Behaviour guru Kahneman's embrace of the irrational enriched rational investors
₹150, say, and if it’s tails, you lose ₹100. Since either outcome is half likely, this punt’s pre-toss expectation value is ₹75 to be won and ₹50 lost—which should make us go for it. Yet, many of us would shrink from it because “losses loom larger than gains." So, while the ₹25 extra on the table is a rational prospect, it may still fail to cover the psychic pain of possibly losing ₹100.
And so long as folks behave this way, as studies have found they do, we had better look beyond economic models that make no leeway for evident human foibles. Losses are painful to any investor, of course, and pain does not always lend itself to clarity of thought. As Kahneman’s psychology experiments revealed, we tend to let our memory of pain dominate our actual experience of it, with the result that the patchy imprint left by its peak and most recent sensation matters above all else.
In his ‘cold hand’ experiment, subjects were asked to immerse one hand in a tub of painfully cold water at 14° Celsius for 60 seconds. This was Option A. Of course, they could pull their hands out if the chill got unbearable and were given warm towels at the end.
After a break, they were asked to dunk their other hand in similarly chilled water for 60 seconds in an identical ordeal, except that it was followed by 30 more seconds of immersion, this time with warm water slowly flowing into the tub, raising its temperature by 1° Celsius by the time the hand was withdrawn. This 90-second trial was Option B. After another break, all hand-dunkers were asked which episode they would repeat if they had to choose between A and B.
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