Diversification Bias

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Diversification Bias

  1. 1. Diversification Bias: The fear of focus<br />Dr. Russell James III<br />Texas Tech University<br />
  2. 2. Potential positive outcomes of planned focus<br />Avoiding negative addictions<br />Pursuing positive addictions<br />Achieving competitive mastery<br />Barriers to planned focus<br />Hyperbolic discounting<br />Projection bias<br />Diversification bias<br />Focus<br />
  3. 3. Diversification bias: The fear of focus<br />We hate losing options, even if they are bad ones. <br />We love diversification, even when it is pointless and costly.<br />We avoid focusing, even if it is the only correct choice.<br />But, controlling your decision environment means focusing your choices and sometimes eliminating future options.<br />
  4. 4. Diversification bias: We hate losing options<br />Experimental finding<br />“options that threaten to disappear cause decision makers to invest more effort and money in keeping these options open, even when the options themselves seem to be of little interest”<br />Shin (MIT) & Ariely (MIT), 2004, Keeping doors open: <br />The effect of unavailability on incentives to keep<br /> options viable. Management Science, 50, 575-586.<br />
  5. 5. An experiment on diversification bias<br />First, pick a door.<br />Shin, J. (MIT) & Ariely, D. (MIT), 2004, Keeping doors open: The effect of unavailability on incentives to keep options viable. Management Science, 50, 575-586.<br />
  6. 6. An experiment on diversification bias<br />Then click on the payoff box for some unknown amount (avg. 3¢ per click).<br />$<br />
  7. 7. An experiment on diversification bias<br />Then click on the payoff box for some unknown amount (avg. 3¢ per click). 50 clicks total. Earn as much money as possible.<br />1¢<br />2¢<br />4¢<br />5¢<br />$<br />
  8. 8. An experiment on diversification bias<br />Can continue to click on the payoff button. <br />Or can click to switch doors. <br />But, switching uses up one of your 50 clicks.<br />1¢<br />2¢<br />4¢<br />5¢<br />$<br />
  9. 9. An experiment on diversification bias<br />All doors have the same average value (3¢). <br />What is the best strategy?<br />1¢<br />2¢<br />4¢<br />5¢<br />$<br />
  10. 10. If all doors have the same average value (3¢), the best strategy is…<br />Never switch doors because switching uses a click<br />Use ⅓ of clicks on red door, ⅓ on blue, ⅓ on green<br />Use ½ of clicks on one door and ½ on another door<br />Switch doors on every other click<br />Switch doors randomly<br />$<br />
  11. 11. An experiment on diversification bias<br />Best strategy: Pick one door and keep clicking. Never switch!<br />1¢<br />2¢<br />4¢<br />5¢<br />$<br />
  12. 12. An experiment on diversification bias<br />Participants explicitly told: These doors all have the same average payoff. <br />Did they switch doors during the game?<br />1¢<br />2¢<br />4¢<br />5¢<br />$<br />
  13. 13. An experiment on diversification bias<br />Participants explicitly told: These doors all have the same average payoff. <br />The average number of switches: about 1.<br />1¢<br />2¢<br />4¢<br />5¢<br />$<br />
  14. 14. An experiment on diversification bias<br />New twist. Each time a door is clicked, the others shrink 1/15th. At the 15th time without being clicked they disappear. <br />1¢<br />2¢<br />4¢<br />5¢<br />$<br />
  15. 15. An experiment on diversification bias<br />All doors still have same average payout. Does the best strategy change? <br />1¢<br />2¢<br />4¢<br />5¢<br />$<br />
  16. 16. If all doors have the same average value, but unclicked doors eventually disappear, the best strategy is…<br />Never switch doors because switching uses a click<br />Use ⅓ of clicks on red door, ⅓ on blue, ⅓ on green<br />Use ½ of clicks on one door and ½ on another door<br />Switch doors on every other click<br />Switch doors randomly<br />$<br />
  17. 17. An experiment on diversification bias<br />Participants explicitly told: These doors all have the same average payoff. <br />Did they switch doors during the game with disappearing doors?<br />1¢<br />2¢<br />4¢<br />5¢<br />$<br />
  18. 18. An experiment on diversification bias<br />With the risk of door disappearance the average number of door switches changes from 1 to almost 7! <br />1¢<br />2¢<br />4¢<br />5¢<br />$<br />
  19. 19. An experiment on diversification bias<br />People can’t stand to let the option disappear, even if it they know there is no advantage! <br />1¢<br />2¢<br />4¢<br />5¢<br />$<br />
  20. 20. An experiment on diversification bias<br />Similar results… <br /> if switching costs a click and 3¢. <br /> if you could make the door come back. <br /> if the disappearing doors have a lower payoff. <br />1¢<br />2¢<br />4¢<br />5¢<br />$<br />
  21. 21. Can diversity bias (the irrational desire to avoid losing options) apply to dating?<br />Prof. Dan Ariely’s comments<br />http://www.youtube.com/watch?v=RpvpCLI5wxE<br />
  22. 22. Discussion<br />Working in groups of 2-5, answer this: When can an irrational desire to keep options open be detrimental to a person’s future?<br />Careers? College major? Athletics? Relationships?<br />Addiction? Other examples?<br />Sometimes focus (eliminating other options) leads to a better set of new options. <br />
  23. 23. Another Experiment<br />Students in class given the option of snacks at the end of class each week: Snickers, Oreos, chocolate with almonds, tortilla chips, peanuts, and cheese-peanut butter crackers.<br />Group 1: What would you like right now? (Asked each week for three weeks.)<br />Group 2: Asked to select choices for the following three weeks in advance.<br />Read, D. (Carnegie Mellon) & Loewenstein, G. (Carnegie Mellon), 1995, Diversification bias: Explaining the discrepancy in variety seeking between combined and separated choices. Journal of Experimental Psychology: Applied, 1, 1, 34-49.<br />
  24. 24. What do you think?<br />Group 1: Asked what would you like right now? (Asked each week for three weeks.)<br />Group 2: Asked to select choices for the following three weeks in advance<br />Who was more likely to select three different snacks for the three different weeks?<br /> a) Group 1<br /> b) Group 2<br /> c) They were about the same<br />Read, D. (Carnegie Mellon) & Loewenstein, G. (Carnegie Mellon), 1995, Diversification bias: Explaining the discrepancy in variety seeking between combined and separated choices. Journal of Experimental Psychology: Applied, 1, 1, 34-49.<br />
  25. 25. People plan more future variety than they will want<br />
  26. 26. Irrational diversification?<br />Suppose there are three types of balls: <br />●red, ●blue, and ●yellow. <br />One color will be randomly picked as the winning color. You get to draw one ball out of a jug. <br />Is one color more likely to win than the others?<br />
  27. 27. Irrational diversification?<br />Suppose there are three types of balls: <br />●red, ●blue, and ●yellow. <br />One color will be randomly picked as the winning color. You get to draw one ball out of a jug. <br />Is one color more likely to win than the others?<br />No. The winning color is drawn at random.<br />
  28. 28. Irrational diversification?<br />●red, ●blue, and ●yellow. <br />One color will be randomly picked as the winning color. You get to draw one ball out of a jug. <br />Since all colors are equally likely to win, does it matter what variety of colors are in your jug?<br />
  29. 29. Irrational diversification?<br />●red, ●blue, and ●yellow. <br />One color will be randomly picked as the winning color. You get to draw one ball out of a jug. <br />Since all colors are equally likely to win, does it matter what variety of colors are in your jug?<br />No. The winning color is drawn at random.<br />
  30. 30. Irrational diversification?<br />Since all colors are equally likely to win, does it matter what variety of colors are in your jug?<br />
  31. 31. Irrational diversification?<br />Since all colors are equally likely to win, does it matter what variety of colors are in your jug?<br />No.<br />
  32. 32. Irrational diversification?<br />Since all colors are equally likely to win, does it matter what variety of colors are in your jug?<br />No.<br />But wouldn’t you “feel” better if you had all the colors in your jug instead of just one?...<br />This feeling may be an example of irrational diversification bias<br />
  33. 33. Experiment<br />Either ●red, ●blue, or ●yellow will be randomly picked as the winning color. You get to draw one ball out of a jug. If you select the winning color you receive $30.<br />Your jug has three red balls. You can pay $1 to replace one red ball with another color. You can pay $2 to replace two red balls with a blue and a yellow. <br />●●●<br />●●●<br />●●●<br />
  34. 34. Experiment<br />Either ●red, ●blue, or ●yellow will be randomly picked as the winning color. You get to draw one ball out of a jug. <br />Since all colors are equally likely to win, does it matter what variety of colors are in your jug?<br />●●●<br />●●●<br />●●●<br />
  35. 35. Experiment<br />Either ●red, ●blue, or ●yellow will be randomly picked as the winning color. You get to draw one ball out of a jug. <br />Since all colors are equally likely to win, does it matter what variety of colors are in your jug?<br />●●●<br />●●●<br />No.<br />●●●<br />
  36. 36. Experiment<br />Either ●red, ●blue, or ●yellow will be randomly picked as the winning color. You get to draw one ball out of a jug. <br />You can pay $1 to replace one red ball with another color. You can pay $2 to replace two red balls with a blue and a yellow. <br />In trials of this experiment what percentage of people pay for this pointless diversification?<br />●●●<br />●●●<br />●●●<br />
  37. 37. Experiment<br />Either ●red, ●blue, or ●yellow will be randomly picked as the winning color. You get to draw one ball out of a jug. <br />In trials of this experiment what percentage of people pay for this pointless diversification?<br />●●●<br />39% paid $0<br />●●●<br />31% paid $1<br />61%<br />●●●<br />30% paid $2<br />K. Eliaz (Brown) & G. Frechette (NYU), 2008, “Don’t put all your eggs in one basket!”: An experimental study of false diversification. Brown University Economics Department Working Paper [XYZ replace colors] <br />
  38. 38. Irrational variety?<br />You are trying to guess the color outcomes of a roulette wheel spin where 60% of slots are red and 40% are black.<br />To maximize your payoff, what color should you pick?<br />
  39. 39. Irrational variety?<br />You are trying to guess the color outcomes of a roulette wheel spin where 60% of slots are red and 40% are black.<br />To maximize your payoff, what color should you pick?<br />Red<br />
  40. 40. Irrational variety?<br />You are trying to guess the color outcomes of a roulette wheel spin where 60% of slots are red and 40% are black.<br />To maximize your payoff, what color should you pick on the second spin?<br />
  41. 41. Irrational variety?<br />You are trying to guess the color outcomes of a roulette wheel spin where 60% of slots are red and 40% are black.<br />To maximize your payoff, what color should you pick on the second spin?<br />Red<br />
  42. 42. Irrational variety?<br />You are trying to guess the color outcomes of a roulette wheel spin where 60% of slots are red and 40% are black.<br />To maximize your payoff, what color should you pick on the third spin?<br />
  43. 43. Irrational variety?<br />You are trying to guess the color outcomes of a roulette wheel spin where 60% of slots are red and 40% are black.<br />To maximize your payoff, what color should you pick on the third spin?<br />Red<br />
  44. 44. Irrational variety?<br />You are trying to guess the first five color outcomes of a roulette wheel spin where 60% of slots are red and 40% are black.<br />To maximize your payoff, what five colors should you pick?<br />
  45. 45. Irrational variety?<br />You are trying to guess the first five color outcomes of a roulette wheel spin where 60% of slots are red and 40% are black.<br />To maximize your payoff, what five colors should you pick?<br />Red RedRedRedRed<br />
  46. 46. Irrational variety?<br />Let’s look at some experiments similar to guessing the color outcomes of a roulette wheel spin where 60% of slots are red and 40% are black.<br />Will people’s irrational love of diversification cause them to chose the lower probability (i.e., the black slots)?<br />
  47. 47. Cards Experiment<br />Five cards are chosen randomly from a deck of 100 colored cards: 36 Green, 25 Blue, 22 Yellow and 17 Brown.<br />Choose, in advance, the predicted color of the first five cards. You receive a prize for each correct prediction.<br />What is the best prediction?<br />A. Rubinstein (Princeton), 2002, Irrational diversification in multiple decision problems. European Economic Review, 46, 1369-1378.<br />
  48. 48. Cards Experiment<br />Five cards are chosen randomly from a deck of 100 colored cards: 36 Green, 25 Blue, 22 Yellow and 17 Brown.<br />What is the best prediction?<br />5 Greens<br />5 Blues<br />2 Greens, 1 Blue, 1 Yellow, 1 Brown<br />2 Greens, 2 Blues, 1 Yellow<br />3 Greens, 2 Blues<br />
  49. 49. Cards Experiment<br />Five cards are chosen randomly from a deck of 100 colored cards: 36 Green, 25 Blue, 22 Yellow and 17 Brown.<br />What is the best prediction?<br />5 Greens<br />5 Blues<br />2 Greens, 1 Blue, 1 Yellow, 1 Brown<br />2 Greens, 2 Blues, 1 Yellow<br />3 Greens, 2 Blues<br />
  50. 50. Cards Experiment<br />Five cards are chosen randomly from a deck of 100 colored cards: 36 Green, 25 Blue, 22 Yellow and 17 Brown.<br />Chose, in advance, the predicted color of the first five cards. You receive a prize for each correct prediction.<br />In a test of 74 college students, what percentage selected all greens?<br />
  51. 51. Cards Experiment<br />Five cards are chosen randomly from a deck of 100 colored cards: 36 Green, 25 Blue, 22 Yellow and 17 Brown.<br />Chose, in advance, the predicted color of the first five cards. You receive a prize for each correct prediction.<br />In a test of 74 college students, what percentage selected all greens?<br />38%<br />A. Rubinstein (Princeton), 2002, Irrational diversification in multiple decision problems. European Economic Review, 46, 1369-1378.<br />
  52. 52. Cards Experiment: Replication 1<br />Five cards are chosen randomly from a deck of 100 cards. The deck is composed of colored cards: 36 Green, 25 Blue, 22 Yellow and 17 Brown.<br />Chose, in advance, the predicted color of the first five cards. You receive a prize for each correct prediction.<br />In a replication test of 50 college students, what percentage selected all greens?<br />
  53. 53. Cards Experiment: Replication 1<br />Five cards are chosen randomly from a deck of 100 cards. The deck is composed of colored cards: 36 Green, 25 Blue, 22 Yellow and 17 Brown.<br />Chose, in advance, the predicted color of the first five cards. You receive a prize for each correct prediction.<br />In a replication test of 50 college students, what percentage selected all greens?<br />42%<br />A. Rubinstein (Princeton), 2002, Irrational diversification in multiple decision problems. European Economic Review, 46, 1369-1378.<br />
  54. 54. Cards Experiment<br />Five cards are chosen randomly from a deck of 100 cards. The deck is composed of colored cards: 36 Green, 25 Blue, 22 Yellow and 17 Brown.<br />Chose, in advance, the predicted color of the first five cards. You receive a prize for each correct prediction.<br />How many of each color did most of the other students select?<br />
  55. 55. Cards Experiment<br />Five cards are chosen randomly from a deck of 100 cards. The deck is composed of colored cards: 36 Green, 25 Blue, 22 Yellow and 17 Brown.<br />Chose, in advance, the predicted color of the first five cards. You receive a prize for each correct prediction.<br />How many of each color did most of the other students select?<br />2 Greens, 1 Blue, 1 Yellow, 1 Brown<br />A. Rubinstein (Princeton), 2002, Irrational diversification in multiple decision problems. European Economic Review, 46, 1369-1378.<br />
  56. 56. Cards Experiment<br />2 Greens, 1 Blue, 1 Yellow, 1 Brown<br />Is this an irrational preference for diversification?<br />
  57. 57. Cards Experiment: Replication 2<br />In a later replication test of 46 college students in intro to statistics, what percentage selected all greens?<br />
  58. 58. Cards Experiment: Replication 2<br />In a later replication test of 46 college students in intro to statistics, what percentage selected all greens?<br />15%<br />C. Kogler (U. Salzburg) & A. Kuhberger (U. Salzburg), 2007, Dual process theories: A key for understanding the diversification bias? Journal of Risk Uncertainty, 34, 145-154.<br />
  59. 59. Cards Experiment: Replication 2<br />In a later replication test of 46 college students in intro to statistics, what percentage selected 2 greens, 1 brown, 1 yellow, and 1 blue (maximum diversification)?<br />C. Kogler (U. Salzburg) & A. Kuhberger (U. Salzburg), 2007, Dual process theories: A key for understanding the diversification bias? Journal of Risk Uncertainty, 34, 145-154.<br />
  60. 60. Cards Experiment: Replication 2<br />In a later replication test of 46 college students in intro to statistics, what percentage selected 2 greens, 1 brown, 1 yellow, and 1 blue (maximum diversification)?<br />61%<br />C. Kogler (U. Salzburg) & A. Kuhberger (U. Salzburg), 2007, Dual process theories: A key for understanding the diversification bias? Journal of Risk Uncertainty, 34, 145-154.<br />
  61. 61. Cards Experiment: Dual-Self Replication<br />The professors believed that by intentionally engaging the “intentional, analytic, rational” side of the two-system self, they could improve these results. <br />Tested a second group after waking up this system by calling it a “statistical test” to find out “statistical competence” and encouraging students to do their best.<br />What happened?<br />C. Kogler (U. Salzburg) & A. Kuhberger (U. Salzburg), 2007, Dual process theories: A key for understanding the diversification bias? Journal of Risk Uncertainty, 34, 145-154.<br />
  62. 62. Cards Experiment: Dual-Self Replication<br />C. Kogler (U. Salzburg) & A. Kuhberger (U. Salzburg), 2007, Dual process theories: A key for understanding the diversification bias? Journal of Risk Uncertainty, 34, 145-154.<br />
  63. 63. Majors experiment: More irrational diversity?<br />Five students are selected from the university at random. Guess the major of each student. Each correct guess enters you in a drawing for a prize.<br />What is the best strategy?<br />
  64. 64. Majors experiment: More irrational diversity?<br />Five students are selected from the university at random. Guess the major of each student. Each correct guess enters you in a drawing for a prize.<br />What is the best strategy?<br />Guess the most likely major and then select that major five times.<br />
  65. 65. Majors experiment: More irrational diversity?<br />In a similar 1999 experiment with students in an economic game theory class, what percentage selected the same major for all five guesses?<br />
  66. 66. Majors experiment: More irrational diversity<br />In a similar 1999 experiment with students in an economic game theory class, what percentage selected the same major for all five guesses?<br />7%<br />A. Rubinstein (Princeton), 2002, Irrational diversification in multiple decision problems. European Economic Review, 46, 1369-1378.<br />
  67. 67. Mall experiment: More irrational diversity?<br />21%<br />You are a police officer trying to find a person. He is about to enter a mall through one of four gates. The share of people using each gate is as follows:<br />27%<br />20%<br />32%<br />You can assign only one officer to one gate based on the spin of a roulette wheel. Assign the spaces on the wheel: Blue: __% Green: __% Red: __% Yellow: __%<br />What is the correct answer?<br />
  68. 68. Mall experiment: More irrational diversity?<br />21%<br />You are a police officer trying to find a person. He is about to enter a mall through one of four gates. The share of people using each gate is as follows:<br />27%<br />20%<br />32%<br />You can assign only one officer to one gate based on the spin of a roulette wheel. Assign the spaces on the wheel: Blue: __% Green: __% Red: __% Yellow: __%<br />What is the correct answer?<br />100% to Red<br />
  69. 69. Mall experiment: More irrational diversity?<br />21%<br />You are a police officer trying to find a person. He is about to enter a mall through one of four gates. The share of people using each gate is as follows:<br />27%<br />20%<br />32%<br />You can assign only one officer to one gate based on the spin of a roulette wheel. Assign the spaces on the wheel: Blue: __% Green: __% Red: __% Yellow: __%<br />What percentage of students gave the right answer?<br />
  70. 70. Mall experiment: More irrational diversity?<br />21%<br />You are a police officer trying to find a person. He is about to enter a mall through one of four gates. The share of people using each gate is as follows:<br />27%<br />20%<br />32%<br />You can assign only one officer to one gate based on the spin of a roulette wheel. Assign the spaces on the wheel: Blue: __% Green: __% Red: __% Yellow: __%<br />What percentage of students gave the right answer?<br />33%. Everyone else diversified<br />A. Rubinstein (Princeton), 2002, Irrational diversification in multiple decision problems. European Economic Review, 46, 1369-1378.<br />
  71. 71. Diversification bias: The fear of focus<br />We hate losing options, even when they are bad ones. <br />We love diversification, even when it is pointless and costly.<br />We avoid focusing, even when it is the only correct choice.<br />But, controlling your decision environment means focusing your choices and sometimes eliminating future options.<br />
  72. 72. Slides by: <br />Russell James III, J.D., Ph.D., CFP®<br />Associate Professor <br />Division of Personal Financial Planning <br />Texas Tech University<br />russell.james@ttu.edu<br />Please use these slides! <br />If you think you might use anything here in a classroom, please CLICK HEREto let me know. Thanks!<br />The outline for this behavioral economics series is at <br />http://www.slideshare.net/rnja8c/outline-for-behavioral-economics-course-component <br />

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