A few weeks ago, I strongly recommended that my readers take the free course on Irrational Behavior offered by Dan Ariely. I have no idea how many readers actually followed my suggestion, but I’m now in the middle of the course, enjoying it, and learning from it.
One of the topics discussed in the course is risk aversion. Consider the following experiment: You are offered a chance to flip a fair coin. If it turns up heads, you win $1,100. If it turns up tails, you lose $1,000. Would you willingly do this?
According to the course, most people wouldn’t go for this. They see the negative effects of losing $1,000 as being far larger than the positive effects of gaining $1,100.
I, of course, would jump at this opportunity. I have an Expected Value of $50 on this game. I have a 5% advantage. Slurp. Slurp. Slurp. Give it to me all day long!
Ariely’s methods include creating experiments that test a proposition. The way he “knows” that most people wouldn’t go for this bet is that he’s run a number of experiments and learned from the results. I haven’t run my own experiments to test this proposition, but I suspect that most successful gamblers would go for this opportunity. (There are possible bankroll considerations which could make this otherwise attractive bet just too much money for some. In that case, consider it $110 if you win and $100 if you lose. Or even $11 if you win and $10 if you lose.)
I’ve asked some of my students about this bet. Some say it’s a good thing. Some say not. One who didn’t go for it, Pete, is someone I’ve long suspected has the skills to be a successful gambler but not the temperament. It’s a good thing if you can match up your personality with your profession. Pete has chosen to be a professional gambler; unfortunately, he is often miserable. He has wins and losses like the rest of us, but his losses (even though they are smaller than his wins) make him much unhappier than his wins can ever cheer him up.
Another student, Sam, brought up the argument that he would go for this deal only if he was guaranteed the opportunity to do it 200 times. He was worried about running bad at the outset and not having the chance to catch up afterwards.
Wouldn’t that be sweet? Not only would he require finding someone willing to give him an opportunity worth $50, this person now must also continue his largesse 199 additional times so that the EV becomes worth $10,000. Good luck at talking anyone into making that deal!
Requiring a certain number of specific betting opportunities is only an important consideration if it really matters how well this particular gamble turns out. From a real-world standpoint, I don’t think this matters at all. While this is a somewhat larger bet than almost all of us are used to making, full time video poker players make 2,000,000 or more bets a year. We win some and lose some. What happens on any particular bet isn’t very important. What happens on the sum of the bets is.
If it’s a good bet to do 200 times, it’s a good bet to do one time. Continue to make bets where you have the advantage and you’ll end up doing quite well financially. How happy that makes you feel is something you’re going to have to figure out for yourself.
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