Advancing Behavioral Economics with Colin Camerer

28:59So the left side makes stuff up. Confabulates an explanation for why they're waved. Exactly. It's like the publicist for, you know, a very guilty person. And or Mike Gazzaniga calls it the interpreter. So the interpreter says, I don't really know why. So I'll kind of make give a plausible answer. And they'll say something like, oh, I saw somebody I knew walking by out the window outside. So that's an example of where we know what the brain saw and why the wave occurred, but the left part of the brain doesn't know. That's really fascinating. Let's stay with the idea of tracking eye movement. So you could do this with glasses.

29:39You can do this with a computer. When you're tracking eye movement, asking people about, hey, would you purchase this product? How big of a tell is it when they look at the price? And is it something they just kind of glance at? Or is it a repeated and obvious they're focusing on the cost? Yeah, there's sort of two interesting markers. Number one, it's not that big of a tell. So if we try to predict whether they're going to actually buy something, we might get, say, 42 % right. And with the eye tracking data, it might get up to like 54%, you know. So as academics, we think that's kind of a modest effect size.

30:18If you're running a business and you want a 2 % lift and purchase, maybe a billion dollars, right? So sometimes we're a little cautious as academics about, is this a big deal or not? Whereas some of these things, the same in the world of nudges and so on, sometimes a small, you know, a half percent increase in get out the vote. If we could do that, you know, scientifically may well decide an election, right? Anyway, so the lift is not that big, but the two tells are basically looking at the price and the other is refixation. Which basically means not just looking once, but going back and forth.

30:52You know, it's the rapid brain equivalent on a one or two second basis of, say, a couple who's shopping for a house going to look at a second time and a third time. You know, the repeated looking. Right. Usually good signal. Exactly. Tells you they're serious. Huh. That's really interesting. So give us some examples of what the studies or the experiments look like when you're doing eye tracking. What are you trying to – what parts of the brain are you looking at or is it just the eye tracking? Is this by itself or can you combine this with other types of neuroeconomics? Yeah. So actually the eye trackers we use, which are commercially made for science basically and sometimes for clinical use, they use cameras to look at where the eye is looking.

31:41They sync that up with where on the computer screen you're looking. and so besides the location of where the eyes are looking you also measure pupil dilation and pupil dilation turns out to be you know the eyes that went into the soul so that the pupils actually generate a lot of information although it's it's crude what the pupil dilation is telling you is about cognitive difficulty am i having a hard time thinking about this and arousal which again may be negative or positive it's like so wide pupil is your aroused tight pupil is you're having a hard time exactly exactly and so um i think if you trained yourself and maybe depending on the the color of the eyes you might be able to tell like a poker player might be able to train themselves with a to notice pupil dilation but just in case that's why poker players often will wear glasses sunglasses yeah there's sunglasses right because the idea is if you look at your cards and you have two aces, your pupil will dilate.

32:42And it might be hard to see with the naked eye, but the machines we use can definitely see it. That would be a big jump, a big tell. And so we're able to use pupil dilation and eye tracking to judge things like cognitive difficulty. A lot of the early studies actually were used in game theory, because in game theory, the assumption is if I might want to see what my opponent's payoff is in order to decide what they're going to do. And if you ask people, what are you looking at on this computer screen? You know, there's a four by four matrix of numbers, and I'm trying to think of what you're going to do.

33:15There's a lot to look at. And if you ask people for a self-report, they're not going to tell you exactly what their eyes are doing the whole time. They're probably looking at 42 different things, sometimes very quickly. Sometimes they're going back and looking again and again and again. They just don't have conscious access to that process the way that the eye tracking does. So that's really fascinating that speaking to the brain but not the person gives you a whole lot more insight into the decision-making process. Speaking generally, what does this tell us about people as rational, profit-seeking actors in the world of finance and investing?

33:57I think it's useful to think about, say, young, naive investors, or they didn't mean to be young, but people with less knowledge about the markets and people who've spent a lot more time thinking about estimating fundamentals, reading 10Ks, you know, having years of trading experience. Because another important fact, which we try to keep track of in behavioral economics, is that a lot of decisions and structures people have to make are not things that we're necessarily evolved to be particularly good at. But people are also extremely good at learning and able to collect memories and distill things into knowledge.

34:39So let me turn to the concept of price bubbles, because I think that's a useful one. So we have a couple of one fMRI study on price bubbles, and we have some new stuff that includes skin conductors measurement to see if, you know, can you kind of predict when a crash is coming from people's hands, you know, reflecting nervousness. It looks like we can predict a little but not great. You know, that's a high mountain to climb. What we found in our first fMRI study about bubbles was people trade an artificial asset. So we know the fundamental value of the asset, which we never know in natural markets.

35:13And the price is completely what they agree upon. So typically what happens is the fundamental value is a number that we control, which happens to be 14. And so the value of the asset comes from the fact that if you hold at the end of a period of trading, you get a dividend. Or you can invest currency in risk-free bonds. And so the trade-off between the risk-free earnings and the value of the dividends establishes an equilibrium price. It's a very simple equation. And typically, the price starts around$14 ,000 and goes up to maybe$20 ,000 or$30 ,000 and then crashes. And then in order to bring the experiments to a close, we have them trade for 50 periods or 30 periods.

35:55And at the end, they were able to cash the assets out at$14 ,000. So what would you pay for an asset that you'll get$14 ,000 for? Correct. After a series of dividends, 30 or 50 trading periods in the future. And so put yourselves in the mindset of somebody who in period 31, the price is 60. Right. And you kind of know that in period 50, 19 periods from now, it's going to be 14. Sell. Well, unless you think it's going to go up to 75. Right. Right. So it's true. And in fact, that's very helpful for me. So what we found from the brain was that there was two interesting signals. I'll start with the more interesting one.

36:33The other one's a little more obvious. The interesting signal is people who sold before the bubble crash, which was the smart thing to do. And again, the bubble crash is not announced. It's something you only see historically looking back in the rearview mirror. Same in natural markets. Exactly. Just like in natural markets. Right. Bubbles are only shown in hindsight. Gene Fama has written a lot about this. It's one reason he's skeptical that we should even talk about bubbles, you know, as a scientific phenomenon. Okay. I think he goes too far with that. But anyway. Anyway, yeah, you know what I mean.

37:04So it turns out the people who are more likely to sell when the price is at 60 and we know it's going to crash, but we're not sure when, have heightened activity in insular cortex, which is another region that's involved in emotion and interoception. So interoception means knowing what's going on on the inside of your own body, like a self-awareness. Exactly. So perception is the outside world. Interoception is the brain's, like the body's ambassadorship to the brain, you know, knowing if I'm nervous or, and it's often activated by, particularly by negative emotions. So if you see something disgusting, insula.

37:40If you, if you choke a person a little bit or you, you know, you cut off the oxygen, not so it's dangerous, but just to make them uncomfortable, insula. financial uncertainty insula and so we think of the insula is the early warning signal that there's going to be a crash and the other interesting brain region is is nucleus accumbens which is basically a reward center in what's called stratum part of basal ganglia in the very center of the brain and that's active in the people who are fueling the bubble like when the bubbles you know forming the people who have the highest nucleus accumbens activity by the most.

38:16So you have a run of traders participating in this, and you could tell by the brain activity who's contributing to the bubble and who's saying, this is getting crazy. I want to take my chips off the table. Now, number one, we can't tell with exquisite precision. You can sort of see these groups, and we're only looking at this ex post. So I think it's conceivable, but challenging to do this in real time you know so there's you're watching the market unfold you're doing real time fmi measurement that can be done um and and it's like okay traders seven nine and eleven you know we think they're probably going to sell they're the skeptics they're the the bulls and 14 17 and 21 their nucleus that comes activity seems they're really all in they're going to be forming the bubble and so on and so on i mean we're we're a few steps away from being able to do it.

39:04But we see these as what we call proofs of concept. Like it can be done. It may take a few million dollars if any donors are listening. But it makes perfect sense that - That is possible. Different parts of the brain are responding to different inputs. And it's consistent with what we've observed amongst just various investors and traders. There are people in the latter stages of market, they think it's just going to keep going forever and they pile in. And the flip side of that, if there are people, the famous irrational exuberance speech by Alan Greenspan, in 1996, you still had a ton of gains until the March 2000 top.

39:51So some people, I'm just curious what drives that. Now that you know what to look for and how to measure it in traders in real time, what do you think is the underlying drivers of whether a person is going to be participating in one tribe or the other? That's a great question. I'll say a little tiny bit more about that. You mentioned the term irrational exuberance, which was coined, as I recall, by Bob Schiller in his book about. I think it was from the irrational exuberance speech. Schiller may have helped Greenspan with that speech, if I'm remembering, because I've seen Yeah. I've seen both, whether it was Schiller's phrase or Greenspan's.

40:34It may be, you know, it's kind of a combination. Yeah. You know, some apocryphal, you know, we're not sure exactly who said it first, but certainly there was a kind of meeting of the minds that this was useful. And in fact, when we didn't we use the phrase in our paper, but we didn't put it in the title. It just seemed a little too unscientific. It's OK for USA Today or something. But this is the proceedings of the National Academy of Sciences, you know. And but we think of this nucleus accumbens activity. That's that's the measure of irrational exuberance. And the irrational part is, you know, when it's too high, you're going to end up paying a high price for something that crashes fast.

41:10So the rational is really in there, literally. But yeah, and also when I present this in academic seminars and later today I'm meeting some Caltech people, we talk about this famous saying from Warren Buffett, I believe, when people are afraid, be greedy. When people are greedy, be afraid. and in these brain areas like insula is similar to fear and greed and nucleus accumbens. It's about as close you're going to get to brain areas matching what Warren Buffett had to say, which was such a wise thought. So you really kind of answered the question I was about to ask, which is, why has behavioral economics been so successful describing decision-making where traditional economics seems to have faltered?

41:56But what you're really saying is we don't know what's going on in our brain when we're making decisions as individuals. And when you look underneath the hood, it turns out there's a lot more things happening than at least classical economics seems to imply. Yes, exactly. Exactly. And also, this isn't something we've carefully researched, but I think it's a good speculation for your audience, which is like when I was going to Chicago in the late 70s, all of my graduate student friends were also kind of critics. of nobody liked behavioral economics at that time oh really oh yeah it was um you know people said things like i think you know i'm worried you might be ruining your career because you switched out of finance and um well and what it was was there was a series of of critical questions which were but if people make all these mistakes couldn't someone profit from you know arbitrage or selling them crappy goods like well it seems like that may happen you know or if people make these mistakes Don't they learn over time not to make mistakes?

42:58That may also happen. It may be that there's a sucker born every minute, but there's a generational process. And markets are always filled with some combination of new investors or sovereign funds of people who aren't very savvy about markets or something like that. So early in the history of behavioral economics, there was really a lot of hostility about it. And then we gradually – one thing about Chicago and the economics profession in general is data do win arguments. So ideology will often persist. Like for Gene Fama, for example, he'll always be skeptical about behavioral finance for his own reasons and their ideas, but eventually data went in arguments.

43:40And there were just so many anomalies and ways in which investors were making mistakes. And it wasn't just small investors who were refinancing their mortgage mistakenly. It was some of these implicit things may be very big. Like a venture capitalist joked about how, well, I think of Mark Zuckerberg in a hoodie. And that's kind of my template for a good founder to invest tens of millions of dollars. Right, right. That's not as sophisticated. That's not home economicus. That's big economics. I recall reading one of the papers Bob Schiller wrote was looking at dividend yield and saying, if markets are fully pricing in all data, why does this dividend yield swing around so much?

44:23It should be much more consistent than this. Correct. But apparently it's not. I was very amused by Fama and Schiller being awarded the Nobel together. It's almost as if the committee said, look, markets are kind of efficient, except when they go crazy. You two guys work it out. Yes. Yeah, it was quite a, it was kind of a charming and I think sensible award for that reason. And the, you know, the journalist said like, well, is there, you know, one person says A is true. One says A is not always true. Like, how could you give that award? The answer is they both made a lot of progress, you know, in different ways.

45:02Let's talk about some of the other ways that we can look inside. Are we looking at things like adrenaline or dopamine or any of the sort of hormones that seem to affect our behavior when we're trying to analyze decision making? Yeah. So actually, that's a very good question, Barry. Neuroeconomics uses a lot of different methods. The fMRI is sort of like, you know, the movie star in a family with four sisters, you know, the glamorous one that everyone pays attention to, but it's actually high maintenance. But all the other siblings are kind of contributing in some interesting way. So pharmacology is something people are really interested in.

45:41Meaning specifically pharmacology, drugs that are in your system or hormones? So pharmacology is drugs. But some of those, for example, L-Dopa will actually ramp up dopamine levels. And you can see if some interesting things happen. L-Dopa is a drug you can consume? Correct. In order to raise your dopamine levels? Exactly. So L-dopa is basically administered to Parkinson's patients have a degradation of dopamine. And so to kind of ramp them up to normal levels, L-dopa is often used in treatment. Pharmacology is one. What are some of the other four systems? So we do look at neurotransmitters like oxytocin.

46:18Arginine vasopressin is one that we've studied. Oxytocin sounds a lot like Oxycontin. Any overlap? No, exactly. So oxytocin is sometimes called like an affiliation hormone. So, for example, if you get a really pleasurable massage, you might feel a surge of oxytocin. When my wife was giving birth, to induce labor, they often give somebody synthetic oxytocin. And oxytocin is also produced after birth and when the mom is first coming to the baby and probably the dad, although maybe less. you know it's this very pleasurable thing that makes you want to like hug somebody and feel feel affiliated affiliated as the sort of bio term so there's a bunch of studies on oxidosis yesterday and that improved trust but there's a cautionary tale which is we me and some colleagues went back and looked at those carefully and it seems that giving people artificial giving people oxytocin for a modest dose and then seeing what happens you know an hour later it improves trust a little bit, but it's scientifically very, very tricky.

47:28And some of the standard results, if you do the same exact experiment over again, you just don't always get the same result. So we don't know how sturdy oxytocin is. What are some of the other chemicals you mentioned, neurotransmitters? So when we studied, I'll say a little bit, it was arginine vasopressin. And so that's another hormone which is similar to oxytocin. And that when animals are bonding in groups, this Argonine vasopressin sort of, you know, you'll get a surge and it shows that. So when you say bonding in groups, I'm thinking of a wolf pack or a hyena pack where they're cooperative species that work together and there are chemicals that contribute to that.

48:08Is that what we're suggesting? So part of me wants to say we're just meat sacks operating obliviously to what's going on underneath our skin, where we think it's free will, but it sounds like there's a lot of things happening below the surface that's really influencing our decision making. Yeah. Oh, absolutely. I mean, think about things like breathing. You know, breathing is so automatic. And when we stop and do sort of breath work and try to think about it, like Navy SEALs might have a breathing exercise to calm down before a terrifying thing they have to take. You know, it actually takes a lot of executive function to think about breathing because we never have to.

48:47Because it's automated. It's because it's so automated. So the fact that it actually grabs a lot of attention is because the automation is we've completely flipped back in the opposite situation. Let me tell you an organized vasopressin study we did. So there's a game similar to Prison Dilemma, but not the same, called the stag hunt game. And the idea is two people decide to show up in the morning and hunt for a stag. It's a very old fashioned name from the Jean-Jacques Rousseau in the 1600s. We're talking about a male elk or deer? Yeah, an elk or deer. Yeah. The point of the stag is it's so big that one person can't catch themselves.

49:22One person has to spot and the other to shoot or something like that. Or they cannot show up in the morning at the appointed spot and just hunt for rabbits on their own. And so the structure of the game, when we do it with money or reward with animals, is you get one point if you just go for rabbit. if you both hunt for stag you get two if you hunt for stag but if you show up by yourself prepared to hunt for stag you can't catch any you get zero and so the choosing a rabbit is choosing one and not helping your friend both showing up for stag is better for the both of them but they have to somehow coordinate that activity and so what we found was when you give people this avp and it's a crossover design which means sometimes they get avp and sometimes they get a placebo because there's a well-known placebo effect where if they think maybe they got the AVP, it might subconsciously affect the behavior.

50:17So we always control for placebo effects, just like in drug trials, the same thing, very routine. When you give them AVP, they're more likely to choose STAG, which is the socially risky and beneficial thing. It generates this willingness to join the group in a way that's going to help everybody if another and if no people join um and the the other thing that was really nice in this paper was um we we also used fmri so we had two groups of people with administering avp one group was scanned and one was not scanned which is just to see like to replicate do you get the same behavioral thing if they're not you know boom boom boom in the scanner and in the scanner you see activity in globus pallidus which is known to be it's a small region it's not one of the more familiar areas that show up a lot over and over in our economics, like basal ganglia, amygdala, unsula, PFC.

51:10But you do see activity in globus pallidus when people under AVP are choosing stag. So it looks like the AVP is sort of promoting the stag choice. But when we see people working cooperatively, you see a similar neurotransmitter as you do in the pack animals. Exactly. And it's causal, right? So these are a group of people, and sometimes they just get this drug. And it makes them want to cooperate. And it makes them want to cooperate in a way that's risky, but benefits the group. But we sometimes think of it, it overcomes their inhibition to be, well, I don't know if you're going to choose stag, and I don't know if you're going to show up.

51:50Well, the prisoner's dilemma is you're always better off throwing the other person under the bus. This is not that. And this is the opposite. Because here, if the other person helps out, you want to help out, too. Right. It's the best response. So it's different structurally than the prisoner's dilemma. So I keep coming back every time I read a new anything about behavioral finance, neuroeconomics, anything about this. I can't help but come back to the conclusion that all of our evolutionary biology has led us to a state where we're so well adapted to adjusting to changes in the natural world.

52:29and all of those things that have developed over the millennia really don't help us in the modern world. If anything, certainly in investing, it seems to be pretty problematic. Yeah, exactly. In fact, that's called the evolutionary mismatch hypothesis. Oh, really? I didn't know it had a name. Yes, exactly. So tell us about - We can call it the Ritholtz hypothesis. If only. So this mismatch is simply, we evolved to adapt on the savanna, and that doesn't help us figure out which bonds to buy? Is it that simple? Exactly, exactly. So another way to think of it is institutions, sometimes it's families, it's political advertisement, it might be fine print about fees in a financial advertisement.

53:14Those are all things that are kind of tricking or exploiting vulnerabilities in our basic ancestral biology. Now, again, people are smart too. So there is adaptation and kind of plasticity. So over a lifetime, you might or maybe in one MBA course or even possibly a high school course, you might learn some principles of basic finance that really help you avoid dumb mistakes. You know, like compound interest really compounds quickly. You know, the caveman brain thinks compounding quickly. I have no idea what that means. My brain can't imagine that if I invested in the S &P$1 ,000 40 years ago, how much I'd have.

53:54You know, I can't compute that number. Right. Well, we live in an arithmetic world. Exponential numbers are hard to comprehend. The brain is mostly linearizing things. Right. And if they're not linear or they're dramatically nonlinear, like pandemic compound interest, we can learn to overcome it, but we need these kind of external tools. It's almost like exoskeleton, you know, whether it's education, advisors, and so on. So let's talk a little bit about risk aversion, which has been this behavioral finance concept. People dislike losses twice as much as they enjoy gains. What does the world of neuroeconomics say about loss aversion?

54:35I've seen a few mathematicians claim, oh, it's just a statistical anomaly. I remain unconvinced that that's the case. Yeah. So actually, I know a lot about loss aversion. We published a meta-analysis last year about— There's a reason I'm asking you this question. It's not out of left field. Right. You came to the right place. So in the meta-analysis, we looked at hundreds of studies, basically every study we could find, you know, using informatics. And nowadays you can really do this. It's like industrial fishing. You know, you throw this net out and you get 4 ,000 studies, then you winnow it down to the ones that are really just all trying to measure the same thing so you can add them up.

55:14There was something like 370 estimates of lambda, which is the Greek symbol that means the ratio of the disutility of loss to gain. And as you mentioned, two is sort of a, we think it's a little bit It's smaller, like 1.7. But, you know, it's comparable. Yeah, it's comparable. And it's not one, which would be the case in which you're not distinguishing loss and gain at all. You know, they're just like one scale. So the evidence is pretty good. Some other fun facts about loss aversion, which is you might think that loss aversion is some kind of handicap. But actually, we published a paper with two people who have brain damage and bilateral amygdala, which means neither part of the amygdala can compensate for the other.

55:58It's a very unusual disease. It comes from an Urbagvita disease, and they basically – the amygdala is kind of like calcified. So it's there, but it's like deep freeze. It just doesn't work. So these people lose the ability to have these emotional responses to stimulus. Correct. Correct. Correct. and a lot has been known about because they've been studied one of my colleagues ralph adolph has studied um several of them for years and they um you know they come back every so often and do a different kind of task and um so let me guess they're pretty good traders generally they're in disability because uh-huh the amygdala damage is enough to make they basically take too much risk in a lot of areas of life um so so they're risk embracing not risk averse exactly So the idea that risk and fear are there to kind of protect you applies to them.

56:49Like when you remove that, like one of the patients, SM, makes a lot of poor choices. Give us examples. Well, the example I recall, I hope I'm not getting that my memory is not mangling it too badly, is she went on some kind of a date and the person was very sexually aggressive and she ended up okay. And then somebody said, well, would you want to go out with that person again? She said, yeah, yeah, it was fine. It was fine. She just didn't have this trauma. The amygdala was not processing. This is really bad. Run away, run away, avoid, avoid. So how does this manifest itself amongst investors making risk decisions if their ability to process threats, process fear isn't present?

57:33What happens with those sort of decisions? Well, so for these two patients with amygdala damage, they have no loss aversion. None whatsoever. None. So aggressive traders and investors. Well, yeah. So the way we measure is we give them these simple financial risks. Like you could win, most people, if you say you could win 10, but you might lose 8 or might lose 7, they're kind of just indifferent. Because a loss of 7 and a gain of 10 or 1.5. If I could do that on a billion dollars, I'd love to do that. But these two, so damage to the amygdala, no more loss aversion. So that's partly a reminder that be careful what you wish for.

58:12Right. Like you don't want to react emotionally to everything. Correct. Right. The reason it's so hard to do what Warren Buffett says is when everybody's clamoring to buy, most people get caught up in that enthusiasm. We're social primates. And when the group is screaming buy, buy, buy, it's very hard to go the other direction. And then at the bottom, when everybody is selling, the fear is palpable. The fear is almost contagious. Yeah, very much so. Right. Yeah, yeah, yeah. So you lose that risk aversion. Do you have the ability to just go opposite the crowd because you don't care? It could be.

58:52I mean, I've. I have a feeling successful traders, it's not that they're not loss-averse, but they manage to inhibit it somehow. Or we did a study in this, but I don't think the details are all that interesting for your readers. Or they're able to do what we call bracketing or kind of portfolio view, which is to say you have bad days and good days. And at the end, it's my P &L at the end of the month or at the end of the year or the end of the quarter and manage to kind of shrug off a loss. Now, I don't think that's that easy to do if you have intact amygdala. Right. Right. So it's almost it leads into another interesting topic which we've studied a little bit called emotion regulation, which is the fact that a lot of our emotions are sort of involuntary.

59:38You know, if there's a loud boom, you and I are both going to have this fear reaction. You know, hair will stand up, we'll freeze. But you can also learn to regulate emotions. I mean, kids are learning that when they learn to, you know, not be too afraid on the first day of school. As people get older, they learn to regulate emotions. It's a pretty important skill. And so I think successful trading is probably some kind of cocktail of either a little less natural loss aversion, but not too little. Right. Because you don't want to like going crazy. You don't want them to be immune to loss, just like you don't want your hand to be immune to pain.

1:00:16Right. Because you're going to lean on a hot stove one day and not notice that your hand is on fire. Right. So a good trader probably has a little less natural loss aversion. And then a really good ability to emotionally regulate when too much loss is acceptable or getting you into trouble. So the emotional regulation aspect is really interesting. I'm going to push you a little outside of your normal, I think, of your normal research area. One of the interesting comments that have come up when discussing who's a great fund manager, who's a great trader, who are these folks that have put together these really impressive track records, a surprising number of neuroatypical folks.

1:01:04Oh, yeah. The reason I asked you this is, it seems like not only is there a little bit of ability to manage the emotions, but there's that ability to step outside of the crowd and say, I don't care what the rest of the primates are doing here in March 2009. Stocks look really attractive, and I want to be a buyer, even though everybody else is selling. Is there an aspect of that to those sorts of trends? Yeah, I think that's a fantastic topic. In fact, it is close to something. Oh, it is. All right, good. We've been thinking about. So one thing is, I was going to mention from before. So one of the striking things, I was working on a neuroeconomics book, and I was reading a lot of papers on social conformity.

1:01:46It turns out that almost every study finds the typical paradigm is something very stylized and simple, like, you know, you see a face and three other people see the same face. And you're asked to say, is this person friendly or unfriendly? And in the conformity case, the other three people say friendly and some other subject, the other three say unfriendly. And people, people, there seems to be reward activity when you conform to the group. Right. And these are not, we're not super stress testing. So we're not quite something like, you know, you're in the depth of a crash, 2008 crash, and everyone's selling.

1:02:24And, you know, ethically, it's hard for us to generate that dramatic event in the lab. But but even for these mild effects and a lot of these people, if you ask them, do you follow the crowd? They would say, no, no, no, I kind of go my own way. Like if a bunch of people said someone is friendly and you weren't sure if you thought they weren't friendly, would you disagree? Yeah, yeah, yeah, I wouldn't bother me. But study after study after study shows there's generally reward value from conformity, which is essentially just the the modern evidence for what you were talking about, which is that part of being a social animal.

1:02:54Right. The evolution of cooperation has been very successful for us. And it's hard to fight the crowd. It did its job. Yeah, exactly. So I thought that was quite striking. Again, if you wanted to study anti-authoritarian personality, it might be a way to get into that. There may be people who are almost pathologically. But let's get back to your point about neurotypical people. So we're actually working on it, beginning a study on autism. So autism is called a spectrum disorder, which basically means it's not like you have it or you don't, like schizophrenia. So statistically, it doesn't look like two humps.

1:03:32Right. You have a little, you could have some, you could have more, you can have a lot. Correct. Correct. And there's often differences of symptoms. Extreme autism often involves catatonia and severe language deficits and what have you. And so when people often think about Asperger's syndrome, which is something that's called high-functioning autism, Right. Which is basically you just socially awkward and hard to understand what people do. But a lot of these pathologies or disorders, I should say pathology is not the right word. A lot of these disorders are accompanied by some enhancement. so for example asperger's patients have are more likely to have perfect pitch for a sound they are better at ignoring some costs which is a classic behavioral economics right you know i spent so much on this dessert i you know i came to new york as 18 dollars for some flower you know flowerless cake i have to finish it right the autism money is spent whether you get the calories or not so the autists have the right idea right um and there is a sweet spot i'm going to get you a list of the people who I know in this field who have put up impressive numbers and have either stated they're on the spectrum or it's kind of obvious.

1:04:47Hey, yeah, yeah, yeah. You could look at video or written statements and, you know, machine learn them and say this person talks or looks. I'll ask on Twitter who's on the autism spectrum in the world of finance and has a good track record but i have like two dozen names in my head i'll give you a name i would unfortunately he just died not too long ago charlie munger so i got to meet charlie a few times right and he doesn't strike me as a very spectrumy well but one marker of autism is is like poor conversational turn taking you know and so when i the times i met charlie just twice and if you see him at the the berkshire hathaway i mean he's amazing i think it was like the mark twain of finance for sure you Because he was really witty.

1:05:34But also, there was always a really deep psychological insight in there. It wasn't just funny. It was funny and true. And often something other people didn't want to say. But when I met him, he was just like a freight train. And so you had to interrupt. And I realized the goal is to not have a conversation. You're just going to move the train in different directions. Just nudge him in different directions. Right. Exactly. Well, you know, that reminds me of X. Boom. And then he's off discussing X. I never realized that about him. So you're saying that's my non-clinical. I am not a clinician, but, you know, disclaimer, part of it is reflected in why he was successful.

1:06:09You know, he he saw himself as an average person who wasn't making the dumb mistakes other people make. But some of those dumb mistake people make, you know, he may have not made them because he doesn't get caught up in social conformity or because he's very focused on he has good metacognition. Like if I don't I don't buy a company, I don't understand. Right. You know, that's probably a good strategy. So I'm working on a new book. I'm almost done. And Munger is one of the two people I dedicate the book to. And the quote of his that very much informs the theme of the book is someone once asked him, was Berkshire successful because you and Warren are so much smarter than everybody else?

1:06:51And his response was, it's not that we're smarter than everybody else. We were just less stupid, which is such an insightful observation. Hey, just fewer Charlie Ellis. Make less unforced errors and you'll do better in tennis or investing than the guy trying to slam the ace in. Most people are not going to get it in. Him and Munger had the two Charlies had the same belief system. Just be less stupid. It's really fascinating. So when you've interviewed Munger, what are some of the takeaways you've had from your conversations with him? um one thing i remember was for we so we went and looked at our neuroimaging center he um did you ever get him in a machine no um i wish we i wish we had he we he may have gone for it too he's a you know he's a pretty interesting person and i think very open mind into crazy stuff right scientifically curious yeah as well as in his um financial life he had gone to caltech for a while so he was um we got to run into every so often of course we're always people like that they're always trying to get them to give money and right or at least show up and give a speech something yeah talk and so um so we showed him the brain scanner he had a really interesting thought which i didn't quite appreciate till later which was um he said what you guys should be doing is if you're trying to change behavior like let's say you're trying to get somebody to vote or to um wear a mask or you know quit smoking opioids the really hard stuff you know weight loss he said what you should really do is rather than doing one little thing you should go for a lollapalooza you know like basically try to add in six different things to get the biggest ability to get people to quit smoking let's say makes sense and so he was thinking as a practitioner like i want i want to know what's what's going to work as scientists we're often thinking piecemeal like if we put six different things in and it works we don't know which of the six is the active ingredient.

1:08:50But it could be a different combination for each different person. Exactly. Exactly. But and so the reason I was thinking about that was nowadays one of the fallouts or one of the products I should say from fallout's definitely the wrong word. One of the products from behavioral economics was this idea of a nudge that often because people are often sensitive to very subtle things like opt-in versus opt-out. Right. You know there may be a low-cost light touch way to change behavior a little bit. Well, just look at the 401k. Exactly. Making default go to just some specific investment as opposed to it just sits there in cash for God knows how long seems to have really had a big impact.

1:09:33Yes, exactly. That was definitely the poster child for the simplest nudge. And we kind of understand the psychology of it. Anyway, so now what a lot of people are thinking about nudges is exactly this Lollapalooza idea of mongers, which is if we want to get people to get out the vote, rather than try six different things, we should be trying like six combinations of three things. Statistically, it's messy because you'll never really end up knowing which of those is the active ingredient. But to just get results, that's useful information. It's useful information. So the nudge enterprise, which I've been connected to a little bit, is moving somewhat in that direction that Munger mentioned many years ago.

1:10:13Really interesting. All right. I only have you for a limited amount of time. So let me jump to my favorite questions that I ask all of my guests, starting with what are you watching or listening to these days? What's keeping you entertained? So Katie Milkman's podcast, Choiceology, is one that I've been on that I think is quite good. It's basically the behavioral economics podcast. There are quite a few others, but Katie is a real expert on this and is a great interviewer and has had good guests. Choiceology. Choiceology. Tell us about your mentors who helped to shape your fascinating career. So two people who were on my thesis committees, Robin Hogarth and Hilly Einhorn were two.

1:10:55And there's an interesting story. So Robin was Scottish, very verbal. every sentence started with um howsoever therefore notwithstanding hilly was a very blunt jew from brooklyn and it was the exact opposite right so hilly would mark up my thesis and put in all these fancy hilly would rather would take out the whatsoevers and the howevers and the therefores and he was like putting more like boom like short sentences no semicolons but like he had one punctuation mark, period. That's it. Right. Like, you know, he bought a million periods at a store and like, I'm not going to use those. And Robin was the other way around.

1:11:34Oh, this really needs to do the semicolon, you know, let's plop this in. And at one point I was going back and forth, you know, near the completion of my thesis with the two of them were co-advisors. And I got so frustrated and I said, how should I write this? And we had this, this kind of like grasshopper moment of it's your thesis. You figure out how you want to write it. And I realized they were kind of waiting for me to find my voice, like they say in writing. Right. You know, like, and one of them loved tables and the other loved graphs. So the drafts of my thesis was the table and a graph that were exactly the same thing.

1:12:09And I had to decide, was I a graph person or a table person? Or was I kind of like bilingual? So I basically became kind of bilingual in terms of how I was thinking about science. That was very helpful. The other person probably is Dick Thaler because he's a very good writer. He did exactly what so many academics aspire to, and we always ask for more of, which is to write a small number of extremely high-quality papers. It's very unusual because for career reasons and stuff, you have to get tenure and da-da-da. Right. And Dick just couldn't really write a bad paper. I don't write as many great papers as him, and as a result, I write too many okay papers.

1:12:47But that's something I think is useful for everyone. He's one of my favorite people in the world. I got to interview, I don't know, half a dozen times, only once since he won the Nobel Prize. But I always find him so informative and entertaining. And I just loved his response to winning the prize. What are you going to do with the money? His answer was, I'm going to spend it as irrationally as I possibly can. It's just so him. He enjoys life. He very much does. He's just also a fascinating, charming guy. Let's talk about books. what are some of your favorites? What are you reading right now? I am reading Emma Klein, a book called The Guest, especially for New Yorkers in your audience.

1:13:31It's about a very grifty, sketchy woman who goes to the Hamptons and kind of cons her way around the Hamptons. It's really, it's almost like a very... Didn't we have kind of a real life thing like that happening a year or two ago? Yes, exactly. It may be loosely inspired by Anna Delvey in Manhattan or some similar cases. is basically almost like a 19th century novel about class. Because she's very conscious of not belonging in the haptons, but she's very beautiful and kind of charming in this sort of man-eater, femme fatale way. And I'm almost done with that. It's really delicious. The other thing, I love movies and books about capers and heists and grift, which includes Emma Klein, the guest.

1:14:13So I'm reading these books by Jim Swain, who's not well known. I got onto it because Lee Child, who I love. And his wife reads all of his books, plowed through all of them. Exactly, yeah. And did that include the Reacher series? The Reacher series, yeah. That's what he's most famous for, the Lee Child. But so Jim Swain was blurbed by Lee Child saying, Jim Swain's the best at what he does. And what he does is he writes about a very sophisticated cheater in Las Vegas who cheats casinos. And, you know, I'm going to recycle this very shortly for you. But basically, there are procedurals about how to cheat a casino.

1:14:52But in the end, if you get caught, there's also this sort of socio-psychopolitical thing of, you know, if I make up a story about why something happened, like if there's a murder in a casino and I make up a story about it that helps them act like the murder was freakish and won't drive away customers. I'm actually delivering a gift to them and they're going to trade off. They're not going to send me to jail if I give them this gift. So there's a lot of layers of this is not Dostoevsky. It's not brilliant. This is not high-brand literature. This is fun summer beach reading, it sounds like. But for me, there's a lot of like psychology and, you know, in a way it's a game theory.

1:15:28What if there's an arms race between the Vegas Gaming Commission and each of the individual casinos who are very sophisticated? They hire a lot of ex-cheats, you know, to tell them what to look for. And then these cheaters who know, you know, so it's really this arms race of who's going to win. I found those really interesting. If you like books on grifts and cheats and corruption, I'm going to recommend pretty much anything he's written. I've been a fan of his for years. Carl Hyassin was a reporter for the Miami Herald, a crime reporter. And then just one after another, these series of novels.

1:16:07And one of his more recent books is now a TV series on Apple Plus, Bad Monkey. Oh, is it? But all of his books, it's Bad Monkey and I think the sequel is called Razor Girl. But all his books take place in Florida. Everybody's corrupt. The police are corrupt. The building inspectors are corrupt. The politicians are corrupt. And there's always one or two good people in the heart of the story. And it's how do they navigate this just endless sea of treachery and corruption. And he's just a delightful, entertaining writer. You could randomly pick any of his books and they're just all, they're great beach reads.

1:16:48Let me also mention The Wire because I grew up in Baltimore County. The series. Yes. And David Simon's book, The Corner, is kind of a precursor. I mean, he's a very interesting person. He was a reporter. And I think he may have been a teacher. In Baltimore, is that right? Yeah. And The Corner is like this beautiful, I think it was a precursor to The Wire. But it's basically about a corner in West Baltimore where everyone buys drugs. And it's about drug addiction and all the things that surround it. So as somebody who, you know, one of the things we study in behavioral economics is habits and addictions.

1:17:21And, you know, and neuroscience, of course, is fascinating along the way. And that one is great. And The Wire, having grown up in Baltimore County, which is not Baltimore City, The Wire is almost like a documentary. And it has all this Baltimore stuff as well as Baltimore accents where, you know, people are talking about talking like this. And it has Tommy Garcetti is this political character who's sort of inspired by Tommy D 'Alessandro, whose daughter is Nancy Pelosi. Oh, really? That's amazing. I found the series The Wire. It's a tough watch. It's a great show. But it's brutal. Gritty is mild.

1:17:57I mean, some of the stuff that goes on in the show is just like. Yeah, there's a famous scene with a nail gun, which if your listeners have their stomach, that's pretty classic. Similar in the Jack Reacher series. There's something not that far off. They toned it down for television, but the book is really brutal. All right, we're up to our final two questions. What sort of advice would you give to a college grad interested in a career in fill in the blank? like neuroeconomics, behavioral finance, or even just investing? For somebody who, say, doesn't want to get a PhD, that's a different track and probably of less interest.

1:18:39You can get a lot of advice on how to do that. I would study not just finance, like straight asset pricing and derivatives, but also behavioral economics, game theory, I think. Because even though game theory is usually like two players or small numbers of players, it really sharpens the logic of, you know, when do I know something another person doesn't know? And do I know that they don't know it? You know, you have to really relentlessly think about the math underlying that. And then there's a lot of experimental and real world data. One of my, I just got a text from our students this term. And there's a lot of data from sports about whether sports activities are like equilibrium responses to other players.

1:19:23So you can actually, there's a lot of sources of data. besides just say the lab experiments i talk about in my book from 2003 sneaking the plug in um cognitive science is something i would study too so cognitive science is a modern brand of cognitive psych that has more math in it and a lot of it actually goes back to something we spoke about like evolution or mismatch but they're quite interested in what they call resource rationality which means a lot of the mistakes people might make like anchoring on one number and being influenced by that, a famous anchoring adjustment heuristic, may actually be rational if you only have so much working memory or you're under time pressure or you're tired.

1:20:03It's also closely related to the way economists would think about mistakes, which is they may be optimal given some constraint. Like, what is that constraint? And can we test that experimentally? So I think there's a lot of stuff you could learn there that will help you think about markets. The other thing I would say is get experience thinking about markets, whether interning or – I'll tell you a story about what worked for me, which was when I was 12 years old in Cockeysville, Maryland, every August there was a one-month racing program at a small racetrack called Timonium, Maryland. And it was a five-eighths of a mile track, so it was like a small.

1:20:43I would go with my dad and a friend of his who is a stockbroker. And we would also go to the big tracks like Pimlico where the Preak to Stakes is. But if you go to Timonium, you get to see all the horses. There was so much interest. You learn so much about markets. Number one, it gives you, I think, a respect for market efficiency. Because the odds are actually not that bad. They're extremely good. They're pretty dead on. Exactly. And so you see, you know, eight horses come out. They all look pretty similar. You know, the jockeys are all, you know, the same size and they're all pretty good. There's a lot of statistics you can see.

1:21:16But somehow the crowd has decided that number three is even money favorite, which is a 50-50 chance to win. And number six, who looks pretty good too, is like 70 to 1. And they're mostly right. So, you know, part of why I got into economics and psychology was thinking about episodes like that. How does the market put this information together? And are there mistakes? Like, how do you beat the market? So Fama turns out to be more or less right about the efficient market. He was right about Timonia, Maryland. And there were other interesting lessons, too. Like, if you go around the third race, you know, I was a kid, so I was broke.

1:21:53And my poor mom, my Irish mom, was worried I was going to lose too much money. I kept telling you, it's tuition, mom. It's tuition. But if you go in the third race, there are these people who would sell tip sheets for like$5. Right. Because they know what's going to happen. They're selling the tip sheets, not making the bets. Exactly. The customer's yachts. Exactly. But if you go like in the third or fourth race, they would quit selling them and they would just give them to you. Oh, really? Well, like a loss leader. Maybe next time you'll buy it. And so I'm sitting here. Here's my little cynical 12, 13 year old brain thinking, why are you giving away for free tips that you claim can make me money?

1:22:35Like this does not, the math does not math. And I think that's a good lesson in life for markets, right? Yeah. You know, just to clear away like the most naive, you know, immunize yourself to the most naive schemes, you know. You would think if the tips were valuable rather than waste your time printing it up and selling them, you would just bet on the winning horses, right? Especially in a parimutuel system, right? Because, you know, the more your tip sheet buyers are betting on your horses, the less you can make. The lower the odds, right. Exactly, right. Because then you're betting against yourself.

1:23:10It's counterproductive. Our final question, what do you know about the world of neuroeconomics today? Might have been helpful when you were first getting started back in the 1980s. You know, I'll answer that like a politician. I'll answer a question I have a better answer for, which is about behavioral finance. Sure. Well, either or. BFI or neuroeconomics. Sure. Got it. So, neuroeconomics, I don't think we made too many mistakes. I wish we had, you know, we got a lot of grant support. Caltech was very supportive. I got to know a lot of interesting people who were generous with their time, who were kind of my tutors on neuroscience.

1:23:47I never took any formal, you know, coursework on it. It came way, way, way after my original grad training. So thank you, everyone. I wish we had – we have not had much impact in academic economics particularly. And that's something we're kind of working on. Maybe we can do better. Behavioral finance, I think – I started graduate school in the late 70s. In 1978, Mike Jensen published a very influential paper. It was an introduction to a special issue. And one of the first sentences is, the market efficiency hypothesis is one of the most well-established empirical regularities in economics. But that was like the high watermark.

1:24:29Right. And the special issue was about there's some things that are anomalous, like earnings drift. Right. You get a weird earnings announcement. The market reacts, but then the market reaction drifts up. It takes a couple weeks, almost like food for the market. So absorb, it should not take a couple weeks. Right. There were other things where we see, you know, like within one hour, markets are repricing really well. but despite this jensen article the um hostility to behavioral finance was ferocious for that's a big word at that time it was that so late 70s early 80s late 70s early 80s and so that's when i was kind of deciding do i want to stay in finance or mix it with it and i remember having a discussion i don't know if gene remembers it the same way with i had to write a paper for eugene fama's course who was also kind of a mentor in the sense that even though i didn't end up doing work that was close.

1:25:22You know, he was really relentless and very empirically driven. And he had a really good idea. When he started, people thought he was crazy. Right. Because there was all this stuff on, you know, there was even, he wrote some papers on dividends, like, well, the optimal dividend payment policy. And of course, Miller and him was like, why pay dividends at all? You just like take money from one pocket and put it in the other. Well, back in the early days of widows and orphan stocks, you, people lived on their Yeah, exactly. Because of the liquidity. Right. You don't want to sell. You want to hold on to it.

1:25:54And then the dividends is enough to live on. Now the theory has shifted towards it's more efficient return of capital to shareholders doing buybacks than dividends. But that's only total return. If you're looking for that income stream, buybacks don't necessarily help you. Right, right, exactly. And that's also where the behavioral economics comes in with, you know, why can't you just like create whatever income stream you want by borrowing and selling? Right, that's right. And, you know, if you're really liquidity constrained or credit constrained, you can't. But for most people, that's not a big deal.

1:26:29Anyway, so if I had known behavioral finance would – it didn't take off quickly. So from 1978, which is Jensen, 1981, I graduated. 1985 was the Thaler and DeBont paper about January effects. And even that was published as a – it was in the proceedings issue, which meant that the president of the AFA could handpick papers. So the proceedings issue had the most radical papers that were the foundation of avroeconomics. Fisher Black wrote a paper called Noise Traders. In fact, it might have just been called Noise. And then Dick Roll wrote a paper called R Squared. And he said, you know, if only news moves the market, right, then the R Squared on days with no news, you know, you shouldn't have any volatility.

1:27:17And, of course, days with big news and small news, similar to the story you were telling in the beginning, days with big news, big obvious news and hardly any news move about the same. The assumption being by the time it's in the front page of The New York Times, it's already reflected in the markets. But also there may be things that are not newsy at all, like in the October 87 crash, you know, the Bundesbank moved rates by a quarter of a point or something. Who cares? That was the big news. Right. But, you know, you never know when that last straw breaks the camel's back. But so all those ideas now that we, you know, we feel like we have an understanding and examples, there was a lot of hostility to that.

1:28:01So I remember asking, Gene, I'd like to study market psychology. Like, what do you know about market psychology? And he said, what's that? Market psychology, this Boston accent. You know, I think it's just a word they use on the news, like in Bloomberg. It's just a word they use on the news when the market moves and they don't know why. Right. Well, no one wants to admit it's fairly random day to day. Humans are very, I know that. humans are very uncomfortable. And we're good at pattern sense making. Right. We make up patterns. We come up with a narrative to explain it. I recall Dick Thaler quoting, maybe it was Max Planck, who was talking about physics.

1:28:47Science progresses. One funeral at a time. Thaler said the same thing about behavioral finance. And he also said, I'm bypassing the current generation and going right to the kids. So they'll adapt it wholesale. And literally, he said, I'm teaching grads and undergrads this, so we don't even have to wait for the funeral. And it seems to have worked. Oh, yeah. No, absolutely. Colin, thank you so much for being so generous with your time. This has been absolutely fascinating. I'm glad we finally managed to do this. We have been speaking with Professor Colin Kammerer of California Institute of Technology.

1:29:25If you enjoy this conversation, well, check out any of the 500 previous interviews we've done over the past 10 and a half years. You can find those at iTunes, Spotify, YouTube, Bloomberg, wherever you find your favorite podcast. And be sure and check out my new short form podcast, At The Money, short single subject conversations with experts about issues that affect your money, earning, spending and investing it. at The Money in the Masters in Business podcast feed or wherever you find your favorite podcast. I would be remiss if I'd not thank the crack team that helps with these conversations together each week.

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