From the Boston Mock Exam yesterday, a coin is flipped and tails appears 5 times on the trot. The professor then asks his student what the probability of a head will be in the next throw. The student is convinced that it’s >50%. Is the student exhibiting overconfidence or representativeness? I had a bit of time in the exam and thought about this for 5 minutes. My conclusion was that the student is exhibiting both: He believes that past performance is representative of future performance and he is overestimating his ability to interpret information correctly. Your thoughts please…
This is a clear description of gambler’s fallacy, which CFAI actually talks about in its books as part of representativeness. (Not at all in Schweser as far as I know.) That being said, it also sounds like overconfidence to me since he’s setting too narrow of a CI for possible outcomes, but I tend to get these wrong a lot so who knows. If I had to pick one I’d go with representativeness since that’s where CFAI grouped it but it sounds like this might have been an essay question. I’m guessing your response was wrong?
I also initially put overconfidence. The way I see it, if you’re given a situation where someone follows a trend or infers something from a trend, go with representativeness. This is what CFAI wants you to answer. Otherwise, go with overconfidence. Also from the exercises I’ve done, overconfidence is more depicted through overtrading, or other elements that define it than this. J.
Did not do Boston Mock Exam but here my two cents. The answer is more overconfidence, through the wording should to be much stronger, sth like “The student is pretty sure/quite certain that it’s >50%.” However, it is overconfidence nevertherless. As Aimee pointed out, this is a case of “Gambler’s fallacy”, which is a wrong application of “law of average”. It is NOT representativeness (although it is mentioned in the representativeness section). Actually, they are opposite but both are wrong. representativeness: believe that the trend will continue, so in this case, one would guess that the chance is <50%. gambler’s fallacy: believe that the trend has been long enough that it is about time that the trend reverses to be back to “normal”, so in this case, one would guess that the chance is >50%. The right answer is of course chance is exactly 50%
The reason it might be representativeness is because people strongly believe (“stereotype”) that it cannot go on like this, it has to be heads now… representativeness doesn’t necessarily mean - “the trend will continue”… representativeness relies on beliefs (for example, “the market has been trending up for too long… it has to go to BELOW average!”) People are not objective in these situations;
kurmanal Wrote: ------------------------------------------------------- > The reason it might be representativeness is > because people strongly believe (“stereotype”) > that it cannot go on like this, it has to be heads > now… representativeness doesn’t necessarily mean > - “the trend will continue”… representativeness > relies on beliefs (for example, “the market has > been trending up for too long… it has to go to > BELOW average!”) People are not objective in these > situations; Just reread the book, it seems that gambler’s fallacy IS part of the representativeness heuristics. I was wrong