Friday, 14 September 2007

Cutting Your Loses

Via OneGoodMove I found an interesting article called 'Lessons on the Surge from Economics'. Its an interesting read, dealing with why the Bush administration continues to remain in Iraq.

What struck me about it though was how easy it is for people to get sucked into negative reinforcement spirals. Its the first part of the article that contains what I'm talking about;

Economics professors have a standard game they use to demonstrate how apparently rational decisions can create a disastrous result. They call it a "dollar auction." The rules are simple. The professor offers a dollar for sale to the highest bidder, with only one wrinkle: the second-highest bidder has to pay up on their losing bid as well. Several students almost always get sucked in. The first bids a penny, looking to make 99 cents. The second bids 2 cents, the third 3 cents, and so on, each feeling they have a chance at something good on the cheap. The early stages are fun, and the bidders wonder what possessed the professor to be willing to lose some money.

The problem surfaces when the bidders get up close to a dollar. After 99 cents the last vestige of profitability disappears, but the bidding continues between the two highest players. They now realize that they stand to lose no matter what, but that they can still buffer their losses by winning the dollar. They just have to outlast the other player. Following this strategy, the two hapless students usually run the bid up several dollars, turning the apparent shot at easy money into a ghastly battle of spiraling disaster.

Theoretically, there is no stable outcome once the dynamic gets going. The only clear limit is the exhaustion of one of the player's total funds. In the classroom, the auction generally ends with the grudging decision of one player to "irrationally" accept the larger loss and get out of the terrible spiral.
I've played poker a few times and this instinct to "outlast the other" has often led me to make poor decisions. Indeed some years ago when I played in a few small time tournaments I had to battle to suppress it. *

This instinct however hasn't gone away. To give a simple example, on my way home from work I can opt to choose one of two bus stops. Stop No. 1 will bring me nearly to my door but is less frequent than Stop No. 2. Stop No. 2 is more frequent but i have to get off further from my house. There is a little distance between the two bus tops.
  • One day I waited at Stop No. 1.
  • After 10 minutes the bus had not appeared but I felt confident one would be along "any minute now."
  • After 20 minutes I began to get irritated. Also a bus from Stop No. 2 passed me.
  • After 30 minutes I was mentally writing official letters of complaint to Dublin Bus. Another bus from Stop No. 2 passed me.
  • After 40 minutes the strongly worded letter of complaint had been replaced by an AK-47. Yet another bus from Stop No. 2 passed me.
  • Finally after almost 55 minutes the bus arrived.
My point is that the longer I waited the less I wanted to leave, even though 3 buses from my second option passed me. I irrationally kept at it. I had already invested time waiting so to give up would have felt like losing. The sensible thing to do would have been to walk to the second bus stop as soon as I began to feel annoyed.

But there is something very difficult about cutting your loses and walking away. Good poker players can do this but I have to work at it, and anyway, I don't wait at that bus stop anymore.

* I still lost.