Are you ready for Christmas?

Finance is based on the idea that we are rational and risk-averse. When investing we prefer higher returns to lower ones, and if two investments offer the same return we will choose the one which is less risky. When faced with the choice between an investment with low risk and return and another with both higher risk and higher return I know what I would do, but cannot speak for you. In other words I understand my preferences but not yours, which makes it difficult for one person to give investment advice to another. This explains why, if you go to an independent financial advisor they will ask you to complete a questionnaire designed to indicate just how risk averse you are.

Buying Christmas gifts is a bit like offering investment advice, it is difficult if you do not know the preferences of the recipient. In a book with the wonderful title Scroogenomics, Joel Waldfogel² explains how he has estimated the deadweight welfare loss that is created by our Christmas shopping. A welfare loss is created when I buy a gift for £10, but as far as the recipient is concerned, it is worth less than that. Think about all those weird and wonderful novelty gifts that appear in department stores at this time of year - wind-up racing snails, singing hamsters and reindeer slippers. If you are a rushed or confused shopper these seem like a good idea at the time, but are they really what your loved ones want? The trouble is that anyone receiving that kind of gift will smile when they see it. Research by Yang and Urminsky³ shows that gift givers like to hand over their presents in person because they are hoping for a reward in the form of a smile. You as the recipient may not think it is worth £10, but the more you smile at a singing hamster this year, the more likely you are to get a dancing llama next year and so the welfare loss carries on year after year.

How can rational people overcome this problem? For Waldfogel the answer is gift tokens. If I give you a token valued at £10 you can buy something which you value at £10, it makes you happy and makes life easier for me. I may not see a big smile, but at least I don’t have to listen to your singing hamster …

Notes

1. As reported by finder.com/uk/Christmas-shopping-statistics
2. Waldfogel, J. (2009) Scroogenomics Princeton University Press
3. Yang, A.X. and Urminsky, O. (2018) The smile-seeking hypothesis: How immediate affective reactions motivate and reward gift-giving Psychological Science 29 (8) 1221-1233