Paradox of loss aversion

...but it is interesting that, all of a sudden, baseball teams and football teams become, in general, more strategically correct when they have more on the line.
 

In the World Series, closer usage is a lot better, when you bring your best guy in in the eighth inning or the seventh inning. You see in the NFL teams will go for two more often in the playoffs, go for it on fourth down more often in the playoffs. Which is a hint that when the stakes are low, culture tends to prevail. When the stakes are high and the outcome of the game is all that matters, then things are different.
 

An answer from Nate Silver in a conversation with Tyler Cowen, emphasis mine. The context is sports, but this is a paradox that occurs in real life so often, especially in the business world.

[BTW, a conversation between those two should be self-recommending, but if it isn't, consider this a recommendation. Sports and politics (what's the difference, really?), New York real estate, food, travel...they cover all their favorite topics.]

So often, companies will try anything that what is the right move, just because it's culturally expedient. Pressure from shareholders, investors, employees, reporters, your current users, and the public at large prevent companies from doing the right thing until they're at death's door.

It may be uncomfortable to do something controversial when things are going well (why rock the boat?), but it's far more pleasant to make changes when you're still growing than when you've hit the shoulder of the S-curve and are starting to flatline.

Mathematically, you should never buy insurance in Blackjack, even if you are dealt a Blackjack yourself, but depending on how you've been running up until then, you might buy insurance, just to break a losing streak. When things are going bad, you might stop hitting on 16 or 12 even when the probability says you should, even though it's sub-optimal strategy.

So many times at Amazon we'd do things that the stock market would punish, but Bezos had enough control of the company and the conviction to ignore the cultural pressure and make the right long-term move. It's not surprising that some of the most successful technology companies today like Facebook, Amazon, and Google are able to shrug off external pressures. The founders have a controlling stake, of course, but also the will to enable their employees to play optimal strategy all the time, even if the risk of failure is higher.

Successful modern technology CEOs remind me some of studio executives in the 60's, many of whom, like Robert Evans, enabled directors to take creative risks. Now that most movie studios are public corporations, largely set up as financing vehicles, that type of movie is harder to get off the ground. The economics have changed, too, but the larger point is that leaders who understand that loss aversion is sub-optimal strategy need to create an environment in which the right types of failures are tolerated, even encouraged.

Loss aversion is most damaging, I suspect, when it's your current users who protest the loudest. If you're not willing to do your own customer segmentation, the market does it for you, and the largest segment is the the silent majority that choose not to use your product/service.

Especially for networks, analyzing the people who've tried and abandoned your service is just as important, if not more so, than rejoicing over those that have. The latter are of course critical to understanding your product-market fit, but the former are just as critical to assess when you're likely to hit the upper shoulder of the S-Curve.

The paradox of loss aversion is that so much of tech is winner-take-all, like tournament poker instead of a cash game, so loss aversion is often the strategy that leads directly to total loss.

The Witch

[MODERATE SPOILER ALERT: No major plot spoilers for The Witch below, but if you're a purist about these things, as I can be, feel free to skip this entry]

Early contender for most feminist movie I'll see all year is Robert Eggers The Witch. It's been mis-marketed a bit as a horror film, and given the huge box office returns of horror sensations like Paranormal Activity, it's not surprising that studios might try to run that playbook. The movie is less a pure horror film than one of oppressive dread, and those are far more disturbing.

A jump-scare-filled horror movie is heart-pounding for the time you're watching it in the theater, then is quickly forgotten. But a movie like Nicolas Roeg's Don't Look Now, one of my all-time favorites, laden with a feeling of inescapable doom, has been lodged in the deep recesses of my memory ever since I saw it, like a splinter that burrowed under my defensive psychic membrane. What is despair but the absence of hope? A movie of dread builds a world in which you see all the characters stumbling towards the cliff and it feels both believable and inevitable. The Witch is less a horror film than a tragedy.

The false advertising of The Witch is less worrisome as an aesthetic misrepresentation than it is as a marketing blunder. It may chase away people who don't like horror movies and disappoint those who come in expecting to be grasping popcorn by the sweaty palmful to soothe their nerves. It's no romantic comedy, some of the images are disturbing, but it's more of an arthouse horror film than you'd suspect from the trailer.

As with the most profound horror movies, The Witch locates true horror in ourselves, in Christianity and the deep-seated guilt it plants in every member of this family banished to live on the edge of a forest. A mother who doesn't feel like she is a supportive wife or adequate caretaker for her children. A father who, well-versed in the Bible but not with a hunting rifle, doesn't feel he can provide for his family. A son who feels shame whenever he glances at his sister's bosom with the first longings of puberty. And a daughter, played with remarkable emotional precision by Anya Taylor-Joy, who chafes against the limited options available for women in 1600's Puritan society.

The movie can be read many ways. It's also a story of a family evicted from the human construct of society but ill-equipped to conquer and tame nature, represented here in all its destructive power by the fairy tale trope of the dark forest and the titular witch who dwells there (played, in one scene, by Victoria's Secret super model Sarah Stephens, which we discovered much to our amusement from a look at IMDb).

The ending is controversial, and I have yet to decide where I come down on it. My initial reaction was that it was too much, that the movie should have ended earlier. I might have left it as an alternate ending for the DVD.

Still, one can understand why Eggers might want to take the movie all the way there, just to stir up some sympathy for the devil.

Trump vs. a Japanese whale

The story of Akio Kashiwagi, drawn from Trump’s memoirs and news accounts from the day, offers a revealing window into Trump’s instincts. It shows that Trump isn’t just a one-time casino owner—he’s also a gambler, prone to impulsive, even reckless action. In The Art of the Comeback, published in 1997, Trump explains that until he met Kashiwagi, he saw himself as an investor who dealt only in facts and reason. But his duel with the great whale in action made him realize “that I had become a gambler, something I never thought I was.”
 

Perhaps just as important, when gambling failed him, Trump didn't quit: He doubled down. But he did it shrewdly, summoning a RAND Corporation mathematician to devise a plan that would maximize his chance of fleecing his Japanese guest.
 

And it worked. Kind of. In Trump’s recollection, which he shared for this story, his showdown with Kashiwagi was another one of his many great wins. Just don’t look too hard at the ledger.
 

A bizarre and nutty tale of the time Donald Trump hired a RAND Corp mathematician to try to win back money a Japanese gambler took from one of his hotels in a hot night of Baccarat.

Before reading the piece, I thought perhaps they had changed the rules of the game somehow to raise the house edge. But no, they just changed the terms under which Kahiwagi to play, counting on the house edge to manifest over the long run.

Behind the trademark bluster, however, Trump grew more calculated. Having looked in the mirror and seen a gambler, he reverted to careful strategy. Trump consulted Jess Marcum, a mathematical probabilities expert who co-founded the Rand Corporation—a government-affiliated think tank then better known for modeling nuclear war with the Soviet Union—on how to maximize his odds in a second showdown with Kashiwagi. Marcum knew the only way to compensate for the house’s very slight baccarat advantage, of just over one percent, was to keep the game going for as long as possible. Time was on Trump’s side.
 

So Marcum and an Atlantic City casino insider named Al Glasgow prepared a report for Trump proposing a “freeze out” agreement. Under the deal, Kashiwagi would bring $12 million to the table and play until he had either doubled it—or lost everything. Even with huge bets, that would take a long time. Marcum simulated the match in detailed hand written notes. Kashiwagi might surge ahead early, he estimated, but after 75 hours at the table – far longer than he had stayed the first time - his chances of winning would fall to 15 percent. The key was to prevent a repeat of Kashiwagi’s first visit, when he had walked out while ahead.
 

Kashiwagi, presumably fuzzier on the probabilities, agreed to the terms. There was no legal way to hold him to such a deal but Trump felt the men were honor-bound. “Gamblers are honorable, in their own way—at least about gambling,” he later wrote.
 

The peculiar thing about Trump is that, as offended as I am but so many of the things he says, I'm not convinced he actually believes half the things he spews with such gusto. Yes, he's a politician, and they're always churning out rhetoric for reasons of positioning, but Trump exceeds even other politicians in his commitment to artifice.

Because of that, when he says something I disagree with, I'm more offended by the casual way he tosses around such damaging ideas than the ideas themselves, and when he says something I agree with—which is, admittedly, rare—I don't give him much credit.

He needs no exaggeration to be rendered a caricature, because he has done it himself, both figuratively and literally, like one of those figures in Pinocchio who becomes the physical embodiment of its own hubris. If you were a cartoonist on assignment to lampoon him, you could just snap a photo and collect a full day's pay.

Optimal pricing for bread and circuses

A survey (pdf) by Anthony Krautmann and David Berri has found that most fans in many popular sports pay less for their tickets than conventional economic theory would predict.
 

Which poses the question: are team owners therefore irrational?
 

Not necessarily. There are (at least?) four justifications for such apparent under-pricing.
 

Lots of things in the real world are underpriced. Most popular concerts and sporting contests lose some volume of revenue to aftermarket transactions on sites like StubHub and SeatGeek. It's nearly impossible to get a reservation at some of the most popular restaurants in San Francisco like State Bird Provisions. There's a waiting list for NOMA Sydney that's 27,000 people long.

If you were pricing to maximize revenue, to match supply and demand exactly, you'd boost prices or perhaps auction off all the seats. What would NOMA Sydney have to charge until its waiting list dropped to zero? I can't even begin toguess, but would it surprise you if it was well north of $2,000 a head for dinner?

Given all of that, I was curious to see what this author thought might explain football ticket underpricing.

The first argument is that underpricing tickets leaves more revenue to be gathered through ancillary sales like souvenirs or overpriced concessions. Without data, I'm skeptical. My instinct is that concession and souvenir sales are less elastic with ticket prices than hypothesized.

The second point is that it's better to have a full stadium for team morale and to influence the officiating. But again, you could sell tickets via a mechanism like a Dutch Auction and maximize revenue while still filling the stadium.

The other two arguments are more convincing.

Thirdly, higher ticket prices can have adverse compositional effects: they might price out younger and poorer fans but replace them with tourists – the sort who buy those half-and-half scarves and should, therefore be shot on sight. This increases uncertainty about longer-term revenues: a potentially life-long loyal young supporter is lost and a more fickle one is gained. It also diminishes home advantage: refs are more likely to give dodgy decisions in front of thousands of screaming Scousers than in front quiet Japanese tourists.
 

I went to a couple games at the old Chicago Stadium, during Jordan's early years with the Bulls, and that place was loud. When they moved to the United Center and the ticket prices went way up, the crowd felt different. More wealthy, and definitely not as loud. It could just be the acoustics of the new space, but anecdotally, I saw fewer fans standing and screaming. Also, the rise of the smartphone means more of the dead moments in a game are filled with people scrolling on their phones, quietly.

Fourthly, high ticket prices can make life harder for owners. They raise fans’ expectations: if you’re spending £50 to see a game you’ll expect better football than if you spend just £10: I suspect that a big reason why Arsene Wenger has been criticised so much in recent years is not so much that Arsenal’s performances have been poor but because high prices have raised expectations. 
 

It's hard to lower prices. Some sports teams may have done it at some point, but I've never seen it. You can raise prices when the team is good and on the rise, but those prices tend to stick when the team declines, and that's when stadiums start to empty out.

Saison is the restaurant in San Francisco that feels closest to pricing to match supply and demand. When I first moved to San Francisco, I had a meal there for $79. The next time there, the meal price had jumped over $100. Then the next time, it was up to $149. Later I heard the tasting menu had risen yet again to $248. The last time I went, thankfully on some banker's expense account, the price was $398 for dinner.

The dining room is usually full, but it's usually possible to get a table the same week. It feels like they've finally reached a price that about as close as you can get to where the supply and demand curves meet. Since the number of seats and turns is limited each night, perhaps this is revenue maximizing pricing, but the margin of error is razor thin.

My guess is that optimal pricing is somewhere below the price that matches supply and demand perfectly. Always being sold out adds a feeling of exclusivity, and no one knows how sold out you are, so being just sold out may be as good from a perception standpoint as being having a massive waiting list.

At the same time, I have a sneaking suspicion continuing to raise the price of a dinner would actually raise demand at some high end restaurants. There may be some Veblen-like qualities to restaurant pricing.

If the glove kinda fits, do not acquit?

So I wrote down the simplest model I could think of — a model too simple to give useful numerical cutoffs, but still a starting point — and I learned something surprising. Namely (at least in this very simple model), the harsher the prospective punishment, the laxer you should be about reasonable doubt. Or to say this another way: When the penalty is a year in jail, you should vote to convict only when the evidence is very strong. When the penalty is 50 years, you should vote to convict even when it’s pretty weak.
 

(The standard here for what you “should” do is this: When you lower your standards, you increase the chance that Mr. or Ms. Average will be convicted of a crime, and lower the chance that the same Mr. or Ms. Average will become a crime victim. The right standard is the one that balances those risks in the way that Mr. or Ms. Average finds the least distasteful.)
 

Here (I think) is what’s going on: A weak penalty has very little deterrent effect — so little that it’s not worth convicting an innocent person over. But a strong penalty can have such a large deterrent effect that it’s worth tolerating a lot of false convictions to get a few true ones.
 

Steven Landsburg lands on a counter-intuitive conclusion: you should lower your standards for conviction the harsher the punishment.

It seems as if Landsburg's model argues for convicting any number of people who surpass some lowered threshold of evidence for a crime. Several people all seem like they could have committed a crime, so convict all of them, even if only one could have committed the crime. Perhaps I'm misunderstanding the implications, others can help verify Landsburg's model.

Also, how often are there N people who all seem equally guilty of a crime? I'm at a disadvantage here in not having seen Making a Murderer, but perhaps Landsburg's model here applies equally as well to that case as it does to Serial Season 1.

Let's broaden the conversation and bring in Alex Tabarrok, discussing one area in which fellow economist Gary Becker may have been wrong.

Becker isn’t here to defend himself on the particulars of that evening but you can see the idea in his great paper, Crime and Punishment: An Economic Approach. In a famous section he argues that an optimal punishment system would combine a low probability of being punished with a high level of punishment if caught:
 

If the supply of offenses depended only on pf—offenders were risk neutral — a reduction in p “compensated” by an equal percentage increase in f would leave unchanged pf…
 

..an increased probability of conviction obviously absorbs public and private resources in the form of more policemen, judges, juries, and so forth. Consequently, a “compensated” reduction in this probability obviously reduces expenditures on combating crime, and, since the expected punishment is unchanged, there is no “obvious” offsetting increase in either the amount of damages or the cost of punishments. The result can easily be continuous political pressure to keep police and other expenditures relatively low and to compensate by meting out strong punishments to those convicted.
 

We have now tried that experiment and it didn’t work. Beginning in the 1980s we dramatically increased the punishment for crime in the United States but we did so more by increasing sentence length than by increasing the probability of being punished. In theory, this should have reduced crime, reduced the costs of crime control and led to fewer people in prison. In practice, crime rose and then fell mostly for reasons other than imprisonment. Most spectacularly, the experiment with greater punishment led to more spending on crime control and many more people in prison.
 

Why did the experiment fail? Longer sentences didn’t reduce crime as much as expected because criminals aren’t good at thinking about the future; criminal types have problems forecasting and they have difficulty regulating their emotions and controlling their impulses. In the heat of the moment, the threat of future punishment vanishes from the calculus of decision. Thus, rather than deterring (much) crime, longer sentences simply filled the prisons. As if that weren’t bad enough, by exposing more people to criminal peers and by making it increasingly difficult for felons to reintegrate into civil society, longer sentences increased recidivism.
 

It's a great post by Tabarrok. He does give Becker, one of my economics idols, credit.

Let’s give Becker and the rational choice theory its due. When Becker first wrote many criminologists were flat out denying that punishment deterred. As late as 1994, for example, the noted criminologist David Bayley could write:
 

The police do not prevent crime. This is one of the best kept secrets of modern life. Experts know it, the police know it, but the public does not know it. Yet the police pretend that they are society’s best defense against crime. This is a myth
 

Inspired by Becker, a large, credible, empirical literature–including my own work on police (and prisons)–has demonstrated that this is no myth, the police deter. Score one for rational choice theory. It’s a far cry, however, from police deter to twenty years in prison deters twice as much as ten years in prison. The rational choice theory was pushed beyond its limits and in so doing not only was punishment pushed too far we also lost sight of alternative policies that could reduce crime without the social disruption and injustice caused by mass incarceration.
 

The problem with annual reviews in companies is not necessarily with an annual review process but with lack of immediate feedback in between those reviews. The most useful thing I learned from the 10,000 hour rule wasn't that you needed 10,000 hours to become an expert, it was that people improve with deliberate practice if feedback on their work is immediate.

For effective parenting and coaching, shorten the time between performance and feedback, and be consistent.