Personal Finance: The grass isn't always greener on the other side
The sun is out and so are the lawnmowers. Cue the friendly banter between enthusiasts of the walk-behind mower, the ride-on mower, and the robotic lawn mower. Whatever your preference, it comes down to choosing the right model. Provided you find all the information you need, that is... Cutting through the tall grass gives us the opportunity to consider the “ambiguity effect”: a cognitive bias that steers us away from options with patchy information, despite their potential benefits.
Investment advisor at Societe Generale Private Banking.
Rose petal colours could influence your choice of mower!
With around one million lawnmowers sold in France every year1 (10% of which are tractor ride-on mowers), we can hazard a few thoughts on the subject over a summer barbecue. The real risk lies in the purchase itself: how do you make the right choice with such a big investment that, on average, is only made every 10 years?
In 1961, Daniel Ellsberg conducted an experiment involving an urn filled with 90 balls of three different colours, the quantity of which only one is known. To stick to our garden theme, we’ll replace the urn with a wicker basket and the balls with rose petals: 30 red petals, and the rest yellow and white in quantities unknown. The participants in the study had to choose between two bets:
Bet A: participants win the bet if they draw at random a red petal from the basket (and lose if they draw a yellow or white petal).
Bet B: participants win the bet if they draw a yellow petal is drawn (and lose if they draw a red or white petal).
Most participants chose Bet A.
Then the options were changed so that participants lose the bet if they draw either a red or yellow petal:
Bet C: participants win the bet if a red or a white petal is drawn (and lose if they draw a yellow petal).
Bet D: participants win the bet if a yellow or white petal is drawn (and lose if they draw a red petal).
Here, most participants chose Bet D.
Therefore, the participants went with bets based on the red petals (either to win a bet or avoid losing a bet). This research supports the ambiguity effect’s premise that we prefer to take a risk when the probabilities are known (the toss of a die, heads or tails, roulette, etc.) rather than take a chance on uncertainty that leaves us without any indication in terms of risk probabilities.
Back to our green grass! The ambiguity effect means that without precise information on an important feature (range, warranty, etc.) of the lawnmower we are considering, we won't end up buying it. The effects of ambiguity on consumption is covered in a leading study2. Taking as an example the little-known and relatively unregulated sector of remanufacturing (particularly of electronics), the research shows — unsurprisingly — that the degree of tolerance to ambiguity (the lack of precise information about the processes used) conditions both the perception of the quality of remanufactured products and the price consumers are willing to pay. Equally, if your lawnmower is the only one on the retailer website without reviews from other customers, you're unlikely to choose it — even if other models are rated poorly or have negative reviews. But is the grass really greener on the other side?
If you are sensitive to the ambiguity effect, you are likely to opt for a recognised brand. This was shown in a study published in 20093. Participants identified as averse to ambiguity were twice more likely (50% to 64% depending on the product) than others (23% to 37% depending on the product) to choose the “established”' brand, even though its characteristics were less impressive than those of the alternative brand!
Your vegetable patch has no future online — do your homework instead!
We see the ambiguity effect in numerous areas: in medicine, where doctors prescribes treatments they know; in the choice of service providers, where preference is given to those with an average rating over newcomers, etc. This bias is also why fruit and vegetable e-commerce is struggling to take off: not being able to smell or touch produce gives way to the ambiguity effect in terms of quality. So don't pin your hopes on selling your homegrown fresh produce online!
In personal finance, the ambiguity effect — or ruling out options for lack of complete information — means that we tend to favour investments perceived as safe (regulated savings accounts, bank deposits) and avoid volatile (but often more profitable) investments. Thus we naturally gravitate towards fixed-rate debt (rather than variable-rate debt) and investments with “predictable” returns (for example, a contractually fixed return) rather than unpredictable returns (a capital gain). But by not considering investments with too many uncertainties could ultimately lead to missed opportunities.
To avoid missing out, you need to seek out the information you need to consider such investments. At the very least you’ll be making an informed decision.
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We hope this article gives you the information you need to consider the consequences of the ambiguity effect on your personal finance!
1lautoporte.info/marche-du-tracteur-tondeuse/
2 The role of ambiguity tolerance in consumer perception of remanufactured products, Benjamin T. Hazen, Robert E. Overstreet, L. Allison Jones-Farmer, Hubert S. Field, 2012
3 Ambiguity Aversion and the Preference for Established Brands, A. Muthukrishnan, L. Wathieu, A. Jing Xu, 2009
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