Behavioural Economics and watch collecting
Exploring the work of Thaler, Kahneman and Tversky, evaluating the endowment effect, status quo bias and loss aversion - to better understand how watch collectors' think.
Richard Thaler, Daniel Kahneman and Amos Tversky are the pioneers of the field called “behavioural economics”, two of them even won Nobel prizes for their work and the third would have too, if he was alive to receive it. The trio uncovered numerous ways in which people make poor decisions without knowing it. Here's a short podcast where Thaler tells a number of stories that bring behavioural economics to life. This post explores some of their findings and draws comparisons with watch collecting.
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Here’s one of the stories that Thaler tells in the podcast about a bottle of wine:
Before you continue, imagine you're a wine collector, or someone who buys numerous bottles and keeps them around for a while before drinking them. How much would it cost you to drink a bottle of wine that you bought many years ago for $10, but which is now worth $100?
If you don’t drink, do the same with cigars, or some other luxury consumable, even sneakers would work! Once you've thought about this, leave a comment with your answer and then can come back to it later with your reflections. Be a sport!
“Divided by the number of times I look at it, it really isn’t that expensive.”
Here's the full story in Thaler's own words:
“One case came from Richard Rosett, the chairman of the economics department and a long-time wine collector.
He told me that he had bottles in his cellar that he had purchased long ago for $10 that were now worth over $100. In fact, a local wine merchant named Woody was willing to buy some of Rosett’s older bottles at current prices.
Rosett said he occasionally drank one of those bottles on a special occasion, but would never dream of paying $100 to acquire one. He also did not sell any of his bottles to Woody.
This is illogical.
If he is willing to drink a bottle that he could sell for $100, then drinking it has to be worth more than $100. But then, why wouldn’t he also be willing to buy such a bottle?
In fact, why did he refuse to buy any bottle that cost anything close to $100? As an economist, Rosett knew such behaviour was not rational, but he couldn’t help himself.”
It is worth reminding ourselves of some definitions.
A sunk cost is money you have spent already, and nothing you do now is going to change that. You have to write it off. In this case, the $10 spent to buy the bottle in the first place is a sunk cost.
An opportunity cost is the price of choosing one course of action over another. In this case, choosing to drink the bottle instead of selling it for $100, or perhaps keeping it and selling it for even more money in the future.
With this in mind, here's the experiment which Thaler used in a survey sent out to the annual subscribers of a wine publication called Liquid Assets:
“Suppose you once bought a case of good Bordeaux for $20 a bottle. The wine now sells at auction for about $75. You have decided to drink a bottle. Which of the following best captures your feeling of the cost to you of drinking the bottle?”
$0. I already paid for it.
$20, what I paid for it.
$20 plus interest.
$75, what I could get if I sold the bottle.
-$55. I get to drink a bottle that is worth $75 that I only paid $20 for so I save money by drinking this bottle.
What is your answer now? How does it compare to the answer you came up with before?
Interestingly, Thaler asked the question again but with a small modification. He posed it like this:
“We asked subjects how it would feel if they had dropped and broken the bottle. A majority said they felt that dropping the bottle costs them, $75, what they could get for selling it.”
This intuitively makes sense, as we're quite prone to loss aversion - just ask any insurance company!
Nevertheless - The Wine Test is more than a party trick. Though the correct answer according to economists would be “4: $75, what I could get if I sold the bottle,” only 20% of respondents made that choice. Many people considered drinking the bottle to be free (1: 30%) or even result in a profit (5: 25%). The rest just considered the original price (2: 18%) or included interest (3: 7%).
The bottom line is that we are not purely rational agents who optimise outcomes. Included in a long list of deviations is our tendency to overreact to losses, to overweight near-term versus long-term benefits, and to base decisions based on how they’re worded or “framed.”
The formal theory on this topic can be summarised as follows: Thaler (1980) called this pattern - the fact that people often demand much more to give up an object than they would be willing to pay to acquire it - the endowment effect. To put it another way, people are more likely to keep something they own, than acquire that same object when they do not own it.
The example also illustrates what Samuelson and Zeckhauser (1988) call a status quo bias; a preference for the current state that biases the economist against both buying and selling his wine.
These anomalies are a manifestation of an asymmetry of value that Kahneman and Tversky (1984) call loss aversion—the disutility of giving up an object is greater that the utility associated with acquiring it. Here's an awesome paper that discusses experiments covering all these concepts in more detail.
What does this have to do with watches?
By now you have probably made the connections yourself; when watches are trading above their MSRP in the open market, it isn't difficult to conclude that option 4 is the correct answer in the wine test - the economically rational ‘correct’ choice… i.e. market value.
The key difference is of course: wine is consumable.
Does this, however, change the way we perceive ourselves wearing a watch? Let's say you bought a Nautilus at £25,000 several years ago, and whilst wearing and enjoying it as you used to all these years, you somehow lost it. Would you perceive it as a £25k loss, or closer to the market value of £100k?
Remember, you didn’t plan to sell it, so the possibility of you realising the £100k market value was non existent. How does this compare with the wine example in your mind? I would imagine that everyone will have different opinions on this, so this is more of a thought experiment than anything else.
My advice on this topic is that one should overweight the value of those extravagances which you get to enjoy frequently. My favourite categories for which to pay over the odds are beds and bedding, shoes and mobile phones. Sadly, being an avid watch enthusiast, I can safely say it would probably be cheaper and more convenient to be addicted to cocaine, but I take comfort in knowing that this hobby delivers a type of enjoyment that most other things do not.
A leading academic authority on happiness once justified his Rolex on this basis: “Divided by the number of times I look at it, it really isn’t that expensive.”
Perhaps a useful metric for watch collectors could be ‘cost per enjoyment hour’ or CpEH. This was first developed in the computer games industry to explain why computer gaming enthusiasts pay excessively high prices for a single game. The answer was simple; Observed through the lens of time - where a game might entertain someone for hundreds of hours - it was cheap entertainment.
Using the CpEH formula… living in London or many other major cities is highly disadvantageous for what we might call ‘popular watches’ due to security concerns. The best performing watches by the CpEH metric are Tudor, Unimatic or G-Shock watches for me, as I can wear them without fear of being robbed or targeted. The worst performing watches are all the popular sports models from Rolex, Patek and so on.
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