Dukes of Moral Hazard

The state of affairs of one’s personal finances have helped behavioural scientists model two aspects of their professional lives: to estimate the level of risk they may be willing to take at work to complement their personal risk propensity, and to signal to potential employers or relevant authorities on their reliability to adhere to regulations in the future.

Jennifer graduated at the top of her class in Purdue the same year she married her high school boyfriend. Over the next decade her life saw its ups and downs: she joined a bulge bracket investment bank in New York, moved into a charming townhouse on Long Island; she worked her way up in the trading team for institutional markets, and went through a messy, stressful divorce- during the settlement of which she was diagnosed with rheumatoid arthritis and forced to take a sabbatical from her job. Her high levels of debt brought on by the burgeoning needs of her fast-track lifestyle, multiple mortgages, medical bills and alimony payments to her unemployed husband, meant that she was back looking for high-profile jobs before she had made a full recovery.

By then her debt had caused her consumer credit score, like millions of other New Yorkers, to plummet. As of 2015, the average revolving debt for an American household is $15,609, and the average mortgage debt is $156,706. Credit card debt is now second only to student loans as the largest source of unsecured debt in the United States.

But here’s the kicker: Jennifer’s low credit score puts her at a considerable disadvantage during job interviews. FICO awards no concessions to single divorcees paying alimony, and a large number of employers have now begun to see credit history as a substitute for an applicant’s family background, reliability and a sense of responsibility. This is truer in the financial services industry, particularly for job profiles such as trading, that require employees to make quick, sometimes risky, but extremely profitable decisions on behalf of their company. If the risk pays off, a portion of profit made on the trade is awarded to the employee. Outside of employment, credit scores have also become an important point of reference when leasing apartments or purchasing a cellphone on contract.

The behavioural trigger for such risk taking behaviour is explained by a concept in behavioural economics called loss aversion: picture a visitor to a casino who has already lost $10,000 at roulette. He is more likely to take riskier bets now as compared to when he first stepped in, hoping to quickly nullify his initial loss- and being gleefully ignorant of the prospect of losing $10,000 more in the process.

It is natural for readers to feel indignant at the unfairness meted out to Jennifer. From employers’ perspective, the motivations for such discrimination can be explained by two related concepts: agency dilemma and moral hazard. The former comprises of a principal who hires an agent to make decisions on her behalf. The agent, however, is motivated to pursue his own interests, not those of the principal. A necessary condition is that there is asymmetric information between the two parties: the principal is not aware or not capable of being aware of all of the agent’s activities. The second concept – moral hazard, refers to a particular situation of the agency dilemma, where the agent engages in riskier behaviour because he is protected from its consequences.

The subprime mortgage crisis of 2008 is an example of a continuing chain of moral hazard. The players at each step of the sequence- realtors, consumer bankers, investment bankers, insurance companies, credit rating agencies and regulators- all fuelled by ever-increasing property prices, took higher risks because each felt protected from the repercussions of their decisions as long as they passed the buck up the chain. At the tipping point of the crisis, property prices started to fall and set off a chain reaction that brought the sequence of moral hazard to its worst possible outcome – a global financial meltdown.

Financial regulators have since commandeered several important legislations to minimise moral hazard. For obvious reasons these new legislations have relied on several non-conventional fields of study, including behavioural sciences- which have progressed far beyond being merely an intuitive, behind-the-scenes predictor in assessing such risk. New algorithms by leading credit bureaus attempt to model behavioural traits that predict not just one’s creditworthiness, but also how reliable they are in their personal and professional lives. The Fair Isaac Co. (FICO), for example, uses their Medical Adherence Score to predict the likelihood of a patient following through with their prescribed medication. Other bureaus use similar models to predict asset-side information of clients, which have so far been a major blind spot for the industry: the Income Insight Score by Experian uses credit and personal history to predict an individual’s income levels. Similarly, Equifax offers two products to companies to help predict potential consumers’ discretionary spending power.

The successful use of holistic personal data showcases the predictive power of behavioural models, and thus the ability of university departments and firms that deal with behavioural economics- to widen the scope of predictive analytics. Variables from one’s personal life- number of marriages or broken relationships, frequent visits to party towns and pilgrimage towns (or both), and even the extent of social media presence- may wield a substantial advantage over traditional variables that are restricted to their isolated sphere of study. Moreover, such singular risk assessment models of ex-ante moral hazard come with limitations. In France, for example, young adults whose parents have had few or no accidents (and presumably are safe drivers), are offered lower premiums for their own insurance policies. Over the years, the probability of these youth being involved in accidents has proven by studies to be equal to those youth with parents who were deemed ‘reckless’. Yet, moral hazard may explain these figures in reverse – those youth with lower premiums purchase more comprehensive insurance policies, and are thus more likely to take higher risks on the road. It is this familiar sinusoidal pattern and its moderating effects that must make Jennifer hopeful about not just about her credit prospects, but life in general.

Kids sit back and wait for the bailout

Image Source: The Daily Omnivore/Original Owner: The New Yorker


Fear and loathing in Des Moines

Shaming LetterThe US presidential race is probably the most fascinating election from a behavioral science point of view. From as far back as 1920s, researchers have been studying how to get people to vote and how to get people to vote for a particular candidate. There are many accounts of how data science and behavioral science propelled Obama’s 2012 campaign. But the use of behavioral science is a two-edged sword, as Ted Cruz’ campaign just found out. Ted Cruz’ campaign was recently caught in an embarrassing position of having to defend the ‘shaming’ letters sent to potential voters in Iowa.

The letter sent to people who had not voted in recent elections showed people their ‘score’ and their neighbors’ scores based on past voting record. For added social pressure, the letter mentions that neighbors may see your score and that a follow-up letter may be issued after the election.

The letter caused an outrage on twitter with some even going on to ‘punish’ Cruz by professing support for Trump.

The interesting part was that Cruz’s campaign modeled their letters on ones drafted in a 2008 study that studied how social pressure affected voter turn out. Cruz’ letter was not far off from the most successful letter (an 8.1% lift over the baseline of 29.7% voting rate) in the study that also used voters’ and neighbors’ voting history combined with possibility of a post-election follow-up letter.


Paid for by Cruz for President

So how do we get from the nice 8.1% lift to this backlash? The answer lies in ‘context’ – insights from studies have to be contextualized for the situation or risk such failure. Though Larimer also got complaints from voters because the study, the reaction to the study may well have been muted because an independent agent with no vested interest in the election outcome was running it. Larimer, in an email to Washington Post blames the negative tone of the letter for triggering a ‘boomerang effect’. What he overlooks is that as long as the letter states “Paid for by Cruz for President”, the causal attribution for the situation would fall on Cruz (and not ‘self’, which is required for shame) and the emotion elicited may be anger rather than shame.


Image credit: Braddock Massey on Twitter


Why Prohibition will not solve Kerala’s Alcoholism problem

Source: www.gettyimages.in

Source: www.gettyimages.in

Yet another government, this time the government of Kerala, is trying to solve the problem of alcoholism through the prohibition route. They have taken the first step in that direction by  closing down all bars except the five star hotel bars across the state. Being a Malayalee I know that alcoholism is a big problem in my home state. Given the socialist past of our country we always look up to the state to take care of its citizen’s problems. So when a problem as intense as alcoholism spreads across the state, it is obviously seen as the state’s responsibility to find a solution to the problem. Many an astute politician has understood this and have used ‘finding solutions’ for the alcoholism problem as an  excellent vote catching strategy, more so among the women voters. With elections just a few months away the politicians in Kerala too are not going to be any different.

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Paris attack and the problem of categorization

Blog - Paris Attack

The Paris attacks have been a major shock and we are understandably upset. Most of us have been reminded of some of the earlier acts of terror such as the 26/11 attack in Mumbai or even 09/11 in New York. It also reminded us of the mixed emotions (fear, anger and despair) that we felt during the attacks.

 Since the earlier attacks were also targeted at civilians, we consider this act in the same vein. However, this Atlantic Article – What ISIS really wants suggests that, maybe, this attack is different. The article refers to the origin of the Islamic State from al-Qaeda, the formation of its leader al-Baghdadi, its strong belief of being a key agent of the apocalypse and many other qualities. But the most important point that it tries to make is that ISIS is not like al-Qaeda or any other organization that we tend to categorize as terrorists. The author suggests that we seem to have misunderstood jihadism as monolithic or of a single kind which it is not.

We can probably call this a problem of categorization or essentially mis-categorization.

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Is the end of one-child policy, beginning of a new experiment?


As per the recent NY Times article, one of the biggest human experiment “One-Child Policy” has come to an end.

The policy came into effect in the 1970s as a response to the concern that the population growth was impeding economic growth. The reversal seems to be a response to a new problem – aging of the population.

The ethics and rationale behind such government interventions have been and will continue to be debated in the public policy and macroeconomic circles. But lets view this problem from a different lens – dealing with a wicked problem.

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Getting emotional about razor cartridges

How do you feel about these two Gillette razor blades? Do you like one over the other? Which one would you use?


Though they may seem very similar except for the very obvious color choice, I feel that there will be a big difference in the way the two are used. The key is the color.

The one on the left, designed for Gillette Fusion razors, was launched earlier. The one on the right, designed for Gillette Fusion Power razors, was an enhancement to the product line. Thoughtfully or not, the designers have hit upon a great idea.
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How Catholic Church manages Hyperbolic Discounting

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Human beings have a fundamental problem – we are unwilling to connect the future with what is required of us in the present. The future is uncertain. Instead of inspiring caution, our brains’ typical response to this uncertainty is to sharply reduce the importance of the future in our decision-making, an effect Behavioural Economists call ‘hyperbolic discounting’. We discount larger future gains for the sake of smaller, but more immediate ones. Consequences which occur at a later time, good or bad, tend to have a lot less bearing on our choices the more distantly they fall in the future – even when one’s life is at stake. One of the large global initiative most affected by hyperbolic discounting bias is the conservation of environment.
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How Emotional is Behavioral Economics?

Behavioral Economics is garnering more and more attention everyday. As it should be – the brain subscribes heavily to heuristics and mental models in order to process information efficiently. Our preferences are highly malleable and are usually constructed on the fly – which is why any field studying descriptive decision making would be incomplete if it didn’t take into account the effects that the decision context and decision frames have on our choices. Which is all very good for Behavioral Economics.

Daniel Kanhneman, Richard Thaler, Senthil Mullainathan, amongst many others drive this field and are creating a massive shift in thinking across several domains in classical economics – savings, investment, wealth, losses, gains. The definition of Behavioral Economics is wide. “It studies the effects of psychological, social, cognitive, and emotional factors on the economic decisions of individuals and institutions and the consequences.” However, whilst the definition mentions ‘Emotional’, the reality is that the literature on Behavioral Economics falls painfully short when it comes to Emotions. System 1 & System 2, Prospect Theory, Choice Architecture, Choice Bracketing, Heuristics and Biases – whilst talking about how human beings are ‘economically irrational’ and the role of emotions in decision making, barely scratch the surface of the nuances of the Emotional System. Which is a pity, because Emotions do not merely play a role in Decision-Making, they guide the decision-making process. There are no decisions that are devoid of emotions, even ones that might seem extremely calculated and ‘rational’. We’ve written about the omnipotent role of Emotions before, here


The brain is continuously appraising our larger context, the surrounding environment and stimuli, and basis these appraisals – which could be non-conscious, or completely deliberative, the emotional system responds – determining action tendencies, and ultimately actions. These emotional responses clue us in on the values we attach to things and our motivations. People with damaged emotional circuits are severely hampered in their ability to make even the simplest of decisions. The essence is not in the simplicity of emotions as we colloquially understand but in the complex determinants of emotions. In understanding the role that aspects like Individuals Goals, Relevance to Decision Maker, Self-Image, Sense of Control, Ability to deal with the Outcomes play. The handles that these provide in explaining decision making, understanding behavioral outcomes and influencing preference changes are invaluable.

Lets talk about Investing – To Buy or Not is driven by  two dominant emotions that come into play and drive all decisions. The ‘Fear of Losing’ and the ‘Fear of Losing Out. Fear all the same. With all its positives and ramifications when fear has only cognitive underpinnings. Whilst Behavioral Economics talks about this aversion to loss, the emotions behind it – the aversion/avoidance that are driven as a result of Fear and anxiety are not detailed. Whilst felt Emotions are a huge driver of decisions, Anticipated Emotions are an even stronger influencer – anticipation of gains, losses, happiness, sadness, loss of control are very very powerful and are strong elicitors of Preference Reversals. Again, a lot of the Heuristics and Biases that Behavioral Economics talks about are driven fundamentally by Uncertainty – another powerful emotional mediator. Our decisions might not maximise economic utility, but are most often maximising emotional utility.

For Behavioral Economics to become more powerful and impactful, therefore, there is an immediate need to place emotions at the centre of this conversation so one is able to see the source of heuristics that drive our behavior and then work on one or more dimensions of the emotional determinants to influence decision making and behavioral outcomes. At FinalMile, studying these emotions is central to our process. We use insights/learnings from Cognitive Neuroscience as well as Behavioral Economics, to design our EMGRAM framework which allows us to make sense of the Emotions associated with any problem Context.

- Written with Anurag Vaish

Image Credit:datascience.berkeley.edu


Colour Me Yellow!

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As individuals, the way we each perceive colours might differ, but it does not change the universal emotional responses we have to them. Certain colours are known to be associated with certain distinct emotions.
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Nutrition SBCC Video

Final Mile is part of the SBCC (Social Behavior Change Communication) Expert Working Group constituted by SPRING & GAIN under the aegis of USAID. The EWG is tasked with evolving SBCC strategies for improving Nutrition behaviors at scale. Two S’s are critical to this strategy: Scale & Social.

Final Mile played a key role in shaping of this strategy. The Nutrition community, thanks partly to our efforts, saw value in using learnings from Behavioral Economics, Cognitive Neuroscience and Design Thinking to shape SBCC strategies. The case studies and approaches we shared have demonstrated that application of Behavioral Sciences can be achieved at scale provided we use the right research tools and test various interventions, in context. The future of SBCC in Nutrition is being shaped by a group of highly committed organisations that have proven expertise in their areas and we are delighted to be in that group. Here is a short video that captures the essence of this evolving SBCC strategy. It also captures one of our projects that has been featured as one of the “Great SBCC Examples”


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The Sanitation Monster

The Sanitation Monster









Thanks to Final Mile’s work in the Sanitation context, I have the opportunity to attend some of the conferences on Sanitation in India. There are excellent practitioners in India and many passionate experts who have years of field experience. These conferences are a great learning experience. They also are good places to read the overall sentiment. That usually can be seen as an indicator as to where the Sanitation efforts are headed and whether things are getting better. This collective conscious can be a nice barometer to see if the efforts are going to  bear fruit. The problem, needless to say is quite complex and the scale is mind numbing. I have noticed that this can sometimes be overbearing and bog down our sentiment. In this piece that appeared on DNAIndia, I contemplate some solutions to deal with the Sanitation problem. I argue that the problem needs extraordinary respect but we cannot let this morph in to fear.

Read more here


Impracticality of Ethics

Blatter winning the elections once again and that too as easily as he did does bring into discussion the diminishing role of ethics in social decision making. Most federations voting for him highlight the practicality of this decision while at the same time recognising the moral/ ethical dilemma. The support (favour) that Asian and African football has received and will continue to receive under Blatter makes for a practical enough reason to overlook ethics. And that’s what happened. Ethics would have been just too costly. 

Prisoners dilemma as a model for understanding social decision making lays emphasis on cooperation and defection rather than ethicality. So prisoners, respective of their crime, are now evaluated on a new dimension of ethics – one of cooperation or defection. Resultantly most players in the FIFA elections chose to cooperate rather than defect, irrespective whether the ethical question of Blatter’s responsibility in the many frauds is answered or not.

At times though ethics serve as a great alibi for defection and grand standing, at the core of it, it’s still practicality that weighs more. In FIFA elections the stance of Europe and America does come across as grandstanding against the lack of ethics in FIFA’s dealings over the last decade. Could it possibly be due to the success of Qatar’s and Russia’s bid which jeopardised european leagues due to the timing of world cup in Qatar and so on.

And beyond this support is Blatter’s own stance, which loosely translates into  – even if I am responsible for the situation, I am still the best person to deal with it and put things straight. 

Which may not be as incorrect as it may sound in the first instance. 

Politics is full of situations that depict the impracticality of ethical behavior. 

Kant argued that “all politics must bend its knee before right” which meant that “right must never be accommodated to politics, but politics must always be accommodated to right”. But this purist stance has has often been branded unrealistic and impractical.

Recently The Economist carried an article which depicts the economics of bluffing. Drawing an analogy of Greece and UK’s stance on Euro Exit with buying ‘options’ in market. Where the bluff is positioned to draw inducement, with little intent of really exiting the euro. 

Over Promise and Under Delivery is rampant in Politics across the world. And even though it may sound unethical, it possibly is the only route. Be it about eradication of Poverty, Universal health& education, Job creation, bringing back Black Money, wiping out Corruption, reducing Crime, a measured promise would not yield spectacular electoral results. Case in point is Indian general elections held in May 2014. 

It just seems better to over promise and then go about your business with the right intent, even if it comes across as unethical to a few. Like it or not, its just so much more practical. Winning an election on pragmatic promises isn’t that pragmatic. 

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