might already have tried it unsuccessfully himself. Undeterred, though, I turned to the unenthusiastic teen and asked her to imagine a prize draw with a £100 reward for the lucky person whose ticket number is randomly drawn from a basket.
There are only 100 tickets,” I explained, “so, arguably, each entry ticket is ‘worth’ £1.” She nodded in agreement. “Now suppose I offer you the chance to buy one of those tickets for 90p. Would you take it?” She nodded again, smiling. Was this going to be easier than she thought? “I have to tell you, though, that I own the remaining 99 tickets.” The smile disappeared, probably not because she was unsure of the ‘correct’ answer, but rather because she didn’t appreciate maths questions at a garden party in the middle of the school summer holidays. The girl’s mother, a seasoned fund manager, joined the group and asked me to repeat the problem. “It’s the same odds of winning in both cases,” she ultimately declared, “so I should still take it.”
She was right, of course, but she too probably had an odd feeling in her stomach while reaching that conclusion. Its cause was the focus of her attention. In the first condition, her attention was on herself, the most salient ticketholder, and therefore the most obvious winner. In the second condition, her focus was on me, the holder of the remaining 99 tickets. Suddenly I became the most obvious winner, and so the single ticket appeared less appealing even though its value had not changed. Our judgements, and often our choices, are influenced by human factors that have nothing to do with economics.
The mother seemed unimpressed so I continued: “What if I told you that I only paid 80p for each of my 99 tickets. Do you still want to buy that one for 90p?” Crestfallen, she murmered “Yes, but it is not fun anymore.” We all know the ‘right’ answer, but sometimes that is just not enough.