THE WINNER'S CURSE: PARADOXES AND ANOMALIES OF ECONOMIC LIFE By Richard H. Thaler
Free Press -- 200 pp -- $22.95
Do economists live in this world? Typically, economic models assume that people are both rational and selfish. Yet look at your daily paper. Think about the Middle East and Yugoslavia -- rational? Or firefighters who risk their lives rescuing children from a burning building -- selfish? People often are cooperative, altruistic, irrationally hostile, or trendy -- which makes it hard to predict what they will do.
Some economists would say their profession's narrow view of human nature is its chief failing. In The Winner's Curse, Richard H. Thaler, a Cornell University economist, has documented a host of facts or observations that contradict standard economic theory.
By unraveling a series of real-world puzzles with philosophical and practical implications, Thaler illuminates some fairly abstruse ideas in an entertaining way. I enjoyed the examples having to do with the securities markets and foreign-exchange trading. For instance, the tendency of small-company stocks to rally at yearend and into the New Year -- the "January effect" -- is one such anomaly. In an efficient market, such a well-known profit opportunity should have disappeared years ago. Similarly, Thaler explores why closed mutual funds usually sell at a discount to their net asset value. If you love games, you'll have fun with his chapters on cooperation and bargaining. Also intriguing are insights into why the winner at an auction often pays too much, or why a janitor at a shoe manufacturer earns less than a janitor at a computer company.
The economic view of behavior is simplistic. Still, we turn to economists when we need help divining the impact of tax-cut proposals or regulatory rules because they have useful insights into markets and prices. The best minds in economics today, as Thaler's provocative book suggests, are trying to supplement those insights with a broader understanding of what makes people tick.