1. Diversification Bias: The fear of focus Dr. Russell James III Texas Tech University

2. Potential positive outcomes of planned focus Avoiding negative addictions Pursuing positive addictions Achieving competitive mastery Barriers to planned focus Hyperbolic discounting Projection bias Diversification bias Focus

3. Diversification bias: The fear of focus We hate losing options, even if they are bad ones. We love diversification, even when it is pointless and costly. We avoid focusing, even if it is the only correct choice. But, controlling your decision environment means focusing your choices and sometimes eliminating future options.

4. Diversification bias: We hate losing options Experimental finding “options that threaten to disappear cause decision makers to invest more effort and money in keeping these options open, even when the options themselves seem to be of little interest” Shin (MIT) & Ariely (MIT), 2004, Keeping doors open: The effect of unavailability on incentives to keep options viable. Management Science, 50, 575-586.

5. An experiment on diversification bias First, pick a door. Shin, J. (MIT) & Ariely, D. (MIT), 2004, Keeping doors open: The effect of unavailability on incentives to keep options viable. Management Science, 50, 575-586.

6. An experiment on diversification bias Then click on the payoff box for some unknown amount (avg. 3¢ per click). $

7. An experiment on diversification bias Then click on the payoff box for some unknown amount (avg. 3¢ per click). 50 clicks total. Earn as much money as possible. 1¢ 2¢ 4¢ 5¢ $

8. An experiment on diversification bias Can continue to click on the payoff button. Or can click to switch doors. But, switching uses up one of your 50 clicks. 1¢ 2¢ 4¢ 5¢ $

9. An experiment on diversification bias All doors have the same average value (3¢). What is the best strategy? 1¢ 2¢ 4¢ 5¢ $

10. If all doors have the same average value (3¢), the best strategy is… Never switch doors because switching uses a click Use ⅓ of clicks on red door, ⅓ on blue, ⅓ on green Use ½ of clicks on one door and ½ on another door Switch doors on every other click Switch doors randomly $

11. An experiment on diversification bias Best strategy: Pick one door and keep clicking. Never switch! 1¢ 2¢ 4¢ 5¢ $

12. An experiment on diversification bias Participants explicitly told: These doors all have the same average payoff. Did they switch doors during the game? 1¢ 2¢ 4¢ 5¢ $

13. An experiment on diversification bias Participants explicitly told: These doors all have the same average payoff. The average number of switches: about 1. 1¢ 2¢ 4¢ 5¢ $

14. An experiment on diversification bias New twist. Each time a door is clicked, the others shrink 1/15th. At the 15th time without being clicked they disappear. 1¢ 2¢ 4¢ 5¢ $

15. An experiment on diversification bias All doors still have same average payout. Does the best strategy change? 1¢ 2¢ 4¢ 5¢ $

16. If all doors have the same average value, but unclicked doors eventually disappear, the best strategy is… Never switch doors because switching uses a click Use ⅓ of clicks on red door, ⅓ on blue, ⅓ on green Use ½ of clicks on one door and ½ on another door Switch doors on every other click Switch doors randomly $

17. An experiment on diversification bias Participants explicitly told: These doors all have the same average payoff. Did they switch doors during the game with disappearing doors? 1¢ 2¢ 4¢ 5¢ $

18. An experiment on diversification bias With the risk of door disappearance the average number of door switches changes from 1 to almost 7! 1¢ 2¢ 4¢ 5¢ $

19. An experiment on diversification bias People can’t stand to let the option disappear, even if it they know there is no advantage! 1¢ 2¢ 4¢ 5¢ $

20. An experiment on diversification bias Similar results… if switching costs a click and 3¢. if you could make the door come back. if the disappearing doors have a lower payoff. 1¢ 2¢ 4¢ 5¢ $

21. Can diversity bias (the irrational desire to avoid losing options) apply to dating? Prof. Dan Ariely’s comments http://www.youtube.com/watch?v=RpvpCLI5wxE

22. Discussion Working in groups of 2-5, answer this: When can an irrational desire to keep options open be detrimental to a person’s future? Careers? College major? Athletics? Relationships? Addiction? Other examples? Sometimes focus (eliminating other options) leads to a better set of new options.

23. Another Experiment Students in class given the option of snacks at the end of class each week: Snickers, Oreos, chocolate with almonds, tortilla chips, peanuts, and cheese-peanut butter crackers. Group 1: What would you like right now? (Asked each week for three weeks.) Group 2: Asked to select choices for the following three weeks in advance. Read, D. (Carnegie Mellon) & Loewenstein, G. (Carnegie Mellon), 1995, Diversification bias: Explaining the discrepancy in variety seeking between combined and separated choices. Journal of Experimental Psychology: Applied, 1, 1, 34-49.

24. What do you think? Group 1: Asked what would you like right now? (Asked each week for three weeks.) Group 2: Asked to select choices for the following three weeks in advance Who was more likely to select three different snacks for the three different weeks? a) Group 1 b) Group 2 c) They were about the same Read, D. (Carnegie Mellon) & Loewenstein, G. (Carnegie Mellon), 1995, Diversification bias: Explaining the discrepancy in variety seeking between combined and separated choices. Journal of Experimental Psychology: Applied, 1, 1, 34-49.

25. People plan more future variety than they will want

26. Irrational diversification? Suppose there are three types of balls: ●red, ●blue, and ●yellow. One color will be randomly picked as the winning color. You get to draw one ball out of a jug. Is one color more likely to win than the others?

27. Irrational diversification? Suppose there are three types of balls: ●red, ●blue, and ●yellow. One color will be randomly picked as the winning color. You get to draw one ball out of a jug. Is one color more likely to win than the others? No. The winning color is drawn at random.

28. Irrational diversification? ●red, ●blue, and ●yellow. One color will be randomly picked as the winning color. You get to draw one ball out of a jug. Since all colors are equally likely to win, does it matter what variety of colors are in your jug?

29. Irrational diversification? ●red, ●blue, and ●yellow. One color will be randomly picked as the winning color. You get to draw one ball out of a jug. Since all colors are equally likely to win, does it matter what variety of colors are in your jug? No. The winning color is drawn at random.

30. Irrational diversification? Since all colors are equally likely to win, does it matter what variety of colors are in your jug?

31. Irrational diversification? Since all colors are equally likely to win, does it matter what variety of colors are in your jug? No.

32. Irrational diversification? Since all colors are equally likely to win, does it matter what variety of colors are in your jug? No. But wouldn’t you “feel” better if you had all the colors in your jug instead of just one?... This feeling may be an example of irrational diversification bias

33. Experiment Either ●red, ●blue, or ●yellow will be randomly picked as the winning color. You get to draw one ball out of a jug. If you select the winning color you receive $30. Your jug has three red balls. You can pay $1 to replace one red ball with another color. You can pay $2 to replace two red balls with a blue and a yellow. ●●● ●●● ●●●

34. Experiment Either ●red, ●blue, or ●yellow will be randomly picked as the winning color. You get to draw one ball out of a jug. Since all colors are equally likely to win, does it matter what variety of colors are in your jug? ●●● ●●● ●●●

35. Experiment Either ●red, ●blue, or ●yellow will be randomly picked as the winning color. You get to draw one ball out of a jug. Since all colors are equally likely to win, does it matter what variety of colors are in your jug? ●●● ●●● No. ●●●

36. Experiment Either ●red, ●blue, or ●yellow will be randomly picked as the winning color. You get to draw one ball out of a jug. You can pay $1 to replace one red ball with another color. You can pay $2 to replace two red balls with a blue and a yellow. In trials of this experiment what percentage of people pay for this pointless diversification? ●●● ●●● ●●●

37. Experiment Either ●red, ●blue, or ●yellow will be randomly picked as the winning color. You get to draw one ball out of a jug. In trials of this experiment what percentage of people pay for this pointless diversification? ●●● 39% paid $0 ●●● 31% paid $1 61% ●●● 30% paid $2 K. Eliaz (Brown) & G. Frechette (NYU), 2008, “Don’t put all your eggs in one basket!”: An experimental study of false diversification. Brown University Economics Department Working Paper [XYZ replace colors]

38. Irrational variety? You are trying to guess the color outcomes of a roulette wheel spin where 60% of slots are red and 40% are black. To maximize your payoff, what color should you pick?

39. Irrational variety? You are trying to guess the color outcomes of a roulette wheel spin where 60% of slots are red and 40% are black. To maximize your payoff, what color should you pick? Red

40. Irrational variety? You are trying to guess the color outcomes of a roulette wheel spin where 60% of slots are red and 40% are black. To maximize your payoff, what color should you pick on the second spin?

41. Irrational variety? You are trying to guess the color outcomes of a roulette wheel spin where 60% of slots are red and 40% are black. To maximize your payoff, what color should you pick on the second spin? Red

42. Irrational variety? You are trying to guess the color outcomes of a roulette wheel spin where 60% of slots are red and 40% are black. To maximize your payoff, what color should you pick on the third spin?

43. Irrational variety? You are trying to guess the color outcomes of a roulette wheel spin where 60% of slots are red and 40% are black. To maximize your payoff, what color should you pick on the third spin? Red

44. Irrational variety? You are trying to guess the first five color outcomes of a roulette wheel spin where 60% of slots are red and 40% are black. To maximize your payoff, what five colors should you pick?

45. Irrational variety? You are trying to guess the first five color outcomes of a roulette wheel spin where 60% of slots are red and 40% are black. To maximize your payoff, what five colors should you pick? Red RedRedRedRed

46. Irrational variety? Let’s look at some experiments similar to guessing the color outcomes of a roulette wheel spin where 60% of slots are red and 40% are black. Will people’s irrational love of diversification cause them to chose the lower probability (i.e., the black slots)?

47. Cards Experiment Five cards are chosen randomly from a deck of 100 colored cards: 36 Green, 25 Blue, 22 Yellow and 17 Brown. Choose, in advance, the predicted color of the first five cards. You receive a prize for each correct prediction. What is the best prediction? A. Rubinstein (Princeton), 2002, Irrational diversification in multiple decision problems. European Economic Review, 46, 1369-1378.

48. Cards Experiment Five cards are chosen randomly from a deck of 100 colored cards: 36 Green, 25 Blue, 22 Yellow and 17 Brown. What is the best prediction? 5 Greens 5 Blues 2 Greens, 1 Blue, 1 Yellow, 1 Brown 2 Greens, 2 Blues, 1 Yellow 3 Greens, 2 Blues

49. Cards Experiment Five cards are chosen randomly from a deck of 100 colored cards: 36 Green, 25 Blue, 22 Yellow and 17 Brown. What is the best prediction? 5 Greens 5 Blues 2 Greens, 1 Blue, 1 Yellow, 1 Brown 2 Greens, 2 Blues, 1 Yellow 3 Greens, 2 Blues

50. Cards Experiment Five cards are chosen randomly from a deck of 100 colored cards: 36 Green, 25 Blue, 22 Yellow and 17 Brown. Chose, in advance, the predicted color of the first five cards. You receive a prize for each correct prediction. In a test of 74 college students, what percentage selected all greens?

51. Cards Experiment Five cards are chosen randomly from a deck of 100 colored cards: 36 Green, 25 Blue, 22 Yellow and 17 Brown. Chose, in advance, the predicted color of the first five cards. You receive a prize for each correct prediction. In a test of 74 college students, what percentage selected all greens? 38% A. Rubinstein (Princeton), 2002, Irrational diversification in multiple decision problems. European Economic Review, 46, 1369-1378.

52. Cards Experiment: Replication 1 Five cards are chosen randomly from a deck of 100 cards. The deck is composed of colored cards: 36 Green, 25 Blue, 22 Yellow and 17 Brown. Chose, in advance, the predicted color of the first five cards. You receive a prize for each correct prediction. In a replication test of 50 college students, what percentage selected all greens?

53. Cards Experiment: Replication 1 Five cards are chosen randomly from a deck of 100 cards. The deck is composed of colored cards: 36 Green, 25 Blue, 22 Yellow and 17 Brown. Chose, in advance, the predicted color of the first five cards. You receive a prize for each correct prediction. In a replication test of 50 college students, what percentage selected all greens? 42% A. Rubinstein (Princeton), 2002, Irrational diversification in multiple decision problems. European Economic Review, 46, 1369-1378.

54. Cards Experiment Five cards are chosen randomly from a deck of 100 cards. The deck is composed of colored cards: 36 Green, 25 Blue, 22 Yellow and 17 Brown. Chose, in advance, the predicted color of the first five cards. You receive a prize for each correct prediction. How many of each color did most of the other students select?

55. Cards Experiment Five cards are chosen randomly from a deck of 100 cards. The deck is composed of colored cards: 36 Green, 25 Blue, 22 Yellow and 17 Brown. Chose, in advance, the predicted color of the first five cards. You receive a prize for each correct prediction. How many of each color did most of the other students select? 2 Greens, 1 Blue, 1 Yellow, 1 Brown A. Rubinstein (Princeton), 2002, Irrational diversification in multiple decision problems. European Economic Review, 46, 1369-1378.

56. Cards Experiment 2 Greens, 1 Blue, 1 Yellow, 1 Brown Is this an irrational preference for diversification?

57. Cards Experiment: Replication 2 In a later replication test of 46 college students in intro to statistics, what percentage selected all greens?

58. Cards Experiment: Replication 2 In a later replication test of 46 college students in intro to statistics, what percentage selected all greens? 15% C. Kogler (U. Salzburg) & A. Kuhberger (U. Salzburg), 2007, Dual process theories: A key for understanding the diversification bias? Journal of Risk Uncertainty, 34, 145-154.

59. Cards Experiment: Replication 2 In a later replication test of 46 college students in intro to statistics, what percentage selected 2 greens, 1 brown, 1 yellow, and 1 blue (maximum diversification)? C. Kogler (U. Salzburg) & A. Kuhberger (U. Salzburg), 2007, Dual process theories: A key for understanding the diversification bias? Journal of Risk Uncertainty, 34, 145-154.

60. Cards Experiment: Replication 2 In a later replication test of 46 college students in intro to statistics, what percentage selected 2 greens, 1 brown, 1 yellow, and 1 blue (maximum diversification)? 61% C. Kogler (U. Salzburg) & A. Kuhberger (U. Salzburg), 2007, Dual process theories: A key for understanding the diversification bias? Journal of Risk Uncertainty, 34, 145-154.

61. Cards Experiment: Dual-Self Replication The professors believed that by intentionally engaging the “intentional, analytic, rational” side of the two-system self, they could improve these results. Tested a second group after waking up this system by calling it a “statistical test” to find out “statistical competence” and encouraging students to do their best. What happened? C. Kogler (U. Salzburg) & A. Kuhberger (U. Salzburg), 2007, Dual process theories: A key for understanding the diversification bias? Journal of Risk Uncertainty, 34, 145-154.

62. Cards Experiment: Dual-Self Replication C. Kogler (U. Salzburg) & A. Kuhberger (U. Salzburg), 2007, Dual process theories: A key for understanding the diversification bias? Journal of Risk Uncertainty, 34, 145-154.

63. Majors experiment: More irrational diversity? Five students are selected from the university at random. Guess the major of each student. Each correct guess enters you in a drawing for a prize. What is the best strategy?

64. Majors experiment: More irrational diversity? Five students are selected from the university at random. Guess the major of each student. Each correct guess enters you in a drawing for a prize. What is the best strategy? Guess the most likely major and then select that major five times.

65. Majors experiment: More irrational diversity? In a similar 1999 experiment with students in an economic game theory class, what percentage selected the same major for all five guesses?

66. Majors experiment: More irrational diversity In a similar 1999 experiment with students in an economic game theory class, what percentage selected the same major for all five guesses? 7% A. Rubinstein (Princeton), 2002, Irrational diversification in multiple decision problems. European Economic Review, 46, 1369-1378.

67. Mall experiment: More irrational diversity? 21% You are a police officer trying to find a person. He is about to enter a mall through one of four gates. The share of people using each gate is as follows: 27% 20% 32% You can assign only one officer to one gate based on the spin of a roulette wheel. Assign the spaces on the wheel: Blue: __% Green: __% Red: __% Yellow: __% What is the correct answer?

68. Mall experiment: More irrational diversity? 21% You are a police officer trying to find a person. He is about to enter a mall through one of four gates. The share of people using each gate is as follows: 27% 20% 32% You can assign only one officer to one gate based on the spin of a roulette wheel. Assign the spaces on the wheel: Blue: __% Green: __% Red: __% Yellow: __% What is the correct answer? 100% to Red

69. Mall experiment: More irrational diversity? 21% You are a police officer trying to find a person. He is about to enter a mall through one of four gates. The share of people using each gate is as follows: 27% 20% 32% You can assign only one officer to one gate based on the spin of a roulette wheel. Assign the spaces on the wheel: Blue: __% Green: __% Red: __% Yellow: __% What percentage of students gave the right answer?

70. Mall experiment: More irrational diversity? 21% You are a police officer trying to find a person. He is about to enter a mall through one of four gates. The share of people using each gate is as follows: 27% 20% 32% You can assign only one officer to one gate based on the spin of a roulette wheel. Assign the spaces on the wheel: Blue: __% Green: __% Red: __% Yellow: __% What percentage of students gave the right answer? 33%. Everyone else diversified A. Rubinstein (Princeton), 2002, Irrational diversification in multiple decision problems. European Economic Review, 46, 1369-1378.

71. Diversification bias: The fear of focus We hate losing options, even when they are bad ones. We love diversification, even when it is pointless and costly. We avoid focusing, even when it is the only correct choice. But, controlling your decision environment means focusing your choices and sometimes eliminating future options.

72. Slides by: Russell James III, J.D., Ph.D., CFP® Associate Professor Division of Personal Financial Planning Texas Tech University russell.james@ttu.edu Please use these slides! If you think you might use anything here in a classroom, please CLICK HEREto let me know. Thanks! The outline for this behavioral economics series is at http://www.slideshare.net/rnja8c/outline-for-behavioral-economics-course-component