Decisions Have An Opportunity Cost That Require Tradeoffs

Behavioral Economics: Insider Trading

by Elaine Schwartz    •    Nov 26, 2012    •    1649 Views

Did you know that many college professors have encountered the dead granny phenomenon?

Discussing dishonesty, behavioral economist Dan Ariely tells us that before a college midterm, a student’s grandmother is 10 times more likely to die and before a final exam, 19 times. In fact, failing students experience even more “calamity” because their grandmothers are 50 times more likely to perish before a major exam.

Here, Ariely connects the fabrications to “depletion.” When we run out of energy, we also have less of the will power that preserves honesty.

The WSJ graphic, that follows perfectly illustrates how our “cognitive flexibility” can encourage or constrain dishonesty.

WSJ Interactive Graphic: Dan Ariely Explains Dishonesty


The graphic, can also take us to the former SAC Capital Advisors employee who was accused of alleged insider trading. First, some background on SAC:

  • SAC is a hedge fund that manages close to $13 billion.
  • Tough to precisely define, a hedge fund buys and sells, sometimes within milliseconds, countless types of securities and security products. When they sell short, they are benefiting from a stock price going down.
  • SAC’s average annual return for 18 years (but not 2008 when they were down 19%) has been publicized as an impressive 30%.
  • At approximately 100 million shares a day, their trading volume is massive.

The charges against the former SAC employee involved information he allegedly received about pharmaceutical test results. If indeed he did receive a secret phone call detailing disappointing results at Elan and Wyeth on which his stock trading decisions were based, then his transactions, involving hundreds of millions of dollars, were illegal.

The WSJ graphic, provides clues about why people might engage in insider trading. In a chapter from The (Honest Truth About Dishonesty, on “Collabrative Cheating,” Ariely says that sometimes, the social norms within a group encourage us to engage in “altruistic cheating.” We care about the group with whom we work. We realize that we want and need our supervisors to approve of our decisions. As a result, each group member might “bend the rules” to keep everyone happy. And furthermore, as he also points out, punishment is not necessarily a deterrent.

Indeed, whether on Wall Street or at school when we are exhausted, overwhelmed, and unprepared for the final exam, our “cognitive flexibility can lead to dishonesty. As economists, it leaves us pondering how incentives can be used to elicit the best behavior.

Sources and Resources: I do recommend this video discussion about dishonesty between Yale researcher Laurie Santos and Duke professor Dan Ariely. Ariey also describes his ideas in this WSJ article and his book, The (Honest) Truth About Dishonesty and for more on SAC, here is a 2010 Bloomberg article and a recent discussion of insider trading charges against a former employee.

Monday Behavioral Economics Posts

Leave a Reply

Your email address will not be published. Required fields are marked *

« »