Hyperbolic Discounting

I am about 2/3 of the way through “The UnderCover Economist” by Tim Harford. I guess by releasing this book it kinda blows his cover no? In any case, Tim is an economist and columnist for the Financial Times and in the vein of Dear Abbey, tries to provide rationale solutions to everyday problems through the dissemination of economic research. His style is direct and slightly humorous. I found it on the cheap at Borders and recommend it for a decent read.

There is one particular letter that I would like to highlight, a reader is confronted with two job choices but must make a decision quickly. For those that don’t know I have been examining new opportunities and most recently I completed my 4th interview with a firm. To summarize I was faced with the following options:

1) Stay with my current firm, higher base salary, low to no bonus potential, stressful work environment, and basically no opportunity to growth. In fact the only advantage was the steady salary and the acknowledgment to future employers that I still had a job.

2) Work as a consultant for another firm for 6 months at a discount, at the end of this term I may be offered a position or not, the firm is well capitalized and gives traders a lot of leeway, however this is a simply perform or walk type firm. I was introduced to this position by a collegaue so the price of failure also includes some loss of stature.

I have been agonizing about this for a few weeks and combined with the extremely stressful environment I am currently in, I have had major anxiety and have contemplated just leaving the business altogether.

Back to the book though, the “UnderCover Economist” introduced a new behavioral term called “hyperbolic discounting” which put simply is an irrational compulsion to have things now. I remember acting like this as a kid for a new toy or video game and still do this occasionally with tech gadgets. His remedy was to imagine that neither job is available now and both will available in a years time, which position would you take?

Another effect is known as the ‘endowment effect’ which is an irrational preference to keep what you rather then switch. Better the devil you know then the devil you don’t. The advice in this column was better to make a risk of error then take no action.

Interestingly Ben Franklin devised a simple algo for decision making way back when. List the pros and cons of each choice, assign a weight to each (positive for pro, negative for con obviously), sum it up and see what you get. It’s better to apply some thought process then bemoan the ‘what ifs’ or unknown risks.

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~ by largecaptrader on September 23, 2009.

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