Physiological Biases That Make Investors Become Irrational

Representativeness Bias or Representativeness Heuristic is a shortcut in trying to associate present people or events to past experience. It is the probability that event A is connected to event B because they share common physical characteristics. We observe a person or object and if it shares similar qualities from another object we are familiar with, then we assume that the object is a part of that category.

The behaviour of markets and investors, the decision making in the market place and the dynamics of demand and supply in any given market cannot be determined with a hundred percent accuracy. However master minds in the past have designed various techniques and theories that help investors make a particular buying decision, or to make choices logically. These theories and techniques help today’s investors to peep into the future and make almost immaculate predictions regarding the future behaviour of the market and the ongoing trends. A lay man night view the decision making of an investor as being solely based upon speculation but in reality every move that an investor makes today in the market place is backed up by sound calculation and

Harry Markowitz 1991, developed a theory of “Portfolio choice”, that allows the investors to examine the risk as per the expected returns. In modern World, this theory is known as Modern portfolio theory (MPT). It attempts to attain the best portfolio expected return for a predefined portfolio risk, or to minimise the risk for the predefined expected returns, by a careful choice of assets. Though it’s a widely used theory, still has been challenged widely. The critics question the feasibility of theory as a strategy for

The article “Is Tiger Woods Loss Averse? Persistent Bias in the Face of Experience, Competition, and High Stakes” is analyzed which investigate the existence of behavioral bias in a high stake, competitive setting involving experienced agents. It portrays Deming’s System of Profound Knowledge by complying with its four parts. The complete endeavor provides a practical setting to learn decision theory.

To try to understand this concept, researchers from University College of London and Duke University teamed up to conduct an experiment. The experiment involved showing eighty participants a picture of a jar full of pennies. The participant was instructed to estimate the amount in the jar to another participant who was shown a smaller picture of the same jar. Each participant was doubling as “a professional financial adviser who was instructed to advise an inexperienced client about what investments to make,” said study coach Neil Garrett of University College of London. The experiment conductors gave the participants various incentives to lie. “In some cases, for instance, intentionally overestimating the jar’s contents was rewarded with a bigger cut of the money.” (ScienceNews.com)

One of the biases that have been proposed by Kahneman and Tversky, and researched a great deal is the Availability bias. Availability bias is the concept of giving first choice to events and information because they are often more recent or giving preference to events, observed personally. Senior managers and decision makers are often victims of availability bias. Availability bias occurs when decision makers estimate the probability of outcome based on how prevalent the outcome appears in their lives (Pompian, 2011)

Such decisions may affect the company’s profitability today but judging from the fact that high risk means low stock price and vice-versa, high return waits in the future.

2. As a result of Spin Master’s success, there are several decision errors and traps that might be a problem for them in the future. Initially, representation bias may be an error that will be encountered by the company going forward. Representation bias is when people asses the likelihood of something occurring based on its similarity to a stereotyped set of occurrences. Spin Master may make future decisions about creating new products, simply based on what worked for the company in the past, or because they work for all the other toy companies.

In decision making, we make an array of methodical mistakes that are usually related to many biases that transpire when using judgmental heuristics (Kreitner & Kinicki, 2013). Such judgmental heuristics denotes guidelines followed to decrease data dispensation needs (Kreitner & Kinicki, 2013). We are given eight biases that play a role in our decision- making processes which are availability heuristic, representativeness heuristic, confirmation bias, anchoring bias, overconfidence bias, hindsight bias, framing bias, and escalation of commitment bias.

According to van der Pligt (2001) the study of human decision-making is an interdisciplinary project including economics, statistics as well as psychology, and moreover, decision making behavior involving almost all branches of psychology. After three weeks’ simulation of trading on Australian Stock Exchange, in retrospect, I amazingly find there are substantial bias impacts on my decision with respect to choosing, selling and keeping stocks.

It is has always been better to be lucky rather than smart. You cannot rely on luck, so most of us must make do with smart. It is the best policy to assume that the reward on an investment will bear a direct relationship to its risk. It is necessary, before making any investment that you make some

This essay will explain what rationality of investors and home bias are and then discuss to what extent the ‘home bias’ phenomenon challenges the view that investors are rational.

Effective decision-making is very important on how probability can be applied therefore effective decision-making must be rational. As mentioned before, people who are deciding rationally are attempting to reach goals in a systematic way. They make sure

When loss averse investor faces profits, he strives to keep further his income level higher than the aspiration level (orientation level that discerns gains and losses). On other hand, investors faced with losses attempt to optimize the likelihood that ultimate wealth outreaches the aspiration level. Such kind of behaviour is represented as a break-even effect. When investor is below the aspiration level, due to break-even effect he constantly chooses a speculation over a certain return rate. This kind of behaviour shows that if a loss averse investor lags behind his investments, he starts investing more severely in equities. Berkelaar and Kouwenberg try to explain this idea using following example. Imagine an

An investment also known as a security is a pledge of money from an individual, government, or cooperation that is expected to accrue additional wealth on top of its original dollar amount. An investment can be a long-term or short-term obligation depending on the investor’s goals and/or assets they choose to invest in. The investment decision process is a two-step process which is necessary to make a sound trustable and efficient investment. The first step involves an evaluation of the investment you as the investor are interested in committing money towards, including characteristics of the security (i.e. how it acts in the current market, how the current/future market may react to this investment and possible returns on your investment). Finally, the management of your investment portfolio, including how often it should be revised, how the performance of your securities should be measured (how often they should be measured), and other important aspects of your current investments. Investing revolves around one basic concept, improving our future, investors invest money today to improve their welfare in the future which is why understanding what an investment is and the process of decision making before investing is extremely important.