Behavioral Finance Endowment / Status Quo Feb 12, 2015 Behavioral Finance Economics 437

Behavioral Finance Endowment / Status Quo Feb 12, 2015 Readings for March 3, 2015 Exam Kahneman: Part I: Chapters 1 and 2 Part IV Choices: all Part II: Heuristics and Biases: all Burton-Shah: Chapters 1-5 Chapters 11, 10, 12 Plus All Articles on Syllabus up to March 3rd

Behavioral Finance Endowment / Status Quo Feb 12, 2015 Status Quo Effects Samuelson and Zeckhauser (1988) Subjects told: You inherit a large sum of money in cash. What to do, if choices are: moderate-risk company, high-risk company, treasury bills, municipal bonds Same as above except: A significant portion of your inheritance is not in cash, but instead is invested in a moderate-risk company (assuming no taxes or transaction costs) Second Experiment: new health care plans offered at Harvard (only new faculty accepted them – they were the default option for new faculty) Hartman, Doane and Woo A survey of California electric power consumers revealed two groups: those who felt they had very reliable service and those who had relatively unreliable service Each group was asked to state a preference among six combinations of service reliabilities and rates (with one combination described as the status quo) (highest reliability with full rates; lowest reliability 30 percent discount in rates) Results: Highest reliability group: 60.2 % favored status quo; 5.7% chose lowest reliability Lowest reliability group: 58.3 % favored status quo; 5.8% selected highest reliability

Behavioral Finance Endowment / Status Quo Feb 12, 2015 More on Status Quo TIAA-CREF Investment Patterns Two things Acceptance of the “default” option Unwilling to change the asset allocation over time. Whatever their original investment plan was, they stick to it unchanging through the years

Behavioral Finance Endowment / Status Quo Feb 12, 2015 Status Quo/Endowment Bias X Y t Commodity A Commodity B From position t, X and Y are indifferent From position X, X is preferred to Y From position Y, Y is preferred to X

Behavioral Finance Endowment / Status Quo Feb 12, 2015 Other Dying of thirst on the beach, friend says he will go get you a soda. Asks what is the max price you would pay for the soda. Two scenarios: Friend says he is going to roadside stand Friend says he is going to a nearby resort

Behavioral Finance Endowment / Status Quo Feb 12, 2015 Going to the concert Situation one: you buy a ticket for $ 200 and, on the way, you lose it. Do you buy another ticket and go anyway? Situation two: you don’t have a ticket, but plan on paying $ 200 for a ticket at the box office. Along the way, $ 200 falls out of your pocket and you lose it. Do you still buy a ticket and go anyway?

Behavioral Finance Endowment / Status Quo Feb 12, 2015 You enter a store to buy fancy coat and a pair of socks The coat costs $ 1,000 (but quietly the salesman tells you that across the street, you can buy the same coat for $ 994). Would you cross the street and buy the cheaper coat. You see that the socks cost $ 10, but the salesman tells you can buy the same socks for $ 5. Would you cross the street and buy the cheaper socks?

Behavioral Finance Endowment / Status Quo Feb 12, 2015 You enter a small town in middle America and Observe a quiet lady with glasses walking along the street reading a book. Is she: A librarian A farmer’s wife who spends half her day doing farm chores

Behavioral Finance Endowment / Status Quo Feb 12, 2015 The End