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How Emotions Affect Your Decisions - Doug's Quiz Corner

Posted by Doug Hutchinson | CFA®, Director of Research and Trading
March 11, 2015

Quizmaster, Doug Hutchinson, has come up with another great quiz for us regarding how our emotions can influence our decisions. Let’s see where you stand.

Good luck!

Consider this scenario:

An economist has asked you and your friend Alice to participate in an experiment. In this experiment, you and Alice have been given $100 and must determine how to divide the sum between the two of you.

The experiment states the condition that Alice will propose to you how to divide the $100 between the two of you and you can either accept or reject Alice’s offer. If you accept the offer, the money is split according to the offer. If you reject the offer, neither of you receives any money. You can use any methodology that you like to determine whether you should accept or reject Alice's offer.

In which of these scenarios would you accept or reject Alice's offer? You may choose more than one scenario.

Scenario A) Alice offers $99 to you (and Alice would get $1)

Scenario B) Alice offers $51 to you (and Alice would get $49)

Scenario C) Alice offers $50 to you (and Alice would get $50)

Scenario D) Alice offers $20 to you (and Alice would get $60)

Scenario E) Alice offers $1 to you (and Alice would get $99)

Answer:

The most correct set of answers is to accept Alice's offer in all of these scenarios. As long as the offer is above zero, you would accept the offer because accepting the offer leaves you better off financially than when you started.

In practice, experimenters "consistently find that offers of under approximately 20% ($20 in this example) are rejected 50% of the time."¹ "Evidence suggests that these rejections stem from emotional responses."¹ These responders may have an emotional reaction to Alice's offer: '“Why is Alice being so greedy? Why do I only get $1?"; rather than having a rational reaction: "I'm better off accepting any offer that is greater than zero."

Far too often, when it comes to money and investing, investors let their emotions drive their decision making rather than letting rational thinking drive their decision making.

Sources:

Investment Planning

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