PowerPoint Presentation

[Audio] Heuristic and Behavioral Biases of Investors.

[Audio] Overview: In this module, you are introduce to the Availability Bias Representativeness Bias Overconfidence Bias Anchoring Bias Ambiguity Bias.

[Audio] Learning Outcomes: At the end of this module, you should be able to: Describe the Anchoring Bias, Limited Attention, Storing and Retrieving Information, Availability Bias Explain the Risk Preference as well as the Mental Accounting, and Representative..

[Audio] One kind of investor behavior that leads to unexpected decisions is bias, a predisposition to a view that inhibits objective thinking. Biases that can affect investment decisions are the following: Availability Representativeness Overconfidence Anchoring Ambiguity.

[Audio] Availability bias occurs because investors rely on information to make informed decisions, but not all information is readily available. Investors tend to give more weight to more available information and to discount information that is brought to their attention less often. The stocks of corporations that get good press, for example, claim to do better than those of less publicized companies when in reality these "high-profile" companies may actually have worse earnings and return potential. The availability bias is the human tendency to think that examples of things that come readily to mind are more representative than is actually the case. The psychological phenomenon is just one of a number of cognitive biases that hamper critical thinking and, as a result, the validity of our decisions. What is an example of availability bias? What is availability bias in business? This is assessing the probability of an event occurring based on previous situations that have happened. The decision is influenced by the impact of an incident that occurred How does availability bias affect decision-making? The availability heuristic can lead to bad decision-making because memories that are easily recalled are frequently insufficient for figuring out how likely things are to happen again in the future. Ultimately, this leaves the decision-maker with low-quality information to form the basis of their decision. How can we reduce availability bias? Avoiding Availability Bias Build a team with diverse experiences and points of view. ... Seek broad input from your team. ... Set high standards for clear thinking. ... Utilize your network when making decisions. ... Take on an attitude of continuous learning and apply it on the job and demand it of others..

[Audio] For example, after seeing several news reports about car thefts, you might make a judgment that vehicle theft is much more common than it really is in your area. This type of availability heuristic can be helpful and important in decision-making..

[Audio] Representativeness is decision making based on stereotypes, characterizations that are treated as " representative" of all members of a group. In investing, representativeness is a tendency to be more optimistic about investments that have performed well lately and more pessimistic about investments that have performed poorly. In your mind you stereotype the immediate past performance of investments as "strong" or "weak." This representation then makes it hard to think of them in any other way or to analyse their potential. As a result, you may put too much emphasis on past performance and not enough on future prospects. What is representational bias? 1. Decision Making Biases & Errors. Definition: "It means the managers assess the likelihood of an event based on its closeness to the other events, it is called Representation Bias" What is representative bias in decision making? Representative bias is when a decision maker wrongly compares two situations because of a perceived similarity, or, conversely, when he or she evaluates an event without comparing it to similar situations. Objective investment decisions involve forming expectations about what will happen, making educated guesses by gathering as much information as possible and making as good use of it as possible. Overconfidence is a bias in which you have too much faith in the precision of your estimates, causing you to underestimate the range of possibilities that actually exist. You may underestimate the extent of possible losses, for example, and therefore underestimate investment risks..

[Audio] What is an example of representativeness bias? For example, police who are looking for a suspect in a crime might focus disproportionately on Black people in their search, because the representativeness heuristic (and the stereotypes that they are drawing on) causes them to assume that a Black person is more likely to be a criminal than somebody from another group..

[Audio] Overconfidence also comes from the tendency to attribute good results to good investor decisions and bad results to bad luck or bad markets. Overconfidence bias is the tendency for a person to overestimate their abilities. It may lead a person to think they're a better-than-average driver or an expert investor. Overconfidence bias may lead clients to make risky investments. What causes overconfidence bias? Overconfidence bias is often caused or exacerbated by: doubt-avoidance, inconsistency-avoidance, incentives, denial, believing-first-and-doubting-later, and the endowment effect. What is overconfidence bias in organizational behavior? Overconfidence bias occurs when individuals overestimate their ability to predict future events. Many people exhibit signs of overconfidence..

[Audio] What is overconfidence bias example? A person who thinks their sense of direction is much better than it actually is could show overconfidence by going on a long trip without a map and refusing to ask for directions if they get lost along the way. An individual who thinks they are much smarter than they actually are is a person who is overconfident..

[Audio] Anchoring happens when you cannot integrate new information into your thinking because you are too "anchored" to your existing views. You do not give new information its due, especially if it contradicts your previous views. By devaluing new information, you tend to underreact to changes or news and become less likely to act, even when it is in your interest. What is an example of anchoring bias? Anchoring bias occurs when people rely too much on pre-existing information or the first information they find when making decisions. For example, if you first see a T-shirt that costs $ 1,200 – then see a second one that costs $ 100 – you're prone to see the second shirt as cheap. What is the meaning of anchoring bias? Anchoring bias is a cognitive bias that causes us to rely too heavily on the first piece of information we are given about a topic. When we are setting plans or making estimates about something, we interpret newer information from the reference point of our anchor, instead of seeing it objectively. What is anchoring bias in economics? Anchoring is a behavioral finance term to describe an irrational bias towards an arbitrary benchmark figure. This benchmark then skews decision-making regarding a security by market participants, such as when to sell the investment..

[Audio] Ambiguity aversion is the tendency to prefer the familiar to the unfamiliar or the known to the unknown. Avoiding ambiguity can lead to discounting opportunities with greater uncertainty in favor of "sure things." In that case, your bias against uncertainty may create an opportunity cost for your portfolio. Availability bias and ambiguity aversion can also result in a failure to diversify, as investors tend to "stick with what they know." The ambiguity effect is a cognitive bias where decision making is affected by a lack of information, or "ambiguity". The effect implies that people tend to select options for which the probability of a favorable outcome is known, over an option for which the probability of a favorable outcome is unknown. What is ambiguity effect examples? An example of the ambiguity effect In order to better inform your decision, you decide to search online for reviews of these items. One has an average rating, while the other has no ratings yet, since it has only just been released. In this scenario, most people tend to select the item with the average rating. How do you overcome ambiguity bias? The main remedy of the ambiguity bias is clarity. If you are clear to people what they get from something you present them then they will feel more at ease. By giving them the information clearly and simply they will have higher confidence in your option over someone/something else..

[Audio] Using terms and concepts from behavioral finance, how might you evaluate the consumer or investor behavior shown in the following photos? In what ways might these economic behaviors be regarded as rational?.