18.12: Chapter Exercises

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Chapter Exercises

Investors are often less willing to sell assets at a loss than they are to sell assets that have gained in value. Indeed, many of us are very reluctant to see a falling stock. Is this sensible? What things should you consider in trying to decide whether to sell a stock or other asset that is losing in value.
People often go to investment counselors for help in investing their money. Should they put their money in stocks (with chances of a higher return, but riskier) or in bonds (less chance of high payoff, but less risk). So almost the first question an investment counselor asks a new client is how much risk they can live with. How might subtle differences in the way the counselor words this question affect the answers she’ll receive (and, hence, the advice that she will give)?
Although you can’t arrange such things, do you think you might do better in a job interview if the person right before you turned in a terrible performance? Why? How would you test a hypothesis about this?
Most of us have heard that taking an aspirin a day decreases our chances of getting a heart attack. This result is statistically significant. But is it of any practical significance? What would it mean to say that it is? What information would you need to answer this question? How would you get it? Get it.
What role might the endowment effect play in insurance fraud? Explain. Given an example or two, and be sure to defend your answer.
The following was a question on the pretest: Which do you prefer?
1. A 100% chance of losing $50.
2. A 25% chance of losing $200 and a 75% chance of losing nothing?

About 25% of you, on average, chose (a), and 75% of you chose (b). Explain why most of you probably picked (b). Be sure to use to relevant concepts that were discussed in class. What type of attitude regarding loss does this reveal about most of us?

Countless Americans are currently battling a credit crisis. Indeed, many people owe thousands of dollars in credit card bills. Explain what psychological accounting is and how it could contribute to this crisis. What remedies does psychological accounting suggest?
Give an example, preferably one from your own experience, of the compromise effect. How susceptible to it do you think most of us are?
Researchers randomly divided a group of Duke undergraduates into two groups. The first group was asked to imagine that they had a ticket to that year’s NCAA Final Four tournament (a more important item at Duke than many other universities). They were asked how much money it would take them to sell their ticket, and the median price was about $1,500. The second group was asked how much they would pay for a ticket to the Final Four and their median price was about $150. What could account for this enormous difference? Do you think these figures would hold up if first group of students had the ticket in hand? Can you think of similar examples? What do they tell us about human reasoning?
You and your friend both paid $12 to see the movie, but by the time it is half over you both realize that you aren’t enjoying it at all, and it only seems likely to get worse. What reasons are there to stay? What reasons are there to leave? What should you do? What would you do? What do you say when Wilbur asks how you can waste your hard-earned money by leaving early.
Jodie finds that once she’s installed a piece of software on her computer she is very reluctant to remove it, even if she never uses it. After all, she tells herself, “I might need it one of these days”. But when she recently reinstalled the operating system,she found it easy not to put the software back on her computer. What might be going on here? How sensible is it? Can you think of similar examples in your own experience?
You have lost weight on your new diet, but a few minutes ago you broke down and got a Big Mac and large order of fries at the McDonalds’ drive through window. You haven’t eaten them yet. What should you do?
“To terminate a project in which $1.1 billion has been invested represents an unconscionable mishandling of taxpayers’ dollars.” – Senator Jeremiah Denton, 11/4/81. Is this true or not? What more would you need to decide. What problems could be lurking here?

Answers to Selected Exercises

1. Refusal to sell falling stock or other assets like a house that is declining in value is often a futile effort to honor sunk costs. You would be better off deciding which stocks to buy and sell based sensible expectation of their future performance, not on what has happened in the past. If there is good reason to think the stocks or the housing market will rebound, hold on to them. If not, cut your losses.

10. This is a case of sunk costs.