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Thursday 12 July 2012

A Tall Tale of Risk Aversion

Dead or Alive, It's all the Same

Amos Tversky’s and Daniel Kahneman’s 1981 paper on The Framing of Decisions and the Psychology of Choice demonstrated that people are risk averse in situations involving potential gains and risk takers in situations involving potential losses.  The researchers showed that these traits could be manipulated by presenting the same problem in a different way – so if you offer up the choice of 200 people surviving (out of 600) or 400 people dying (out of 600) then you can invert the behavior.

Nonetheless the relationship demonstrated was a statistical one.  In both cases about a quarter of people preferred the non-standard response; which should hopefully make us wonder if these people have something different about them.  One answer now suggests itself: they’re taller than the rest of us.

Big Coins, Bigger Presidents

You might well think that physical dimensions aren’t the most obvious quality necessary for economic success, but there’s a long history of psychological research suggesting that size does matter.  As far back as 1947 Jerome Bruner and Cecile Goodman showed that when asked to compare the sizes of various coins and equal sized cardboard disks people habitually overestimated the size of the coins.  Moreover the greater the value of the coin the larger the overestimate.  If we perceive more valuable things as larger than they are perhaps might we perceive more important people as taller than they are?

Indeed we do.  In fact this process turns out to be dynamic as Higham and Carment (abstract only) reported when they looked at the variations of perception of height of Canadian politicians before and after they won or lost an election.  Of course, it’s one thing to think powerful people are tall, but it’s another for tall people to actually be powerful.  Although that turns out to be true as well – for instance, most U.S. Presidents have been of above average height.

Beauty and the Bonanza

The link between physical appearance and wages was something we looked at in Trust is in the Eye of the Beholder: more physically attractive people are more confident and are paid more, undeservingly.  This is probably linked to the halo effect, where a single key attribute – attractiveness in this case – is extended to other attributes without a shred of evidence to support the idea (see: The Halo Effect: What's In A Company Name?).

So it isn’t a great surprise to find that when Timothy Judge and Daniel Cable looked at the link between height and wages that they found a positive correlation.  In The Effect of Physical Height on Workplace Success and Income they relate:
“Height is positively related to income … after controlling for sex, age, and weight… The results suggest that tall individuals have advantages in several important aspects of their careers and organizational lives”
Each extra inch of height was worth nearly an additional $800 a year and added up, over their career, to someone six foot tall earning $150,000 more than an equivalent person half a foot shorter.  Age and gender don’t seem to matter – although given that men are taller than women this can present itself as gender discrimination whereas it’s actually a case of apartheight (ahem).

Napoleon Complex

Why might this be?  Well, it may be to do with self-esteem, where taller people are simply more confident, spending their lives literally looking down on others (see: On Incentives, Agency and Aqueducts).  Certainly the more the employee role relies on social interaction the more the height-wage link holds; so short people should presumably look for jobs where they don’t need to talk to other people a lot. 

Indeed there’s some evidence that shorter people make up for their height disadvantages by being more aggressive: the Napoleon complex, as it’s called.  As it happens, the French president it’s named after probably wasn’t very short for his time; he just spent his life surrounded by his Imperial Guards who were selected for their height.  So we shouldn’t expect short people to start trying to annexe their next door neighbour’s garden in an effort to appear bigger than they really are.

Tall and Proud

In fact, as Olaf Hübler reports, there’s a lot to be said for being tall besides simply earning more:
“It has been argued that earnings increase with height because tall people have physical advantages, are more disease-resistant, possess greater authority and have better verbal and non-verbal abilities than do others.”
Hübler argues that it’s likely that height is just a proxy for some or more of these other attributes and homes in on the slightly unlikely hypothesis that taller people are less risk averse than others.  The evidence supports this thesis and offers a possibly explanation for why taller people earn more money – they’re more willing to take risks.

This is supported by George Korniotis and Alok Kumar’s research into Stature, Obesity and Portfolio Choice:
“We find that taller and normal-weight individuals are more likely to participate in financial markets, and when they participate, they hold riskier financial portfolios. Further, change in height during teenage years affect participation and asset allocation decisions. These individuals are also likely to take greater entrepreneurial and home ownership risks.”
Which leads the researchers to the intriguing suggestion that we should estimate the body mass index and height of fund and hedge managers in order to predict their risk preferences and performance.  I’m not sure what Warren Buffett and George Soros would make of that.

Young and Tall

Anyway, Hübler’s research confirms that taller people are less risk averse and  suggests that height is a proxy for other, underlying variables, finding statistical links to parental behavior and social skills.  The suggestion is that this may be linked to social factors during development:
“Tall adolescents tend to think of themselves as leaders, and their peers tend to agree. As a result, they are obliged to make difficult decisions -- that is, to deal with risk – earlier than their peers of average or below-average height. Consequently, risk appeals to them; selfconfident, they tend to downplay the negative aspects of risk-taking, instead of being chiefly concerned with maintaining their status quo.”
This research is partially confirmed by the Persico, Postlewaite and Silverman study used earlier to show U.S. Presidential height. They show that it's teenage height that correlates with the wage difference - short teenagers who grow late don't accrue the same advantages, and taller teens who stop growing do just as well as their loftier cohort.  They also confirm Hübler’s results that taller teens tend to participate in sports and clubs more, and suspect this is somehow involved in the process, possibly through encouraging greater social skills.

Hold the Cookie

None of this reveals whether taller risk takers are actually any more successful at investing than their shorter, squatter risk averse counterparties.  Most likely the results will depend on situation: if these traits are indeed fundamental to the individual’s disposition then cautious investors will do better in poor market conditions and risk-takers in better times. 

Of course, the more balanced investor will be better able to switch modes, dependent on circumstances.   Which presumably suggests that medium height, normally built individuals will eventually carry the day, as long as they can resist that extra cookie.

 Related articles:
Risk aversion added to The Big List of Behavioral Biases.

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