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April 13, 2020

Using Behavioral Finance To Understand The Necessity Of Quarantine

With every drop in GDP from the quarantine, my stomach drops, as well. I can’t help but ask myself, “is this the right way to go?
With every drop in GDP from the quarantine, my stomach drops, as well. I can’t help but ask myself, “is this the right way to go? As a Christian, I would like to submit to the authority of the government (Romans 13), but what if their policies are overly destructive, like cutting off our hand to fix a paper cut? What about the idea of ‘herd immunity’ where we are all exposed to the virus, all-at-once, and get done with it? With no more curves to flatten in the future?”

There has to be a better way than quarantine.

Even though I really have no valid voice in questioning the policies of the CDC, I will provide my perspective as a finance professor. Looking at behavioral finance may actually provide evidence in favor of the quarantine. For many years, I have conducted the following behavioral finance thought experiment with my students from recent Nobel Prize winner in economics, Richard Thaler (Thaler & Ganser, 2015).

Please respond to the following two scenarios:

A. Suppose by attending a lecture you have exposed yourself to a rare fatal disease. If you contract the disease you will die a quick and painless death sometime next week. The chance you will get the disease is 1 in 1,000. We have a single dose of an antidote for this disease that will sell to the highest bidder. If you take this antidote the risk of dying from the disease goes to zero. What is the most you would be willing to pay for this antidote? (If you are short on cash we will lend you the money to pay for the antidote at a zero rate of interest with thirty years to pay it back.)

B. Researchers at the university hospital are doing some research on the same rare disease. They need volunteers who would be willing to simply walk into a room for five minutes and expose themselves to the same 1 in 1,000 risk of getting the disease and dying a quick and painless death in the next week. No antidote will be available. What is the least amount of money you would demand to participate in this research study?

Consistent with what Richard Thaler found in his experiments, my students tended to have dramatically different responses between scenarios A and B. In fact, many of my students would refuse to participate in scenario B (even though it was a thought experiment). Having dramatically different responses to scenario A and B is known as the endowment effect.

The endowment effect has applications in finance by showing that sellers often think that what they own is worth more than its true fair market price simply because it is owned by them (i.e., it has become a part of their endowment). A classic example of this is when investors hold onto stock losers too long (Kalunda & Mbaluka, 2012).

This same effect may explain why a preemptive quarantine is the best strategy for policymakers to enact. If everyone was asked to essentially become exposed to the Covid-19 virus all-at-once, for the sake of Herd immunity, that would be very similar to asking them to participate in scenario B. Put another way, herd immunity is similar to scenario B since it asks people to voluntarily expose themselves to a rare disease in order to be compensated in the form of higher future expected economic wealth for our country. The final result of this would be, just like with scenario B, a refusal by a majority of people, and these people would likely self-quarantine.

Quarantine does not ask people to enter into scenario B.

A delayed self-quarantine is a much more disastrous scenario than an early, government sanctioned quarantine for the following reasons:

  • The delay in quarantine would increase the number of cases, which would then overwhelm the healthcare system, causing thousands of people to die without hospital beds or sufficient care.
  • A very similar economic loss would occur (perhaps worse) than if the government sanctioned a preemptive quarantine.
  • Having both the hospital system become overrun and the government entities enact a system that people will fundamentally not follow would cause a deep distrust in two of the most important institutions in our society. This would cause a rip in our social fabric.

Our current policy does not ask people to be a part of scenario B. This is good. It means that some level of faith is able to be maintained in both our health-care system and in the government’s authority; even while our economies experience heavy losses.

While I may agree, or disagree, with the policies of the kingdoms of this world, as a Christian, I am called to seek His Kingdom first (Matthew 6:33). Through this Covid-19 crisis, God’s Kingdom has not experienced any drop in heavenly GDP. In fact, His Kingdom is likely advancing at a more rapid rate than before, as our idols of self-autonomy and independence are toppled.

Which kingdom do I want to prosper more? If I am desperate for my kingdom to prosper, and mildly interested in God’s Kingdom to prosper, then I am not walking as Jesus calls me to walk.

Which kingdom do I want to prosper more?

During this time, as good, or bad, human policies come and go, the words of Jesus should be at the forefront of my mind:

“In the world you will have tribulation. But take heart; I have overcome the world.” (John 16:33, ESV)”

REFERENCES

Kalunda, E., & Mbaluka, P. (2012). Test of endowment and disposition effects under prospect theory on decision-making process of individual investors at the Nairobi securities Exchange, Kenya.

Thaler, R. H., & Ganser, L. J. (2015). Misbehaving: The making of behavioral economics. WW Norton New York.

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*Advisory Services are offered through CWM Advisors, LLC dba Inspire, a Registered Investment Adviser with the SEC. All expressions of opinion are subject to change. This article is distributed for educational purposes, and it is not to be construed as an offer, solicitation, recommendation, or endorsement of any particular security, products, or services. Investors should talk to their financial advisor prior to making any investment decision.

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