Humans are psychologically sensitive to losses and constantly monitor their investments, which creates an emotional pain from experiencing losses; this heightened sensitivity explains why investors historically demanded very high returns to compensate for the emotional burden of risk, resolving the equity premium puzzle that traditional economics couldn't explain.
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Death by Dashboard | Choiceology Podcast ClipIndexed:
On this episode of Choiceology, Katy speaks with Shlomo Benartzi, professor emeritus, behavioral decision-making, at UCLA Anderson School of Management. Shlomo shares his research on why we tend to overreact to short-term losses—and how this tendency helps explain a puzzle that has long stumped economists. Watch the full episode: https://youtu.be/YDvQAaIf7Iw?si=4H_5dvM7-9HPZ4Bb Subscribe to our channel: https://bit.ly/SubscribeCharlesSchwab Connect with Charles Schwab: Facebook: https://www.facebook.com/CharlesSchwab X: https://www.x.com/CharlesSchwab Open an account with Charles Schwab: https://www.schwab.com/open-an-account [0526-GE5U]
SHLOMO BENARTZI: So what happens? It's the combination. We're sensitive to losses, and we keep looking for them. We open the newspaper, or nowadays, you know, we just open our little devices and we check in the stock app. And before you notice, we see losses, and we think that the stock market is very, very risky because we feel the pain of losses very often.
And as a result, we virtually say we're not going to invest in the stock market unless we're going to get very high returns. And that's one reason we believe, historically, the stock market provided returns that economists couldn't explain. They were just too high given what traditionally we viewed as risk. But if you view risk as kind of more the emotional pain of noticing daily or annual losses, then people would command very high returns.
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