Thinking Fast and Slow How Your Brain Thinks

When to Trust an Expert’s Intuition

  • Two things are needed here. 1) A regular environment and 2) an expert who has learned the regularities of the environment. In environments with little or no regularities like stock picking and politics, experts have knowledge but don’t trust their intuition when it comes to long-term forecasts.
  • Many people are overly optimistic in making forecasts as they neglect to use information available about similar cases. You need a properly chosen reference class to give a more reasonable ballpark. This is called a planning fallacy and the use of available statistics in called the outside view.

Advice for Capitalists

  • Although optimism is a good trait to have and leaders tend to be optimistic, misguided decisions often result from the hubris of optimism. We rely on only the information we have and neglect the surrounding uncertainty. On the other hand, extreme uncertainty can be paralyzing and it’s unacceptable to admit you are merely guessing. The main value of optimism is resilience in the face of setbacks.
  • Kahneman suggests a pre mortem prior to an important decision. This is where you gather people familiar with the decision to write a brief history of how the proposed plan could turn out to be a disaster. If the plan survives, it is more likely to be a good one.

Utility, Prospect, & Endowment Theories

  • Chapter 25 discusses utility theory. The main point here is that the happiness you experience is more a function of recent changes in your wealth or other circumstances than a function of any absolute reference. The person who doubles their money to $2 million is way happier than the person who loses half of their money and ends up at $2 million.
  • Chapter 26 takes on prospect theory. It adds the idea of the reference point which is the earlier state to which gains and losses are evaluated. As you get farther away from this point in either direction, you will become less sensitive for further change. People also tend to be more sensitive to losses than gains.
  • Chapter 27 introduces endowment theory. When dealing with goods held for exchange like money and goods commonly available, your average buying and selling prices are the same. When dealing with scarce goods like Super Bowl or concert tickets, the price you will pay for it is likely to be a lot less than the minimum price you will sell it for once you own it. People inexperienced with trading are more likely to experience this effect.

Bad is More Bad than Good is Good

  • Our brains are hard-wired to recognize bad news faster and respond more strongly to it than good news. Stable relationships need good interactions to outnumber bad ones by 5 to 1 or so. This explains why we are more driven to avoid loses than achieve gains. Animals and humans fight harder to hold what they have than they do to gain something new. This applies to labor negotiations and political reforms.
  • People who buy lottery tickets is an example of the possible effect where we overpay for a small chance to win. People also buy insurance, which is statistically overpriced because they want to be certain of something being protected against loss. This is an example of the certainty effect.

Rare Events and Taking Smart Risks

  • People will overestimate the probability of a rare event if they have heard about similar events recently. The way probabilities are presented impacts peoples’ estimation. Most think that 1 out of a 1,000 is more probable than 0.1%.
  • If you let your risk aversion take over you will reject a risk that is likely to produce a favorable outcome. If you accept enough such risks your chances of losing in the long run gradually approach zero. Your optimism bias protects you in the case of loss and the opposing risk aversion bias protects you from exaggerated optimism. Examples of risks you should take are taking the largest deductible when buying insurance and never buying extended warranties. In the long run you are likely to win on both bets.
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5 Responses to “Thinking Fast and Slow How Your Brain Thinks”

  1. Mark Thompson says:

    Correction: December 18, 2011

    A review on Nov. 27 about “Thinking, Fast and Slow” erroneously attributed a distinction to the book’s author, Daniel Kahneman, who won the Nobel in economic science in 2002. His being a psychologist was indeed unusual but did not make his award “unique in the history of the prize.” Another psychologist, Herbert A. Simon, won the award in 1978. (Simon, a polymath and interdisciplinarian, was also an economist, a political scientist and a sociologist.)

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  3. I read a review in the New York Times.

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