I’m a betting man, and yesterday I was offered a betting proposition. The U.S. Bridge Championships are going on now, and the great Nickell team, which has won the event eight years running, has a bye to the semifinals. My friend Justin Lall, a bridge pro, offered me 6:1 odds on $50 on the field: in other words, he would pay off if any team but Nickell won the event.
Ordinarily I would accept happily. 6:1 is very long odds, and no matter how good Nickell is they still have to win two matches against excellent teams. Except Justin informed me that he was getting 6.5:1 on the same 50 bucks from someone else. So taking the bet gives him a freeroll: plus $25 if Nickell loses, break-even otherwise.
I refused the bet, which, from a strictly economic point of view, is irrational. If I like the odds, then I like them. Why should I care if Justin is using me to hedge his risk?
Anxiety mostly — anxiety, first, about one’s place in the dominance hierarchy. One hates to be a pawn in someone else’s game, Es to his Ich, a means to his end. A moment’s reflection will convince you of the idiocy of this attitude, on which several moral philosophies, like Kant’s and Martin Buber’s, have been erected. Regardless of who initiates the transaction, Justin is just as much a means to my own end — obtaining a bet against Nickell at favorable odds — as I am to his of laying off his risk. Hasn’t he also earned a transaction fee for having done the work of negotiating the bet in the first place and then offering it, at a small profit, to me? I regard the philosophies as foolish and atavistic yet, in this case at least, persist in the attitude. If you want an instance of the dictionary definition of “irrational,” this will serve.
Also involved is a related, slightly different form of anxiety which, for lack of a fancy psychological term, I will call shopping anxiety. Mencken defined Puritanism as the haunting fear that someone, somewhere may be happy: shopping anxiety is the haunting fear that someone, somewhere got a better deal. It is not clear to me why it should detract from someone’s pleasure in his new 56-inch plasma TV to discover that his neighbor bought the same model for $200 less. Neither is it clear why it annoyed me that Justin found a better bet than I had, especially since I hadn’t been out looking. But it did.
Finally there is the fact that Justin is a bridge pro. He knows and has played with members of the Nickell team. He is, in short, far more competent than I to evaluate the odds, and he would rather freeroll than eat the risk. Perhaps the bet isn’t as good as I thought it was. This conceivably sound reason, I am sure, influenced me far less than the stupid ones.
Nickell, as I write, has a huge deficit late in its semifinal match. Who’s sorry now?
Update: Despite a furious comeback, Nickell loses. I’m out 300 bones.
Now think about the fact that most of the population is probably less rational than you. Care to meet me at the crying bar?
There are some people I know who have a very big business “flipping” properties. They will put up several million dollars to go to contract to purchase a property. They will then “flip” the contract to another buyer who intends to keep the property. In the last two years they have done this on several billion dollars of property and have always made a profit. So far, they have not been forced to purchase for their own account.
Now, if people were irrational in the way you suggest, this could not be a business. Moreover, since most of the ultimate purchasers have investors who get diluted by the sponsor’s “promote”, there seem to be even more rational people.
“…rational behavior is not a premise of economic theory, though it is often presented as such. The basic contention of theory is rather that competition will make it necessary for people to act rationally in order to maintain themselves. It is based not on the assumption that most or all of the participants in the market process are rational, but, on the contrary, on the assumption that it will in general be through competition that a few relatively more rational individuals will make it necessary for the rest to emulate them in order to prevail. In a society in which rational behaviour confers an advantage on an individual, rational methods will progressively be developed and spread by imitation. It is no use being more rational than the rest if one is not allowed to derive benefits from being so. And it is therefore in general not rationality which is required to make competition work, but competition, or traditions which allow competition, which will produce rational behavior.”
— Friedrich Hayek, Law, Legislation and Liberty
Sure, but what does alpha theory say?
While we’re parading our irrationalities around, I’m like George Costanza when it comes to parking: I will go to great lengths to avoid paying for it, even up to the point of wasting as much on gas while driving around as I’d be paying for parking. Same thing for service charges, which viscerally offend me for some reason: rather than using Interac, I’ll actually go to the bank to get cash. Even if the bank is further away than it’s “worth.” Stupid, stupid…
The source of that icky feeling in your stomach does not come from the idea that your friend Justin finds himself in a better position then you after laying off the bet. He made a market and your better trader said buy it. You only feel taken advantage of because he was never long the bet in the first place. He only makes the 6.5 to 1 bet AFTER he sells it to you at 6 to 1.
Your street smart bro-in-law