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Introduction to Irrational Choice Framework, Positive Feedback Loops
By: Procyon Mukherjee
Zurich, 10th December 2010
I chanced upon the reference of Hawk‐ Dove survival strategies in the seminal book ‘The Selfish genes’
by Richard Dawkins and later found further references in his more brilliant book, ‘The Blind
Watchmaker’. Indeed hawks and doves have survived in this world for more years than human beings
and both these species survived with different survival strategies, so much different from each other,
but both having its benefits and costs. Indeed not all hawks behaved like hawks and not all doves
behaved like doves to survive as we shall see under what conditions they have better suited themselves
to certain mixture of strategies and benefitted from it to survive.
Hawk and Dove strategies are exact opposite of each other, if we assign the number 1 to one we must
assign 0 to the other. It almost seems like Black or White. But how could it be that such extremes have
survived long years of existence in a world that is severe and leaves very little to benevolence of nature?
In our daily worlds of today such extremes do co‐exist, in the field of business and finance, in the fields
of mergers and acquisition and even in daily interactions of people, in families. But we shall see that the
nature of strategies have changed and the concept of ‘Winner Takes All’ have had a pervasive influence;
the society had accepted such approaches, with all its benefits and costs.
Let me first define these extremes. Extremes come into being from nature when two divergent natural
behaviors either genetically passed on through natural selection or through cumulative selection
become dominant in an environment, where the absence of one or the other make the whole concept
of dominant strategy null and void. If there were only Hawks then there would not have been the idea of
a Hawk strategy as a dominant one and vice versa for doves and it is only that there were two strategies
in nature each dominant in its own way that one could actually examine the benefits and costs
associated with each.
Here we are straddled with the concept of benefits and associated costs for each strategy and also the
overall benefits and costs to the whole ensemble of species. We could actually draw a parallel to
business strategies in situations of market expansion Vs consolidation or competitiveness Vs
collaboration or even War Vs co‐existence. While each could gain or lose by each of these strategies as
independent of each other in its execution, the whole ensemble together could actually benefit or lose
in terms of a shrinking or enlarging pie size. For example if two hawks behaved like doves and shared the
food, each would have gained, while if each behaved like a hawk, the odds of one benefitting more than
the other was low and each would have had to bear a loss in terms of the injury stemming from the
fight.
In the analogy of the business, this could well pan out as a cost benefit analysis of each dominant
strategy. But the Pareto optimality angle should not also be missed, that while each outcome could be
weighed against costs and benefits, the overall outcome needed to be seen whether it generated a
Pareto efficient outcome. We shall examine this in steps.
I later learnt that John Maynard Smith and George Price in their 1973 dissertation brought out the
significance of the payoff matrix for these two dominant strategies. It looks as simple as this:
Suppose we have two players and we have two strategies, one is the dominant Hawk strategy which
means if an opponent attacks the player also attacks, and the dominant Dove Strategy, which means if
an opponent behaves like a hawk, then the reaction is to shy away and take shelter and if there is an
opponent behaving like a dove, then it cooperates to share the food equally. The situation could be
actually fourfold:
1. Hawk‐Hawk: There will be fighting amongst the two for the share of food and there will be one
survivor and one who is hurt and one winner. The pay off could be defined as Benefit (B) minus
the Cost (C) since we are assuming that the loser would be hurt and the winner as well could
lose a portion as cost, or B‐C. But since there are two such opponents each opponent would get
a payoff of (B‐C)/2. We could draw an analogy of two aggressive players in an oligopolistic
market each trying to attack the other in the same market with the same set of strategies of
product choice, features and cost structure and pricing strategies.
2. Hawk‐Dove: When a hawk meets a dove with this strategy, there will be no fight as the Dove
would shirk away and the gain for the hawk would be B and for the Dove would be zero.
3. Dove‐Hawk: Here also the same outcome would occur with Dove getting zero payout while the
whole benefit B would pass on to the Hawk. We could take the analogy of a new entrant in the
market with an aggressive stance on cost (Hawk), while the established player, which is the
Dove, shirks away and simply observes what happens to this doze of cost improvement in the
overall response in the market.
4. Dove‐Dove: In this situation since both would share the benefits, the resultant payoff for each
would be B/2, B/2. This is the classical example of two laggards in a market where each is
picking up the remains of the leftovers of the market by sharing amongst each other. But it
could well be the dominant strategy of a master player in the chess who waits for the similar
strategy player to make the first mistake, which could well be a very fatal error of judgment. I
think in the Second World War both U.S. and Russia played a dove‐dove strategy for some bit of
time while Germany and England played the Hawk‐Hawk. We know what happened later.
If I assume that there are two dominant strategies in the case of Entity A Vs Entity B and I show
them as Hawk Vs Dove, then the two by two payoff matrix looks like this that any text book on
this subject would construct:
Entity A
HAWK DOVE
HAWK (B‐C)/2, (B‐C)/2 B, 0
Entity B DOVE 0, B B/2, B/2
It is clear from this payoff table that when both act as Hawk, the total payoff is B‐C, which is the least
that the combined entity would get, while in the other three situations the payoff changes to B for the
combined entity, which is higher. So if we define value as the summation of what Entity A and Entity B
generate in a market space then the pie size of the two in a limited market would grow in any of three
strategy positions but would be minimum in the Hawk‐Hawk position.
We need to analyze whether a pure Hawk or a pure Dove strategy is better or a mixture of these
strategies gives a higher payoff. If we take the analogy from the natural world, if there were only one
hawk amongst a group of doves, then a dominant hawk strategy would always be doing better as there
was no other hawk to challenge him, so there was no chance of incurring any cost. If there was one dove
amongst the group of Hawks, it is not very easy to say as if the dove waited it could benefit from the
constant depletion of calories of the other hawks due to constant in‐fights, so it is not very easy to say
which is better unless B and C is known. If the costs are too high, then it could well be that a mixture of
Hawk‐Dove strategy could do better as the surviving Dove could actually get the better off and survive
to reproduce.
In a market place analogy, if there was one hawk in the market and rest doves, it does not matter for the
dominant strategy to be Hawk. But seldom do we have such extreme distributions in vogue. We have
unknown hawks and unknown doves, and while one unique hawk strategy could be appearing very
winning, it could well be that a combination of hawk and dove could give a better payoff.
Let me try to elaborate this with the strategy of a mixed player (M) against two dominant Hawk (H) and
Dove (D) strategies taking examples from the text book approach. Let us define two payoffs:
P (H, M): Payoff of pure Hawk player while playing against a mixed player M
P (D, M): Payoff of pure Dove player while playing against a mixed player M
Let us define that p be the probability that the mixed player plays Hawk strategy, in that case (1‐p) is the
Probability that the mixed player plays Dove.
The expected average payoff of H vs. M, P (H, M); will be composed of one part of the Hawk‐Hawk and
one part of the Hawk‐Dove payoffs.
P (H, M) = (probability that M plays Hawk) x (payoff of Hawk‐Hawk) + (probability that M plays Dove) x
(payoff of Hawk‐Dove)
P (H, M) = p (B‐C)/2 + (1‐p) B
The expected average payoff for D vs. M, P (D, M); can be found in a similar manner:
P (D, M) = (probability that M plays Hawk) x (payoff of Dove‐Hawk) + (probability that M plays Dove) ×
(payoff of Dove‐Dove)
P (D, M) = p (0) + (1‐p) (B/2)
When would the M’s optimum mix evolve? It would evolve when both H and D do equally well against it.
This means that M has nothing to gain by skewing the mix towards more Hawk or more Dove than
prescribed by p and (1‐p) respectively. In other words, the optimal mix will be the value of p when P (H,
M) = P (D, M) or this the Nash Equilibrium condition to satisfy.
P (H, M) = P (D, M)
Or p(B‐C)/2 + (1‐p) B = p (0) + (1‐p) (B/2)
Or p=B/C
It gives the percentage of time that M should play Hawk by solving the value of p, which calculates out
to be B/C.
So the outcome entirely depends on the ratio of B/C, or the ratio of Benefits to Cost. This is similar to
our empirical observation that what mixed strategies could succeed would depend on the benefits and
costs.
Going back to the Entity A Vs Entity B payoff matrix, for either of dominant strategies to be played with a
mixed strategy the percentage of time that the mixed strategy should be played with Hawk as the
dominant strategy is entirely dependent on the ratio of B/C.
When the costs outweigh the benefits, neither the all Hawk or the all Dove strategy is stable, while
when the benefits outweigh the costs, the all hawk strategy is clearly the winner. But there is something
that one has to keep a close eye on what are the intended and unintended consequences and also the
total hidden costs and benefits.
In a market there are equally strong players who want to fight with the hawk strategy, and there are
also the doves which have the dominant strategy of avoidance and waiting and sharing rather than
competing. It is clear how the hawk perceives the payoff matrix and strategizes. It computes the
benefits to be always higher than the costs. In so doing it creates its own paradigm of winning
strategies. While on the other hand the dove assumes the costs to be much higher and so with its
strategy of avoidance shoves every effort to take on the dominant strategy of the hawk.
But so far we have assumed that all players are using a rational approach, which means that one is
applying a cognitive logic or perceptive reasoning in response to the other’s move. This is not entirely
the case when one is in the midst of other human factors, both emotional and societal. This adds a
completely different dimension to the problem. We cannot necessarily assume that all offers whether
higher or lower would be a rational offer. For example it could well be that the offer is absolutely an
irrational one. What happens when the total payoff in a given situation is asymmetrically divided or in
the extreme situation one takes the whole and the other is left with nothing or even a negative payoff?
Let me make a thought experiment as follows:
There are two Entities with a payoff matrix as follows:
Entity A
HAWK DOVE
HAWK (B‐C)/2, (B‐C)/2 B, 0
Entity B DOVE 0, B B/2, B/2
Suppose we introduce the element of ‘Winner Take All’ situation. This means when a dominant Hawk
strategy is confronted with a dominant hawk strategy one of the two could actually behave like a
‘Winner Takes All’. The same applies when a dove confronts a dove. Then the payoff structure could
look as follows, with one of the two players taking highest side of the booty on offer in every situation
(Winner takes all):
Entity A
HAWK DOVE
B‐C/2, ‐C/2 or –
HAWK C/2, B‐C/2 B, 0
Entity B DOVE 0, B B, 0 or 0, B
The significant point to note is that the winner in a ‘winner takes all’ gets much higher payoff in every
situation. What kind of behavior do we want to perpetuate in a ‘winner takes all’ matrix? Isn’t it one of
risk taking?
The payoff matrix is not uncommon although it would appear rather odd at the first glance. Think of the
case that when a hawk attacks another hawk and one of the two is the winner, it could well be that the
winner takes all the benefits away leaving nothing to the other hawk, so the gain for one is B‐C/2 while
that for the other is not zero, but ‐C/2, as the total cost is assumed to be shared by the two.
Is this an irrational outcome when two doves meet, when one of them acts as a winner and takes away
the entire booty (B) while leaving nothing for the other Dove?
Let us take the example from the game of sports, where we have a knock‐out tournament. There is one
winner at the end although for the tournament we need many rounds to be played and many players
contributing. But all the prize money is taken by one winner. Is there any consideration of Fairness?
Think about it, the player who played till the Semifinal was just one match away, but could end up
receiving nothing if he does not win the last game. Doesn’t this situation resemble a payoff matrix in a
Winner take all situation shown above?
Or let us take a much easier example from the same field of Sports in a team game where the Star
Player gets 90% of what the rest of players take home. Is this example very odd? But there is a wide
social acceptance of this as a practice.
Let me take another example from the history of Wars. Did any of the defeated nations get any part of
the spoils of the war? But wasn’t it the defeated nation that needed more support and more assistance
for the reconstruction? Isn’t the payoff matrix exactly like the one drawn above?
Let me take the example of the financial leverage that banks do and how an extreme leverage position
becomes risky for the bank while on the other hand the high leverage helps the business houses
transacting in the Main Street to have higher access to financial products of all kinds that leads to better
financial benefits and therefore impacts profits positively. When the banks want to deleverage on the
other hand the corporate bodies and even individuals suffer as less is in the offing. The solutions to this
conundrum was sought by the banks in offloading their risky assets and continue leveraging; which
means that they sought not to lessen their ability to leverage, which appeared as a risky proposition, but
more leveraging, by seeking processes that could eliminate risky assets from the bank balance sheets.
This is an example where instead of reducing leverage the banks went on increasing their leverage. This
was because their incentives (return on equity) were aligned to higher leverage. So while maximizing on
the objective of higher return they did not optimize on the amount of leverage as they found solutions
in bypassing part of the risk through other means of ‘innovation’.
Now from the society’s point of view the total risk was multiplying and therefore the net effect to the
society was that there was a need to deleverage, but the ‘winner takes all’ payoff matrix was designed
to exacerbate just the opposite behavior. So here the total payoff of bank plus individual / corporate
together summed over all such entities moved to an intertwined mesh of payoffs that kept on adding
more risk to the society while no individual pair was worse off in the process.
Here there is a semblance of ‘take it or leave it’ ultimatum game between a high stake bank and the
entity to which the risky asset is offloaded. If I denote the High Stake bank as A and the Financial
Institution who is allured into taking the risky asset as B then the following Winner takes All emerges:
High Stakes Bank A
HAWK DOVE
Financial HAWK B‐C/2, ‐C/2 B, 0
Institution B, 0 or 0,
B DOVE 0, B B
In this case the dominant High Stakes bank wants to allure an FI (B), who is weaker, with a risky asset
and takes all the benefits to its coffers while leaving only the costs to the FI (B). Does this case look
familiar? Even the Dove‐Dove is familiar when the costs are driven down to zero and the entire benefit B
is passed on to the high Stakes bank. This could well be designed through an information asymmetry
where the dominant player is unaware of the true risks entailed in the assets.
What happens when the next round is played with another Institution, the same experience repeats and
more leverage is obtained by dumping the risky asset off the books. This is a start of the contagion of
risk taking as more risk taking begets more, something like the positive feedback loop.
What happens to the payoff for the society as a whole? While the individual benefit is computed, the
cost to the society for the winner take all situation is a bit different, because it incentivizes an extreme
behavior of taking more and more risks, as in a winner take all situation the payoff for the winner is
many times the normal payoff. The society loses as the summation of individual gains by the high stakes
players is less than the losses made by the others on whom the risky assets are dumped. This has been
the recent case where finally through a tax payer bailout the parity was restored that cost Trillions of
dollars to the society. The net worth of all the U.S. holds went through a correction of several Trillion
dollars.
The current trends of financial market runs by the banks and other financial institutions have shown the
deficiencies of the Winner Take All syndromes. The world of the hawks and doves saw a co‐existence of
different strategies and a mix of winners and losers where the society made its rules or modified its
rules so that not one but many winners could coexist and multiply and cogitate.
Our world unfortunately today is more inclined towards few winners and many losers and we gladly
incentivize actions that leave fewer and fewer winners in very high stakes games of all kinds. The society
on the whole, whether it gains or loses is not clear both in the short or the long term as we have seen
how such extreme behaviors of ‘winner takes all’ has left the society with fewer choices. But the sad
part is that today’s society that is more rational chooses an irrational path of avoidance of a debate on
this topic as more losers help the very few winners to grow their claims on the rest of the society. That
in sum is the summary of the Winner takes all contagion that it helps to create as is evident from the
recent example from the Financial World.
This leads me to the concept of the Irrational Choice Framework.
Is there the existence of irrational choices and are some of them exercised by rational individuals? Or is
every choice rational and is it only that in absence of information, one is bound to make an irrational
judgment? A choice is rational only to the extent that it is based on an assumed incentive payoff as
perceived by the participant. If the payoff is assumed to be much higher than the costs, one is bound to
exercise a choice.
Let me illustrate with some examples.
In an election the choice of an individual voter as influencing the final outcome is very low, therefore
there is not so much incentive for any individual voter to participate in an election. In fact political
parties have to work overtime to ensure higher voter turnout. But there are individual voters who still
voluntarily exercise their choice. Is their decision to exercise their choice irrational?
To test this we need to look at the costs and the benefits. In this case the cost is very low (may be
sacrificing a few hours of personal time, in fact that is also coming down with more technological
advancement), and the perceived benefit could actually be higher if the candidate’s choice wins the
election. So the benefit depends on the probability that the winning candidate is chosen by the person
in question. In a multiparty system, like in India, this could actually have a lower probability and
therefore all the more reason that the benefit could actually be low.
So we could create a structure as follows:
Benefit
High Low
High Risky Avoidance
Cost Low Exercise Undecided
Here if we look at the structure of decision making, every decision is based on a rationale of weighing
costs against benefits. But here there is also the element of risk, particularly in the case of costs being
high but benefits being also high. For example it could well be that the costs are high because there is a
threat of being outcast by the community if participation is avoided.
It is only in this risky situation that the question of Irrationality arises, because it is only in this situation
that one is not in a position to weigh the actual risks involved against the benefits to be derived against
a set of costs. It is also in this situation that the exact nature of costs and benefits are unknown and the
participant assigns certain values which could actually vary from one extreme to the other.
It is important to note that if the costs are increased regardless of any change in benefits there would be
more numbers shirking from the participation in the election, which would be guided by their rational
choice, whereas if the costs increase while the benefits increase simultaneously it would be the
irrational choice framework that would play in deciding how risky is the choice.
Let me extend this example to the case of buying of a Lottery ticket. The probability of getting a winning
ticket is very low, but the cost of buying a ticket is also low. Suppose there are two categories of tickets
one, which is high priced, where probability of wining is high and a low priced ticket where the
probability of winning is low. If the same decision matrix is applied it would look like this.
Probability of Winning
High Low
Cost of High Risky Avoidance
the
Lottery
ticket Low Exercise Undecided
So most likely a buyer would avoid buying the high priced ticket, but could actually buy more number of
low priced tickets to increase his chances of winning. Is this decision rational? Let us examine with some
hypothetical numbers:
Low Priced ticket: probability of winning: 1/100 Price of low priced ticket: $ 1, so the Expectation of
winning with ten low priced tickets = 1/10
High Priced ticket: probability of winning: 1/10 Price of high priced ticket: $10, so the expectation of
winning with a single high priced ticket = 1
So the expectation is higher in the case of the high priced ticket. But isn’t it an irrational choice that
more people buy more number of cheap tickets to improve their chances of winning?
It is perhaps because human expectations are computed irrationally when it comes to bearing of costs,
and human brains assign higher costs when there is a risk involved. It is simply that the human mind
cannot compute rational ‘expectations’ in a complex situation.
Let me take another example of assigning of probabilities itself to some events that are rare but having
high impact if they occur. Think of a sovereign default of the order of EU, or for that matter U.S. itself
and the chances of this event happening is close to zero. But the impact this event would cause would
be devastating. The probability‐impact matrix in this case is meaningless because in this case even very
low probability with such a high impact would be devastating and the actions necessary to mitigate such
an event from happening would automatically get precedence over any other alternatives. But is the
collective wisdom of the society directed towards convergence of all efforts towards avoidance of a
default in the long term? I am not sure, as I see that deficits keep soaring while debts keep increasing
simultaneously. Almost like a positive feedback loop.
This is similar to aggregation of deferment actions by postponing mitigation efforts. Is that governed by
an irrational choice framework? Otherwise how could it be that the more fiscally conservative measures
are being deferred while more indebtedness is being enhanced with a more loose monetary policy?
Does it not look like a positive feedback loop?
Let me take some numbers from the U.S. economy. US debt has touched 93% of the GDP, while its
budget deficit has climbed to 10% of the GDP. The solution on which the collective wisdom has
converged is that the deficit need not be curtailed with continuation of the tax cut, while the total debt
need not be stymied at the immediate moment. Is this not a positive loop, irrational outcome?
If debt was kept constant
It is true that this is an unprecedented crisis, and the likes of which have not been witnessed in many
decades. But one would notice that there was a serious effort by the U.S. citizens and the Presidency in
the crisis following the War years, to take down debt and take down deficit in the aftermath of the War
as is evident in these charts given above. The conscious effort to bring down National Debt in the 1940
to 1980 and simultaneously hold on to conservative fiscal positions is in sharp contrast to the current
situation in the period 2008 to 2010.
This need to be seen in the context of major shift in the strategies and particularly in society’s
acceptance of the ‘Winner takes All’ mindset that is all pervasive in every walk of life. The society seems
to believe that for the successes of a few, let many fail, or so it seems.
The question is whether this acceptance gives the society a holistic benefit, which only time will tell.
Procyon Mukherjee
Zurich
10th December 2010