For example, imagine a stranger comes up to you on the street and offers you a coin game, where if you win you gain $1 billion, but if you lose you owe him $1 million. The simplified model would claim that you should play the game because the expected value is positive. A more nuanced model would understand that being that much in debt would be a lot more suffering for me than the offset from whatever I'd do with a billion dollars. Even if the coin was weighted more in my favor, and the penalty was less, an even more nuanced model would recognize that I'm probably doing OK enough in my life with the money I have and that anything to chip away at that is an unnecessary risk.
And then a model that even more completely captures the interplay of reasoning that humans do would acknowledge "wait a second, who the hell is this random stranger offering me a devil's bargain?" The researcher with a simple model would say "oh, just ignore that, just take the situation at face value," but that's never how any decision is made. Our priors for "suspicious people offering bargains too good to be true are actually trying to cheat you somehow even if you don't know how" is very high. This is embedded in cultural/religious parables that teach "you do not make deals with clever demons," and because the culture that taught that has survived and persisted over time, it's probably a good prior to hold onto.
All that complexity is lost if you only think in simple terms of expected value and single-iteration games.
No, it wouldn't. Humans are not maximizing EV of money won but utility of that money. This is fundamental to economic models which Taleb is criticizing.
>>All that complexity is lost if you only think in simple terms of expected value and single-iteration games.
It isn't lost unless you are for some strange reason maximizing expected amount of money which no one sane does (even people who don't understand what expected value is in the first place). If the game is single iteration or multi-iteration doesn't matter either, you just make the best play at every point and it doesn't change no matter if you will get a chanc to make another bet or not.
And then whenever they do a study they are very careful to fully convince subjects that there is no trickery going on. And then when interviewed the subjects don't say "I suspected trickery". So I think that such studies are justified in concluding that the subjects are acting irrationally.
>Our priors for "suspicious people offering bargains too good to be true are actually trying to cheat you somehow even if you don't know how" is very high. This is embedded in cultural/religious parables that teach "you do not make deals with clever demons," and because the culture that taught that has survived and persisted over time, it's probably a good prior to hold onto.
Right, right. But the question of "why do people make irrational decisions?" is exactly what the researchers are studying. They agree with you! The answer is that decisions which are irrational in one domain would be rational in the domain we were designed for.
No one sane plays a game like that with all their money on the line. This is not because there are future bets available but simply expected utility of such a bet is negative. If you play for example with constant sizing your risk of ruin is higher than 0 but lower than 1. It's very often very close to 0.
>>It’s a lot like smoking. One cigarette won’t kill you, but add up the probability cigarette after cigarette, pack after pack, year after year and the probability starts to skyrocket.
But it's not like that. Risk of ruin doesn't skyrocket even if your plan is to make infinitely many bets. That is unless you do something very silly like double the bet amount every time you win.
For more information check "Risk of Ruin" https://en.wikipedia.org/wiki/Risk_of_ruin
Using a cell phone is taking that bet. You are betting that 50 years of cell phone exposure won't cause brain cancer. Nobody knows for sure yet, nobody has had cell phones for 50 years. I'm not saying it will or it won't cause cancer. I don't know. But it has the possibility of risk of ruin.
Second, constant amount betting does have risk of ruin even with an edge. Take a fair coin flip where you start with $500 and get $51 for heads and lose $50 for tails. A clear edge with a constant betting amount. In 100 flips, you have a 27.23% chance of ruin.
For more information consult the concept of "Gambler's ruin" https://en.wikipedia.org/wiki/Gambler%27s_ruin
It's essentially the game we played with the housing bubble.
Already mentioned in another comment, see LTCM as a prime example:
> He wouldn't pass 1st year college math course with that one.
Seems pretty straightforward to me. Let's say you play a game with an edge where you win 2x your money 99% of the time. But if you lose once, you lose all your money (1% risk of ruin). If you play this game 70 times, you are very likely to end up ruined.
It’s a lot like smoking. One cigarette won’t kill you, but add up the probability cigarette after cigarette, pack after pack, year after year and the probability starts to skyrocket.