Bets, beliefs, and portfolios: some further observations on the theses of Bryan Caplan

Bryan Caplan thinks that portfolios don’t reveal much about actual beliefs,.  Here is one of his arguments:

Even prominent Nobel prize-winning economists admit they follow simple rules of thumb when they invest.  So unless people’s beliefs are carved in stone, how could portfolios possibly reveal much about their beliefs?  Tyler is a case in point: He changes his mind a hundred times a day, but he follows a simple financial strategy that hasn’t varied in years.

I view it differently.  I don’t trade in public markets but I vary my allocations by changing how much money I spend and how to allocate my time.  Perhaps not coincidentally, this puts me square into the world of classical finance theory as represented by “the mutual fund theorem,” with a static equity portfolio of fixed proportions and some unique covariances on my human capital.  I call that rationality not inertia.

Bryan, you will note, is a founder of the theory of rational irrationality, which suggests you become more rational as the private stakes from your decisions go up.  These days he is wishing to argue that the truly small stakes reflect what you really think, through the lens of mental accounting and compartmentalization.  Of course that would undercut or at least drastically relativize his earlier theory.  I say he has made a large and successful career bet — much bigger than any of his piddly ante monetary bets — on the theory of rational irrationality, so he must really agree with me after all.

It also happens that Bryan’s emphasis on simple rules of thumb will work against his interest in person-to-person bets as a metric of authenticity.  If you don’t change or examine your overall portfolio very often, that means some reasonably wide range of portfolios is a matter of indifference or near indifference to you, if only because fine-tuned improvements are hard to find.  (Do you really give matters a re-ponder when a firm in your portfolio pays dividends?)  In that case, however, the small bets won’t be authentic either.  One could compartmentalize one’s personal bets quite easily and say to oneself — whether consciously or not — “I can make this small bet: it still keeps my overall portfolio within that broad range of indifference.”  Which indeed it does.  The bet is then undertaken for expressive reasons, which is fine, nothing against that, but for me it is more fun to cheer for Tony Parker (without betting on him).  I think of these small personal bets as akin to sports loyalties most of all and not as a unique window into our real beliefs.

The small person-to-person bets pay off (or not) in terms of pride, including for some people the pride in betting itself.  One relevant substitute is to attempt to produce pride using your own internal mental accounting of your own predictions and so we must make the broader portfolio comparison.  What the $$ betters are signaling is a lack of vividness for their own internal mental worlds.  In my mind, I’m already betting an optimal amount of pride through my own mental accounting.  Maybe some of us are already betting too much internal pride on external events; after all, the variance of pride introduces some new exogenous risk into life and perhaps we should be trying to move in the opposite direction toward greater pride indifference to external events.  That is what the Stoics thought.

Most of all, I fear that Bryan’s results are coming from an asymmetric approach where he applies positive observation to large portfolios and normative recommendations to small bets.  Bryan could go for a “positive vs. positive” comparison, in which case he would point out that people trade and adjust their large portfolios all the time, but don’t make small bets on public policy nearly as much.   Alternatively, he could try a “normative vs. normative” comparison, in which case would you sooner recommend that people drop their inertia for their large portfolios or for their small ones?  To even raise such a question is to answer it.

Do you want to find out “what a person really thinks”?  Look  at whom they married, how much money they spend, and how they devote their time.  That is the most important portfolio of them all.

Just don’t bet that Bryan and I are going to agree anytime soon.


An argument about nothing.

Yes, can someone crisply restate what exactly they are arguing about here?

Is there an empirically testable proposition embedded anywhere in this? Predicting what?

how do we recover "true" beliefs and preferences of people ... are bets a 'tax' on BS, thus incentivizing revelation of the truth? Or are small bets a bunch of BS and you need to look at the big stuff?

this is academic on some level (literatures behind each view) and on another this is policy relevant as it helps sort out heterogenous behavior and outcomes.

I suspect they are both right (and wrong), as there is no one way to get at these attributes ... beliefs and preferences are not as stable, context independent and well defined as economists need them to be. Such is life.

And I thought I was a geek...

IIRC, Noah Smith also had a discussion on bets versus portfolios. But, imho, Nate Silver and Alex Tabarrok meant something simple, straightforward and did not thought of covering the case of a Noah-like betting arbitrageur.

Do you believe inflation is about to break and go into high gear in the US? Yes or no. Simple. Secondary question: By how much? Is CPI going to be 5% annualised? Or 10%? Or ...? Again, simple.

The third question is the more difficult. Why? Why do you believe that inflation is about to break out? Because of past QEs? Or because QE is about to get tapered out?

What you likely should spend the vast majority of your time doing is making sure that you are not making any big implicit bets.

I predict you'll have to wait as much as 20 years.

This reminds me of a common debate between a 30 year old devout xian and a 50 year old (formerly devout xian) atheist. There is no way for the atheist to explain how or why teenage skepticism gets preserved through the years of stifling.

Neither can the 50 year old explain to the 30 year old how or why teenage daydreams connecting internal pride with the acquisition of skills is more likely to eventually resurface than expected.

By the way, how does all this apply to the let's call them just about everyone whose just about entire portfolio consists only of an unaffordable mortgage? I mean, I know those people, the everyone I mean, aren't the target subjects of rational agent models, but humor me.

No. That is the bank's portfolio. Which makes me wonder, how do banks arbitrage their portfolios?

No. The person's house is an asset.

an unaffordable mortgage?...No. The person’s house is an asset.

Only the net value of the house is an asset. So by saying unaffordable mortgage you imply a long (30+ year) note with very little equity and there it's not a substantial asset. So, I agree with Andrew', it's part of the bank's portfolio.

That's at least a part of the borrower's portfolio. It's an unaffordable house bought on huge margin, the unaffordable mortgage is a part of it.

"Do you want to find out “what a person really thinks”? Look at whom they married, how much money they spend, and how they devote their time. That is the most important portfolio of them all."

Very true. And I agree with Adam Ozimek on the value of bets: it just forces clearer thinking. Here's the problem with thinking that bets reveal one's true beliefs. Let's say that I'm a prominent economist, and my career and theory has been suggesting significant hyperinflation for years now. Let's say I take a 3:1 bet that inflation will remain below 5%. (Being generous in allowing even such people to bet against hyperinflation, just at far lower odds than rational people like Noah Smith who take 75:1).

Is it 3 cents to 1? Or 3 thousand dollars to 1? I imagine the prestige and pride in making such a bet outweighs – for such top economists – the cost of loosing it. That is I think people like Niall Ferguson or Paul Krugman would be indifferent within an order of magnitude except at very high values. (For example, if PK looses a 50:1 bet on a thousand dollars what's the worst that happens... he has to give another speech?)

Therefore, only at extreme levels of confidence *and* high bet values (a bit of leniency between the two) can a bet actually reveal true preferences. Otherwise, if I was NF for example, I might take a much bigger bet just to make a statement because what's the difference anyway?

>>>Do you want to find out “what a person really thinks”? Look at whom they married <<<

Does it really reflect so much on what they think now? Or what they used to think (say) 20 years ago when they met the spouse?

Opinions are cheap to change. Spouses harder.

Prominent bullshitters are more likely to resist bets.

Prominent academic bullshitters (naming no names) will even come up with clever reasons as to why they should never be expected to put their money where they mouth is. How vulgar!

I always thought that things like widespread support for minimum wage and relatively simple financial portfolios expressed economists' wise understanding that economic models were only a small (albeit important) component of the vast complication that is reality.

I'd say that such positions *are* an expression of economists rationality.

1. The simple rules are the right rules unless you are a professional and you guys aren't even supposed to believe that.

Not to mention, what you would have an advantage in hopes of hitting a 10 banger you are already WAYYYYY overweight in. That is part of your portfolio. That said, I don't know who I side with.

Hearing "put your money where your mouth is" is a strange notion from economists who should be aware of statutory vs economic incidence.

Caplan is a smart guy but he's just weird. Am I correctly reading that he thinks we should constantly be betting each other on everything? Essentially calling everyone else a liar. Sounds like a pleasant society.

"Looks like it's going to rain today." "I DISAGREE. And my confidence level and risk preference is such that I will bet you $563, at 3.2:1 odds, against it raining today."

I just bet my coworker $10 on a coin flip. I lost. What exactly have we have learned about my beliefs and/or the world?

Problemed gamblers don't even seem to want bets that depend on information.

That you had more than $10 available to buy lunch with.

No, Bryan Caplan does not recommend that "we" constantly bet on "everything".

I bet that I will never meet a human being who actually holds that position.

Tyler, I'm with you...but you probably already knew that...

*bet you probably already knew that...

I thought the way to get people to reveal what they think was to get them to tell you what to do. They will tell you what they think because in helping you they assume you are just like them.

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