Traders, mortgage managers and bankers: Behavioral lessons from the Oscar-nominated The Big Short

BloombergView columnist and author Michael Lewis described Richard Thaler, the eminent behavioral economist as “either way widely disruptive” http://bv.ms/1SGKuV9. Thaler is in news for his new book Misbehaving, as well as for a short sequence in The Big Short based on Lewis’ book. In the film Thaler waxes eloquent about “extrapolation bias” as Selena Gomez equates side bets in blackjack to the synthetic Collaterralised Debt Obligations (CDOs). Sosubprime crisis is back in news adorned with Oscar hues. 

Below are three behavioral biases oft associated with subprime crisis and which characters in the movie embody.

Avoid overextrapolations of past data, rely on real time:

Humans (here mortgage managers, homebuyers) tend to be overenthusiastic about past data. They tend to be too optimistic about past inflations and pay more in present. Past low default rates could have persuaded the mortgage managers to imagine that past will repeat. Of course AAA ratings provided the extra optimistic cushion to believe in this past phenomenon.

Solution: Stay real and rely on real time data. Apps like Compass are beginning to get investors closer to real time real estate data.

When a product strikes a discordant note, pause and research 

The Big Short shows several crackerjack finance professionals repeatedly deluding themselves to believe in subprime securities.

Cognitive dissonance (CD).  Some evangelist characters in the movie tried to point out and prove the price discrepancies in subprime and home loans data. But the majority of real estate decision makers were loath to acknowledge the red flags as that would counter their justification of selling a lucrative product. 

Solution: Do not let yourself to be manipulated to believe in the optimistic outcome. If a product induces dissonance try to minimize it by by more research into the product. Make sure there are no untruths.

Embrace Ambiguity, do not let the feeling of loss overcome sell decisions

The Big Short ends when the evangelists in the film fathom that loan defaults will lead to a run on the banking system. Why did so many people sell at the same time? 

Ambiguity aversion (AA). People do not like to be in situations where they feel  incompetent, when they cannot assign a probability to a future outcome. So when they see evidence of the negative outcome in other people’s investment, they tend to remember their own painful losses and feel less inclined to  bear a future loss (or take risk). Solution: Be aware of loss aversion before selling. 

Hi. My name is Ritu Gurha Lisso. I am a social media content writer and a behavioral finance enthusiast. As a polyglot finance journalist I have worked in India, South Korea, Singapore, Germany and USA.  I am passionate about creating social content and social strategy. Please feel free to reach out and connect with me @ritugurha.