By |Published On: March 15th, 2017|Categories: Research Insights, Guest Posts, Book Reviews, Behavioral Finance|

Psychology permeates nearly every area of human endeavor. In the world of investing, for instance, psychology can help us understand the systematically poor decision-making that drives the academic anomalies explored on this blog. One cannot be a student of investing without also being a student of psychology.

The emergent field of behavioral economics puts our irrational tendencies under the microscope, and is largely based on discoveries that arose from a unique collaboration between two Israeli psychologists, Daniel Kahneman and Amos Tversky (K&T). Although Kahneman went on to win a Nobel Prize in 2002 in connection with this body of work, Tversky, sadly could not share it since he passed away in 1996 (the Nobel is only awarded to living scholars).

In “The Undoing Project: A Friendship That Changed Our Minds,” Michael Lewis tells the story of K&T’s remarkable collaboration and one of the most productive academic partnerships in history.

Undoing Project

Michael Lewis has a way of shedding light on overlooked areas that can have profound influences. If you read his book, “Moneyball,” you know that the Oakland A’s overcame the lowest payroll in baseball by focusing on statistics-driven algorithms, instead of flawed human scouting assessments. “The Undoing Project” explores the how and why of this type of human irrationality, and the history of K&T’s research effort to explore human decision-making under uncertainty.

What I like about the book?

The book offers an engrossing biographical perspective on this brilliant academic duo. The individual stories of these men and their work makes for a fascinating read.

Lewis describes Kahneman’s childhood, which he spent as a Jewish refugee trying to avoid the Nazis during the German occupation of France in the early 1940s. Although Kahneman’s father died during the war, Kahneman and his mother eventually made their way to Jerusalem, where Kahneman attended high school, and later Hebrew University, to pursue studies in psychology. Later, having distinguished himself intellectually by earning a PhD from Berkeley, Kahneman was called on by the Israeli military to apply his knowledge of psychology to the problem of evaluating new conscripts, and training soldiers.

During this time, Amos Tversky, who was several years younger than Kahneman, was jumping out of airplanes as a paratrooper and leading Israeli army platoons in combat. Like Kahneman, he was a formidable intellect, and also studied psychology at Hebrew University. After getting his PhD at the University of Michigan, he returned in 1966 to Israel.

Both men were teaching in the psychology department at Hebrew University in 1969, when Kahneman invited Tversky to speak at a seminar. Tversky presented work by Ward Edwards that described humans as “conservative Bayesians,” an idea that struck Kahneman as attributing far too much statistical sophistication to humans who, as Kahneman knew from his experience with the military, often made messy real-world decisions based on imperfect intuition and misperceptions that didn’t fit easily into elegant math-based academic theories. Kahneman laid into the presentation, and the usually confident Tversky began to question himself, recognizing there were new dimensions to his field that he had not considered.

Soon after, K&T began working closely together, observing the cognitive errors they themselves tended to make, and then testing these on others. They noted that different classes of biases led to predictable logical inconsistencies in how humans reason. They would spend hours together in a room, dissecting their own misjudgments, and could be heard laughing behind closed doors. They devised clever experiments that pinpointed and probed the mechanisms of these errors. Who contributed what to their research efforts? They couldn’t say. It was a team effort and the two worked so well together they would finish each other’s sentences.

They were also polar opposites in temperament. Tversky was gregarious, outgoing and confident. Meanwhile, Kahneman shunned the spotlight and was consumed by uncertainty. It was a combination that worked well together. Kahneman’s self-doubt enabled him to relentlessly explore his own cognitive errors, and Tversky’s brashness drove the forceful tone of a series of pioneering papers they co-authored.
They proposed that people relied on mental shortcuts (heuristics) when forming judgments, and these led to errors: the Halo effect; Representativeness; Availability; Anchoring; Framing; the Endowment effect, and many more. Whole books could be written about each of these areas (we’ve written extensively on these subjects as well). The granddaddy of them all, and the basis for the Nobel prize, may be Prospect Theory, which is the idea that losses hurt more than gains of similar magnitude feel good.

These ideas started as simple observations they empirically measured in others, but revealed profound truths about how humans perceive the world. In the end, we should be skeptical of our own judgment, since it is deeply clouded by bias.

One sense in which their work together was an “undoing project” was in that while their distinct personalities allowed for their combined brilliance, it also created the conditions for their “undoing,” and the dissolution of the partnership.

Tversky had a reputation as a first-rate intellect, and was outspoken and charismatic. Khaneman was left off some papers, and when people called they wanted to talk to Tversky. It was Tversky who was hired for the prestigious positions, while Kahneman was the afterthought. In the end, Kahneman grew resentful of the attention that people paid to Tversky. This became so difficult for Kahneman that they eventually went their separate ways, driven by Kahneman’s desire for recognition of his own talents.

Thus, “The Undoing Project” is a tragedy with an ironic twist — ironic because today, with Tversky gone, it is Kahneman who receives all the accolades, which is the reverse of the dynamic that triggered their separation. It must be bittersweet for Kahneman today, and I’m sure the irony is not lost on him.

Constructive Criticism

One criticism I have of the book is that some of the writing felt like a re-hash of Kahneman’s 2011 magnum opus, “Thinking Fast and Slow,” which is carefully organized around K&D’s work. The “Undoing Project” by contrast, is more of a biography, with the academic ideas presented in hodgepodge fashion, or referred to only in passing, as Lewis races through the literature. Perhaps this is unavoidable. Lewis had to make the book short and accessible, but cover a lot of complex material and condense it into a compelling read.

Meanwhile K&T labored over the language they used. Lewis reports that Tversky might wrestle with the wording of a single sentence for an entire day. Also, even “Thinking Fast and Slow” is itself a summary. If you really want to understand these ideas you have to read the source papers, and study and reflect on the ideas over time. If your goal is to come away with a deep understanding of this academic work, you will be disappointed. There is simply too much ground to cover in a mass-market paperback format.


However, if you are looking for a brief but readable overview of the field and don’t have the patience or time for a cognitively demanding slog through “Thinking Fast and Slow,” the book is excellent. Or, if you are already familiar with K&T’s work and are curious to know more about the personalities and history behind this unique academic collaboration, it’s outstanding. As usual, Lewis spins a good yarn. It’s engaging, entertaining and laugh-out-loud funny in parts. Take this exchange between a Houston Rockets basketball scout and a prospective player:

Rockets Interviewer: What do you know about the Houston Rockets?

Player: I know you are in Houston.

That’s vintage Lewis. He extracts the absurdity of a situation and serves it up for our enjoyment, and instruction: While funny (and not a bad answer?), it has nothing to do with whether the player can help the Rockets! And that’s the point. It’s snippets like this that makes the book fun to read. There’s a lot of this kind of thing. Another great moment: When asked if their work related to artificial intelligence, Tversky responded, “You know, not really…We study natural stupidity instead of artificial intelligence.”

This made me laugh, but also gave me pause. Is it really “stupidity” K&T were studying? I would say it was not so much stupidity, as the failure of human rationality. Maybe those are the same thing?

More generally, the book serves as a reminder of what flawed decision-makers humans are. The more people can appreciate this fact about themselves, the more skeptical they will be about judgments they make every day. If you are aware of the conditions that create bias, you are better able to defend against your own bias.

Since this is a finance blog, perhaps we should circle back to investing, where it’s especially important to understand the biases that work against us because they cost us money. If there are flaws in the Efficient Market Hypothesis, it is because humans are not perfectly rational automatons who always make rational choices. K&T demonstrated this is empirically true.

In investing, prospect theory is likely what drives the “disposition effect,” when we sell winners too early, but hang onto losers to avoid the pain of realizing a loss. Availability bias may play a role in the value effect, since negative news and earnings are salient, and cause us to overreact, sending prices below fundamental value.

K&T can provide the tools that help understand biases that apply across all domains, including investing. They taught us that we should be skeptical of ourselves since we consistently make irrational errors. It’s just how we are wired. In our own lives, it’s up to us, armed with K&T’s insights, to interpret how we can best minimize these biases so we don’t succumb to self-inflicted irrationality.

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About the Author: David Foulke

David Foulke
David Foulke is an operations manager at Tradingfront, Inc., a provider of automated digital wealth management solutions. Previously, he was at Alpha Architect, where he focused on business development, firm operations, and blogging on quantitative investing and finance topics. Prior to Alpha Architect, he was involved in investing and strategy at Pardee Resources Company, a manager of natural resource and renewable assets. Prior to Pardee, he worked in investment banking and capital markets roles at several firms in the financial services industry, including Houlihan Lokey, GE Capital and Burnham Financial. He also founded two internet companies, E-lingo, and Stonelocator. Mr. Foulke received an M.B.A. from The Wharton School of the University of Pennsylvania, and an A.B. from Dartmouth College.

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