Psychology and Risk

Continuing the risk theme from yesterday’s post…

I saw a nice little post (here), that uses an example from the world of NCAA basketball office pools to great effect.  Many of us are willing to brush off easy opportunities to lock in gains — insuring winnings via a hedge in this case — while at the same time spending precious time to pinch a penny or two. 

Jeff summarizes how our thinking betrays us here:

Our experience, observing scores of friends and pool participants in these situations, is that they stick with their original entry. They may think that it is “unlucky” to hedge — a silly notion since they are locking in a set amount. They may think that it does not matter, since they are in for a nice prize either way.

True enough. The $300 difference may not seem like much when viewed in terms of the overall prize. In a few days, however, when the contest has been forgotten, the result of the game will have a net effect of $300 in actual spendable money. A week later, the winner will be making decisions about saving a few bucks in amounts much smaller than $300.