Years before receiving the Nobel Prize in economics, Richard Thaler appeared on a cable news show where the host asked if he could offer any advice to viewers on how to become better investors.
“I said, ‘Switch to ESPN,’ and they switched to a commercial,” Thaler said with a smile. “I haven’t been invited back, which is perfect.”
The anecdote was one of many he shared during his October appearance at the Wharton School, hosted by the Behavior Change for Good Initiative (BCFG). Thaler spoke in front of a packed auditorium about his new book The Winner’s Curse: Behavioral Economics Anomalies, Then and Now. It’s an update to the 1991 version, which chipped away at the conventional economic theory that people always act rationally when making financial decisions. Thaler was joined on stage by Alex Imas, who is his co-author on the update to the 1991 classic and a professor of behavioral science, economics, and applied AI at the University of Chicago’s Booth School of Business.
Hailed as a founding father of behavioral economics, Thaler is a perfect match for BCFG, which conducts large-scale field studies to advance the science and practice of behavior change and unites an interdisciplinary team of over 180 scientists (including Thaler and Imas) to collaborate on its endeavors. BCFG faculty co-directors Katy Milkman and Angela Duckworth kicked off the program with prepared questions before turning over the mic to audience members.
“This version of the book is one that changed my life,” Milkman said, holding up her copy of the original. “I read it as a first-year graduate student. It’s the reason I became a behavioral scientist.”
“We often do things in the moment that we later regret.”— Richard Thaler
Thaler said the first edition was about to go out of print when the publisher asked if he wanted to “freshen it up.” That’s when he decided to dive a little deeper. He enlisted Imas to help reexamine the premise of each chapter. What was supposed to be a six-month project took five years, because after nearly 30 years, there was significantly more research on behavioral economics. And those decades of research prove that anomalies — decisions that are not strictly optimal — are robust and important.
“These anomalies not only have internal validity, they have external validity in the sense that they matter for economics,” Imas said. “And this is why behavioral economics has become such an important field.”
What Is the Winner’s Curse?
Thaler explained that the “winner’s curse” is the tendency for winning bidders in an auction to pay too much because they over-estimate the value of an item. The term was coined in the early 1970s by engineers at American oil company ARCO. They noticed that winning bidders for drilling rights were the ones who offered the most (of course). But because bidders are making a guess on the value of the drilling rights based on imperfect information, the highest offer was usually based on an overly optimistic guess of returns. So, winners typically lost money – they tended to overpay because to win meant to be the most bullish.
Imas said that as more people enter an auction, the more likely you are to have an extremely overly optimistic bidder win and, in the end, lose money.
“The winner’s curse is all about that fact that you’re competing against other people,” Imas said. “The update is about the idea that in a lot of these strategic situations when bidding or competing, the biggest bias people do not take into account is that other people are probably just as smart as you.”
The scholars cited many other examples of how human psychology influences decision-making in ways that aren’t optimal. Thaler recalled putting out a bowl of cashews at a dinner party. His guests — fellow economists — couldn’t stop eating them, and they thanked him when he took away the bowl. For economists, of course, this is very funny, because they would not expect to benefit from having an option hidden from them.
“We often do things in the moment that we later regret. They can be big or small. Economists assume we don’t have this problem, but we do,” Thaler said.
“The biggest bias people do not take into account is that other people are probably just as smart as you.”– Alex Imas
The scholars continued debunking some standard assumptions in economics, sharing insights about the utility function, risk aversion, and what is known as “the default effect.” An example of the latter is research that has found people are more likely to end up enrolled in a savings program if they are automatically enrolled rather than if they are required to opt in to participate, even though they have the freedom to choose whether they want to save in either case.
A giant in the field, Thaler has worked with famed psychology scholars Daniel Kahneman and Amos Tversky. His research has broadened the world’s understanding of behavioral economics and drawn a diverse cohort of recruits to the discipline. Yet for all his seriousness, Thaler is also quick to tell a joke.
“Here’s a bit of advice: Anytime you’re offered an extended warranty, say no,” he deadpanned to the audience. Later, when an audience member asked for investing advice, Thaler quipped: “Suppose you’re shopping for a condo and there’s a bidding war. Move on. You want to be a seller when there’s a bidding war, and you don’t want to be a buyer.”
His jokes reflected the imperfection of human behavior in making decisions — the anomalies he has written so much about. He and Imas said they are excited to see how behavioral economics will continue to grow as more scientists embrace ideas from the field and collect and analyze new data. In the meantime, Thaler offered one last piece of lighthearted advice for investors obsessed with watching the numbers. “Go back to watching football and not the stock ticker.”
Summary Questions
What is the “winner’s curse” in auctions?
Thaler explained that the “winner’s curse” is the tendency for winning bidders in an auction to pay too much because they over-estimate the value of an item. The term was coined in the early 1970s by engineers at American oil company ARCO.
How does having more people in an auction affect the winner’s curse?
Imas said that as more people enter an auction, the more likely you are to have an extremely overly optimistic bidder win and, in the end, lose money. “The winner’s curse is all about that fact that you’re competing against other people,” Imas said.
What does behavioral economics say about people making financial decisions?
It’s an update to the 1991 version, which chipped away at the conventional economic theory that people always act rationally when making financial decisions. And those decades of research prove that anomalies — decisions that are not strictly optimal — are robust and important.
The summary questions above were generated by AI and reviewed by Knowledge at Wharton staff.
