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B. Venkatesh

AN EXPERIMENT in the area of financial economics shows that sometimes our behaviour is similar to that of the birds. No wonder we are sometimes accused of being bird-brained!

Involving hungry pigeons, the experiment documented that the birds prefer smaller quantities of food immediately to larger quantities in the future.

Those familiar with corporate finance will recognise that Gordon's dividend model is based on similar concept. This theory argues that people prefer cash flows now to the chances of receiving larger returns in the future.

"A bird in the hand is worth two in a bush" does indeed have meaning!

The bird experiment also revealed another behaviour. When offered a choice between smaller quantity of food after, say, 20 seconds (and not immediately) to large quantity in the future, the birds preferred the latter.

This change in behaviour is called preference reversal. It shows that the pigeons are impatient in the short term and relatively patient in the long.

Studies have shown that you and I exhibit similar behaviour. Think about this: If you were offered Rs 10 lakh in 13 months or Rs 15 lakh in 24 months, which would you choose?

The way we behave has important implications for modelling in finance. The above experiment shows that we do not use the same discount factor for valuing short-term and long-term cash flows.

It also throws some light on our savings behaviour. We are generally reluctant to save more for retirement out of our current income.

This is because we cannot wait to derive benefits way into the future.

But we would not mind saving more out of our future salary increases because we are patient in the long run.

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