The Lehman bankruptcy, which occurred a year ago today, was the nadir of a financial crisis brought on by excessive risk-taking throughout the investment industry. Naturally, reigning in risky behavior has been in vogue since, and regulators are hard at work trying to do just that wherever possible. Sometimes, however, the problem is not too much risk, but too little. Indeed, research confirms that individuals are hard-wired to avoid certain risks at crucial times—even when, in so doing, they impose costly economic penalties on themselves.
In other words, at key moments people refuse to take chances that will make them money. Behavioral finance has a term for this – risk intolerance.
And, believe it or not, some of what we know about risk intolerance comes from research into two unlikely topics: the games of blackjack and golf.
One putt too late
The golfing research comes from Devin Pope and Maurice Schweitzer, professors at the University of Pennsylvania, who published a paper earlier this year, Is Tiger Woods Loss Averse? Persistent Bias in the Face of Experience, Competition, and High Stakes. They showed that golfers make par putts more frequently than they do birdie putts, and that this proclivity costs a top-20 golfer approximately $1.2 million in prize money per year.
(In golf, each hole has a par score – the number of strokes expected to complete the hole. Finishing the hole in one less than par is a birdie and one more than par is a bogey.)
The professors studied putts attempted by 200 golfers between 2004 and 2008 – 1.6 million putts in all. Using laser technology, they measured the length of each putt and showed that birdie putts were made 3% less frequently than par putts from an equivalent distance.
Of course, the value of a stroke is the same regardless of whether a putt is for birdie or for par.
They ruled out alternative explanations for the effect, such as whether golfers could “learn” from observing putts taken by other golfers before theirs, whether the difference could be explained by player ability, or whether it was due to the ball’s position on the green or the player’s standing in the tournament. After adjusting for those possibilities and others, golfers exhibit a measurable and costly bias known as loss aversion.
Golfers’ fear of making a bogey, the research suggests, carries more weight than the potential benefit of making a birdie. As the New York Times noted when it reported the results of the study, that bias affects how professional golfers play, and many of them acknowledge it.
“When putting for birdie, you realize that, most of the time, it’s acceptable to make par,” Justin Leonard, one such professional golfer, told the Times. “When you’re putting for par, there’s probably a greater sense of urgency, so therefore you’re willing to be more aggressive in order not to drop a shot. It makes sense.”
Even Tiger Woods, perhaps the greatest golfer and arguably most accurate putter of all time, was just as guilty of loss aversion as his competition.
