A great book by the 2002 Economics Nobel laureate. Great to see the comment of Taleb's comment that the book is in the league of Adam Smith's 'The Wealth of Nations & Sigmund Freud's 'The Interpretations of Dreams'!
Mr. Daniel Kahneman shares his ideas on the latest developments in psychology with the readers in his inimitably simple and impressive manner. The book opens our mind to the Nobel Laureate's thought process.
If you venture to read the book, be prepared to be a subject of his numerous psychological studies! He fools your intuitive System 1; he teases your lazy System 2 to work harder. In the process, he reveals many facts about the functions of both the Systems. He unravels many truths which formed the foundation of the behavioral economics! Additionally, he fills us with the latest in the field without resorting to jargon!
Think about the applications; sample this one: bright red/blue readable fonts written on high contrast premium paper in simple, preferably rhyming, sentence with an uncanny resemblance to proverbs (I made it (the proverb one) up with 'Made to Stick' in mind!) can convey the reliability of the messages!
The author brings the results of his lifetime research in this book to help the readers to understand why and how of the decisions we make. No wonder, Taleb's and Levitt's remarks are befitting for the book. I hope, this reading will help me to improve my choices down the line!
In the first part of the book the author covers all the characteristics of System1, which is intuitive, always ON, alerted by System2, many times evolves due to repeated tasks by System2. Some of the tasks covered by System1 are Causal connections, associative memory, immediate sizing of new situations, faces, places,... The system resorts to heuristics to address many issues. This also leads to many biases, which are covered in the next part in detail.
He uses his most celebrated and controversial case of Lucy: Less is more to show that how 85% of Statistics post-grads from prestigious Stanford University choose plausibility over probability when asked to rank the probability! He brings us to the case study through Tom W case, where deliberately Tom W is characterized 'anti-base' to get anti base results from the subjects' System 1 response lazily endorsed by System 2! to highlight WYSIATI ('What You See Is All There Is.' Wow, I thought only computer nerds are good at abbreviations) effect ie. availability effect!
In the second part of the book the author prepares the reader's mind to some of the fallacies since System 1 is causal in approach and System 2 is too lazy to work on issues related to Statistics. In a chapter which talks on Causal character of our mind. He concurs with psychology experts on the following realization '... unwillingness of extrapolation from general to particular is matched by willingness to extrapolate from particular to general'.
A reader (as I noted earlier, here.) will be subjected to surprises to reveal the marvels of Systems 1 and 2. This is a deliberate strategy by the author to prepare our Systems 1 and 2 learn and internalize the concepts. The author has been highly successful on this!
As an example, the author talk about Moneyball, where the hero chooses players based on the earlier performance over intuition and the team was highly successful and could be managed more cost effectively. The others chose 'stars' based on intuition and those 'stars' were costly to own and manage!
In the chapter about taming intuition, the chapter prepares the readers to consider correlation factor while choosing start-up ventures or employees.
In the chapter about algorithm v/s intuition, Kahneman advises a simple method of identifying 5 or 6 MECE parameters. Grade the parameters through 5-10 questions. Close the eyes to get intuition about the right grade. Grade Total and get the best resource!
Kahneman offers advice on when to rely on intuition. If the 'expert' has been on the task for more than 10,000 hours and he has handled every conceivable situation, then we can rely on intuition. The figure 10,000 hours of exposure appeared in Malcolm Gladwell's outliers too! while talking about success in a given emerging field. My guess is, by the time a person works for 10,000 hours with passion (given he is one among the best), s/he has developed intuitive way of leading the team/company to thrive on the emerging wave.
Kahneman shares the skepticism of Taleb about Business Management literature and the mutual fund managers, in the same way. Whereas he says that correlation between the business leader's and success of their organizations is as less as 30%, which can give little better probability of 60% over 50% of flipping the coins. He also conceded that this can be critical in races! If we consider the business management to be a never ending race with greater acceleration every year, we have to depend on the leaders!
But, regarding mutual fund managers, the view is not so optimistic, their correlation to success (better yield) is close to zero! (to be precise 0.01). However, he concedes that the stock pickers may be good on short term bets!
Deriving from his own experiences, while preparing a syllabus for Israel's schools, Kahneman shares Planning Bias. Planning Bias compares with the best case scenarios for resources & time. Also, on benefits side over projections are the global norms, whether public work or private! The examples are rail projects which normally keep on consuming more & more resources and on an average, there was 106% over projection of traffic! An example about a kitchen counter estimation compares well with the rail projects' example! So, there is a need for comparing with the average numbers.
Kahneman covers the overconfidence bias, competition neglect, planning bias in most of the entrepreneurs. At the same time he emphasizes that, very few are blessed with the optimism of entrepreneurs, which can be taught to only certain extent. So, there is a need for entrepreneurs to temper their biases with 'premortem' proposed by Gary Klein. The premortem is simple yet effective. Before committing resources to the new venture/project. The leading team can be asked to come out with 'what if the project/venture ends up as a disaster after a year, how would they write about its brief history.' In the process of coming out with their thoughts on the 'disaster', the team may get sensitized on the biases and be prepared to tackle the eventualities as they arise. According to Kahneman, when he shared this with the recent Davos audience, one of the business leaders exclaimed the advice about the pre-mortem was worth attending the event!
Kahneman refers to his own and many other scholars' biases while talking about his theories on choices.
After laying the strong foundation in the earlier parts, Kahneman takes us through his celebrated Prospect Theory. He introduces Bernoulli's Expected Utility Theory. He also bares open his thoughts about the unchallenged theory for three centuries; attributes it to lazy System 2!
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| A Typical Loss Aversion Graph (Source:http://en.wikipedia.org/wiki/File:Valuefun.jpg) |
Cumulative Prospect Theory adds to Expected Utility Theory through the Reference Point and Decision Weights considering the Loss Aversion. In fact, he makes light of his work saying that he is just articulating what our grand mothers applied implicitly!
He also provides perfect case offered by another expert for his Fourfold Pattern. When 95% sure about winning $1Mn. award in a court case, one may consider settlement of $910K due to risk aversion and Certainty effect because of lower decision weight . The defendant faced with a choice 95% sure about losing the case may avoid settlement due to sunk cost bias since he seeks the risk! When 5% sure about winning the $1Mn. award, the same person may reject the settlement tending to be risk seeker because of higher decision weight due to probability effect! The defendant in this case may opt for settlement because he may become risk averse due to probability effect because of the nuisance value! Kahneman has an uncanny capability to convey his thoughts in simple yet effective manner.
