1 . Mental Accounting bias ignores correlation. I am just wondering does any other bias ignore the correlation as well?
One of the consequences of loss aversion bias (disposition effect) is hold on to losers too long but may sell winders too quickly. Just forgot the reason. Why is that? If they feel more pain from a loss, wouldn’t they want to sell the losses to avoid the pain?
For the heuristics , I found three concepts are related to this. Do you know any other areas mentioned the heuristics? Just trying to use this to remember some concepts.
a. the editing phase under prospect theory uses heuristics to make a preliminary analysis
b. Anchoring and adjustment bias: people use psychological heuristic experience based on trial and error rules to unduly affect Probabilities.
c. Availability bias: people use a heuristic to estimate the probability of an outcome based on how easily the outcome comes to mind.
for C, I’d say the main one tends to be representativeness. IF X THEN Y, generally without further due diligence
Thanks all for the help!
I agree that BPT, Mental Accounting and Goal Based Investing are all related to each other. Just saw another post. " goal based investing is to accommodate biases. BPT explains that there is a reason for goal based investing to exisit."
If so, availability bias and representativeness are very similar. Just reviewed a topics test question “as a result of availability bias, investors may choose an investment based on advertising rather than a thorough analysis of the options.”
Then, how do we separate these two biases? Hope we don’t have question listing both…
What: Using overly simple if-then or rule-of-thumb decisions instead of thorough analysis. Individuals use heuristics (experience) to classify information: “IF it looks a certain way THEN it must be in a certain category.” There are two forms representativeness bias can take: Base-rate neglect is where new info is given too much weight relative to the old information whereas sample-size neglect refers to the assumption that small samples represent the entire population
Consequences: New info is given too much weight, often using simple classifications or stereotypes rather than engaging in the mental effort of updating beliefs (e.g. buying a stock simply because it is in country X or investing with a manager based on short-term results), base decisions on small sample sizes
Mitigate: Consider actual probabilities, focus on historical returns (periodic table of investment returns)
What: Focus on info that is easy to find, or focus on easily remembered past experiences, possibly depending on heuristics or rules of thumb. Caused by:
Retrievability: How easily/quickly something is recalled
Categorization: Using familiar classifications (even if not relevant)
Range of Experience: Narrow experience can cause estimation bias & narrow frame of reference
Resonance: People evaluate situations relative to their own likes/dislikes/circumstances and use those to judge or compare
Consequences: Easily recalled & understood events perceived as being more likely. Select investments base on advertising, may lack diversification because they limit their opportunity set or over-invest in firms and industries that resonate with them. Common issue with analysts
Mitigate: Use an investment policy statement, thorough research, focus on long term results.
Thanks, s1mple! This is an area I still need to work on especially with all the mitigation methods. There some overlaps and one example could show multiple bias. So that is why if was during the exam, I am not sure If I will be brave enough to use the same reason like the one below.
On 2014 morning exam question 11 Part A.
Lam has both Availability and Representatives biases.
One of the reasons for Representativeness is exactly the same as Availability "Lam demonstrates representativeness/availability bias by investing in companies that remind him of his most successful corporate clients since “THEY KNOW WHAT WORKS”.
They also list another reason for availability “Lam gets some investment ideas from advertisements by industry trade groups and from blogs sponsored by the companies he is researching, rather than considering additional independent resources.”