The study of happiness & the equity premium controversy

Transcription

1 The study of happiness & the equity premium controversy

2 Rational investors Rational behavior in economics and finance - Axioms of utility: Utility is driven by wealth Risk aversion Decreasing marginal utility Transitivity Comparability Measurability In a more general way, individuals should display attitudes, beliefs, and preferences that: Adhere to logic and probability theory Be coherent Not be changed based on irrelevant factors Be compatible with empirical observations available to the individual

3 Does money bring happiness? Self-assessed happiness varies cross-sectionally with GDP (source: Inter-American Development Bank, Beyond Facts: Understanding Quality of Life, )

4 Decision utility test Choose between: A: your job pays $35,000; similar co-workers earn $58,000 B: your job pays $33,000; similar co-workers earn $30,000

5 World Happiness Survey (White, A. G.(2007) A Global Projection of Subjective Well-being: A Challenge To Positive Psychology? Psychtalk 56, 17-20)

6 Happy Planet Index (New Economic Foundation 2006)

7 Where-to-be-born-index (Economist Intelligence Unit 2013)

8 World Happiness Report and Rankings (University of British Columbia and The Canadian Institute for Advanced Research )

9 Gore Vidal:...it is not enough to succeed. Others must fail. Beyond and above the poverty level, self-assessed satisfaction is not much correlated with income. Self-assessed satisfaction is correlated, however, with perceived income inequalities

10 Inter-temporal trends: A few facts Tremendous growth in the last years: Level of income Standard of material living and consumption Level of general health Life expectancy Level of education Leisure Choice Democracy and freedom The average European and North-American individual has a higher standard of (material) living today than the King of England in the18 th century The average European and North-American individual has a higher standard of (material) living today than 50 or 30 years ago Yet, the level of self-assessed satisfaction has not changed in more than 50 years

11 Projecting utility (i) How happy would you be if you if you won a $15,000,000 lottery? (on a scale from 1 to 10) For how long? (in years) (ii) How distressed would you be if you were involved in a car accident that left you paralyzed from the waist down? (on a scale from 1 to 10) For how long? (in years) We fail to correctly anticipate future emotional states.

12 The treadmill effect 'Keeping up with the Jones' Aspiration and expectations increase with status and success - treadmill or ratchet effect

13 Utility A tragedy in three acts Steven Pinker (1997) How the mind works Comparison with others everything depends on your relative position Inter-temporal comparison in the long-run, happiness (utility) reverts to a normal state Loss-aversion is stronger than the joy of gaining Paul Piff:

14 What do we perceive as causes of satisfaction and happiness? Social status Relationships Love Family and children Reputation Meaning Choice Income Income and wealth represent a proxy for other variables (ex: social status, relationship, children, reputation, etc.) Proximate motives: social status, relationship, children, reputation, etc. Ultimate motives: survival and reproduction Why social status? In most societies, higher social status gives males more access to females of reproductive age (higher social status = more sex) Why relationships? It allows both males and females to raise children Why reputation? It makes an individual a more desirable social and economic partner

15 The Economics of Satisfaction What makes us happy - nature vs. nurture: Genetic inheritance Environmental factors Identical twins separated at birth: More than 50% of the variation in tastes, personality, and disposition to happiness is due to genetic factors Environmental factors that contribute to happiness: Level of income up to the poverty level Perceived income disparities Level of stress Exposure to sunlight (has an impact on brain serotonin) Etc.

16 Happiness gene? Eugenio Proto and Andrew J. Oswald (2014) National Happiness and Genetic Distance: A Cautious Exploration, working paper Denmark and other Scandinavian countries have been historically the (selfreported) happiest countries in the world. Swedes, Norwegians, and Finns are genetically the most closely related to Danes The least genetically related to Danes ethnic groups are also the least happy (after controlling for GDP per capita, and other economic and social factors) The research looked at the relationship between people's (perceived) well-being and the mutation of a gene (5-HTTLPR ) that governs serotonin In the US, the happier individuals are descendants from Danes and Swedes, and they too carry a close mutation of the (5-HTTLPR ) gene that governs serotonin Genes and life-style play a role in our cholesterol levels, obesity, heart-disease, cancer, mood disorders, etc. Why would happiness be any different?

17 Standard economics and finance Rationality Utility and satisfaction = function (level of wealth) Clear separation between investing and consumption Price of financial securities = as a function of information and future returns Price of consumer goods = as a function of pure satisfaction What if utility, satisfaction, and happiness were dispositional traits rather than a reaction to external events (Costa and McRae 1984; Lykken and Tellegen 1996) Implications: Why and how individuals pursue returns

18 It's the journey, not the destination People who are focused more on the meaning of what they do rather than on attaining an objective (happiness) are also happier Too much (hedonic) introspection has an adverse impact on perceived wellbeing people find cartoons less funny when asked to reflect on why they find them funny. Is it introspection that causes lack of satisfaction or is it that less satisfied people have more reasons to reflect on their (unhappy) condition? Dan Gilbert:

19 Coincidence? Implications for shareholder wealth Frequent (and compulsive) evaluation of earnings targets, and return performance tends to defeat the purpose of value creation Companies that do not keep on evaluating their earnings targets and market performance do not perform worse than those who do: see the 1999 (former) Daimler-Chrysler merger Chrysler used to report (quarterly) earnings targets and estimates Daimler did not

20 Historical returns Warren Buffet on stock returns:

21 The Equity Premium Controversy

22 Source: Rajnish Mehra (2003) THE EQUITY PREMIUM: WHY IS IT A PUZZLE?

23 Why is it a puzzle? The difference is historical returns between relatively risk-free assets and equity is too large If investors have rational expectations, optimized low risk portfolios should lie on the efficient frontier Source: Pimco

24 The equity premium puzzle Over more than the last century, T-bills have returned about 1% annually, while equities have returned between 7% and 8% annually Equity premium: over 7% annually Stocks are riskier than bonds, but the difference in the volatility of returns and relative risk (with respect to the market portfolio, of course) does not justify this large equity premium.

25 Findings On average, investors tend to sell winners (to lock-in the profits), and keep the losers (in the hope to recover) the disposition effect The equity premium is proportional to the number of time investors (re)- evaluate their portfolios Investors who constantly re-balance their portfolios including professional investors depress the value of the assets most likely to appreciate in value and bid-up the value of relatively risk-free securities