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Table of Contents Availability Bias .................................................................................................... 2 Overreaction Bias .................................................................................................. 6 Research Report Analysis .................................................................................... 8 Illustrations .......................................................................................................... 12 Conclusion............................................................................................................

14 Bibliography ........................................................................................................ 15

Availability Bias
Availability bias is a human cognitive bias that causes us to overestimate probabilities of events associated with memorable or dramatic occurrences. A cognitive bias is a pattern of deviation in judgment that occurs in particular situations. A cognitive bias can also be explained as a flaw in judgment which is caused by memory, social attribution, and statistical errors. Since, memorable events are further magnified by coverage in the media; the bias is compounded on the society level. Two well-known examples would be estimations of the probability of plane accidents and the kidnap of children. Both events are quite rare, but the huge majority of the population outrageously overestimates their probability, and behaves accordingly. In reality, one is more likely to die from an auto accident than from a plane accident, and a child has a higher risk of dying in an accident than the risk of getting kidnapped. Availability bias is at the root of many other human biases and culture-level effects. Availability bias is a cognitive illusion. The availability biasis a mental shortcut that occurs when people make judgments about the probability of events by how easy it is to think of examples. The availability bias operates on the notion that, "if you can think of it, it must be important." The availability of consequences associated with an action is positively related to perceptions of the magnitude of the consequences of that action. In other words, the easier it is to recall the consequences of something, the greater we perceive these consequences to be. Sometimes, this heuristic is beneficial, but the frequencies that events come to mind are usually not accurate reflections of their actual probability in real life. Applications Media After seeing news stories about child abductions, people may judge that the likelihood of this event is greater. Media coverage can help fuel a person's example bias with widespread and extensive coverage of unusual events, such as homicide or airline accidents, and less coverage of more routine, less sensational events, such as common diseases or car accidents. For example, when asked to rate the probability of a variety of causes of death, people tend to rate "newsworthy" events as more likely because they can more readily recall an example from memory. Moreover, unusual and vivid events like homicides, shark attacks, or lightning are more often reported in mass media than common causes of death like common diseases.

For example, many people think that the likelihood of dying from shark attacks is greater than that of dying from being hit by falling airplane parts, when more people actually die from falling airplane parts. When a shark attack occurs, the deaths are widely reported in the media whereas deaths as a result of being hit by falling airplane parts are rarely reported in the media. In a 2010 study exploring how vivid television portrayals are used when forming social reality judgments, people watching vivid violent media gave higher estimates of the prevalence of crime and police immorality in the real world than those not exposed to vivid television. These results suggest that television violence does in fact have a direct causal impact on participants' social reality beliefs. Repeated exposure to vivid violence leads to an increase in people's risk estimates about the prevalence of crime and violence in the real world. Counter to these findings, researchers from a similar study argued that these effects may be due to effects of new information. Researchers tested the new information effect by showing movies depicting dramatic risk events and measuring their risk assessment after the film. Contrary to previous research, there were no effects on risk perception due to exposure to dramatic movies. Business and economy One study sought to analyze the role of the availability heuristic in financial markets. Researchers defined and tested two aspects of the availability heuristic:

Outcome Availability availability of positive and negative investment outcomes Risk Availability availability of financial risk

Researchers tested the availability effect on investors' reactions to analyst recommendation revisions and found that positive stock price reactions to recommendation upgrades are stronger when accompanied by positive stock market index returns. On the other hand, negative stock price reactions to recommendation downgrades are stronger when accompanied by negative stock market index returns. On days of substantial stock market moves, abnormal stock price reactions to upgrades are weaker, and abnormal stock price reactions to downgrades are stronger. These availability effects are still significant even after controlling for event-specific and company-specific factors.[18] Similarly, research has pointed out that under the availability heuristic, humans are not reliable because they assess probabilities by giving more weight to current or easily recalled information instead of processing all relevant information. Since information regarding the current state of the economy is readily available, researchers attempted to expose the properties of business cycles to predict the availability bias in analysts' growth forecasts. They showed the availability heuristic to play a role in analysis of forecasts and influence investments because of this. Additionally, a study by Hayibor and Wasieleski found that the availability of others who believe that a particular act is morally acceptable is positively related to others' perceptions of the morality of that act. This suggests that availability heuristic also has an effect on ethical decision making and ethical behavior in organizations. Education

A study done by Craig R. Fox provides an example of how availability heuristics can work in the classroom. In this study, Fox tests whether difficulty of recall influences judgment, specifically with course evaluations among college students. In his study he had two groups complete a course evaluation form. He asked the first group to write two recommended improvements for the course (a relatively easy task) and then write two positives about the class. The second group was asked to write ten suggestions where the professor could improve (a relatively difficult task) and then write two positive comments about the course. At the end of the evaluation both groups were asked to rate the course on a scale from one to seven. The results showed that students asked to write ten suggestions (difficult task) rated the course less harshly because it was more difficult for them to recall the information. Students asked to do the easier evaluation with only two complaints had less difficulty in terms of availability of information, so they rated the course more harshly.[21] Criminal justice The media usually focuses on violent or extreme cases, which are more readily available in the public's mind. This may come into play when it is time for the judicial system to evaluate and determine the proper punishment for a crime. In one study, respondents rated how much they agreed with hypothetical laws and policies such as "Would you support a law that required all offenders convicted of unarmed muggings to serve a minimum prison term of two years?" Participants then read cases and rated each case on several questions about punishment. As hypothesized, respondents recalled more easily from long-term memory stories that contain severe harm, which seemed to influence their sentencing choices to make them push for harsher punishments. This can be eliminated by adding high concrete or high contextually distinct details into the crime stories about less severe injuries. A similar study asked jurors and college students to choose sentences on four severe criminal cases in which prison was a possible but not an inevitable sentencing outcome. Respondents answering questions about court performance on a public opinion formulated a picture of what the courts do and then evaluated the appropriateness of that behavior. Respondents recalled from public information about crime and sentencing. This type of information is incomplete because the news media present a highly selective and non-representative selection of crime, focusing on the violent and extreme, rather than the ordinary. This makes most people think that judges are too lenient. But, when asked to choose the punishments, the sentences given by students were equal to or less severe than those given by judges. In other words, the availability heuristic made people believe that judges and jurors were too lenient in the courtroom, but the participants gave similar sentences when placed in the position of the judge, suggesting that the information they recalled was not correct. Role of Availability Bias in human life Availability bias occurs when we overweigh evidence that comes easily in mind or is more prevalent. This could be recent evidence or what we recognize as meaningless events. As an example, suppose if we happen to see a car accident today, it would be a natural tendency for us to drive more carefully for the next couple of weeks or months and as time passes, our driving would return back to normal. Unfortunately, we are also overly influenced by attention grabbing information that is likely not even relevant. It makes us to think that events that receive heavy media attention are most

important than they really are. Availability bias causes investors to over-react to market conditions whether they are positive or negative. How to avoid Availability Bias? The most important lesson to be learned is to retain a sense of perspective. If we do a thorough job of investigating each and every problem from its root cause, we will be able to understand the true significance of recent news in media and newspaper and will be able to act accordingly. Rely on facts and data, rather than coming to conclusions based on gut!

Overreaction Bias
One consequence of having emotion in the stock market is the overreaction toward new information. According to market efficiency, new information should more or less be reflected instantly in a security's price. For example, good news should raise a business' share price accordingly, and that gain in share price should not decline if no new information has been released since. Reality, however, tends to contradict this theory. Oftentimes, participants in the stock market predictably overreact to new information, creating a larger-than-appropriate effect on a security's price. Furthermore, it also appears that this price surge is not a permanent trend although the price change is usually sudden and sizable, the surge erodes over time. Excess volatility of speculative asset prices is attributed to the fact that speculative asset prices deviate from the long-term trend of the efficient markets model and over many years return to this trend. It appears as if stock prices over-react to some news, or to their own past values, before investors come to their senses and correct the prices .Securities that have exhibited long records of good news are usually overpriced but have low average returns later on. Many other studies have confirmed this finding. Research scholars argue that the theory of observational learning, and particularly of informational cascades, can help explain phenomena such as stock market crashes. Motivated by a variety of psychological evidence, research paper authors present a model of investor sentiment that displays under reaction of stock prices to news such as earnings announcements and overreaction of stock prices to a series of good or bad news. According to one of the research scholar, the apparent overreaction of stock prices to information is about as common as under reaction. This argument is unconvincing, because under- and overreactions appear to occur under dierent circumstances and/or at different time intervals. Odean (1998) tested and found evidence for the disposition effect, the tendency of investors to sell winning investments too soon and hold losing investments for too long. Daniel, Hirshleifer and Subrahmanyam (1998) propose a theory of security markets based on investor overcondence (about the precision of private information) and biased selfattribution (which causes changes in investors condence as a function of their investment outcomes) which leads to market under- and overreactions. Winners and Losers In 1985, behavioral finance academics Werner De Bondt and Richard Thaler released a study in the Journal of Finance called "Does the Market Overreact?" In this study, the two examined returns on the New York Stock Exchange for a three-year period. From these

stocks, they separated the best 35 performing stocks into a "winners portfolio" and the worst 35 performing stocks were then added to a "losers portfolio". De Bondt and Thaler then tracked each portfolio's performance against a representative market index for three years. Surprisingly, it was found that the losers portfolio consistently beat the market index, while the winners portfolio consistently underperformed. In total, the cumulative difference between the two portfolios was almost 25% during the three-year time span. In other words, it appears that the original "winners" would became "losers", and vice versa. So what happened? In both the winners and losers portfolios, investors essentially overreacted. In the case of loser stocks, investors overreacted to bad news, driving the stocks' share prices down disproportionately. After some time, investors realized that their pessimism was not entirely justified, and these losers began rebounding as investors came to the conclusion that the stock was underpriced. The exact opposite is true with the winners portfolio: investors eventually realized that their exuberance wasn't totally justified.

Research Report Analysis

Research Paper 1: Overreaction to Fearsome Risks by Cass R. Sunstein and Richard Zeckhauser The Problem and the Thesis:When risks threaten, cognitive mechanisms bias people toward action or inaction. Fearsome risks are highly available. The availability bias tells us that this leads people to overestimate their frequency. Therefore, they also overreact to curtail the likelihood or consequences of such risks. More generally, fear can paralyze efforts to think clearly about risks. We draw on a range of environmental risks to show the following: 1. Fear leads us to neglect probability of occurrence; 2. as fearsome environmental risks are usually imposed by others (as externalities), indignation stirs excess reaction; 3. We often misperceive or miscalculate such risks. Two experiments demonstrate probability neglect when fearsome risks arise: a. willingness-to-pay to eliminate the cancer risk from arsenic in water (described in vivid terms) did not vary despite a 10-fold variation in risk; b. the willingness-to-accept price for a painful but non dangerous electric shock did not vary between a 1% and 100% chance. Possible explanations relate to the role of the amygdala in impairing cognitive brain function. Government and the law, both made by mortals and both responding to public pressures, similarly neglect probabilities for fearsome risks. Examples relating to shark attacks, Love Canal, alar and terrorism are discussed. An understanding of action bias in the context of low-probability risks, and its common ingredient probability neglect, has important implications for both law and policy. It is predictable that in the aftermath of a terrorist attack, the public will both alter its behavior and demand a substantial governmental response. That will be true even if the magnitude of the risk does not warrant such a response, and even if the danger is far less than that presented by other hazards that do not greatly concern people, perhaps because they do not get much public attention. Consider, for example, the possibility that extensive security precautions at airports will lead people to drive rather than to fly; because flying is much safer than driving, such precautions might sacrifice many lives on balance. The monies spent in recent years on airplane security might be out of scale with the level of risk reduction produced, particularly since numerous tests have found that the screening routinely fails to find weapons. Overreaction to Environmental Risks:Overreaction to risk is frequently found in the environmental realm. A dramatic example is provided by the Three Mile Island accident in 1979. Significant amounts of reactor coolant

were leaked to the environment, including releases of cancer-inducing agents. The Kemeny Commission Report, created under Presidential order, concluded that in expectation less than one case of cancer would be created. Yet the accident affected public and political opinion sufficiently to terminate the construction of any new nuclear plants in the United States for 30 years. The coal- and oil-fueled plants built in their stead surely caused many more health problems, looking only at the air pollution they produced. Overreaction to fearsome risks in the environment can come about for many reasons: (1) Environmental risks are usually imposed unwillingly on external parties. Indignation over such an imposition stirs excess reaction. This proclivity is reinforced in the policy realm, where the party demanding action (the externality recipient) is not the party paying for it. Hence, paying much more to avoid a risk than the benefits secured is not troubling. (2) We misperceive the risk, as happened after Three Mile Island. (3) Though we calculate the risk, as opposed to merely grasping it through some gut process, through a series of conservative assumptions we end up with a probability estimate that is far above what an expected value calculation would yield. Scientific practice, say when proving a theory, is to employ conservative assumptions. However, rational decision theory requires that one act on the expected value of a probability. (4) Though we may have an accurate estimate of the risk, the emotions stirred by its fearsome aspect lead us to neglect probability values. This essay is devoted to the fourth reason. It focuses on low -probability risks. Therefore, not considering their magnitude leads to overreaction. 3. Demonstrating probability neglect Prospect theory (Kahneman and Tversky, 1979) tells us that the perceived benefits of risk elimination will be much less than proportional to the risk avoided, since the probability weighting function takes a downward leap at 0. However, prospect theory alone gives no indication that the ratio of valuations would change dramatically with the nature of a risk, or with the way it was described. The conclusion is that when a hazard stirs strong emotions, most people will pay an amount to avoid it that varies little even with extreme differences in the starting probability. What we are stressing here is that when the probability of loss is very low, people will show action bias. They will favor precautionary steps even if those steps are not justified by any plausible analysis of expected utility. The Demand For and Supply of Law If probability neglect characterizes individual judgment under certain circumstances, government and law are likely to be neglecting probability under those same circumstances. If people show unusually strong reactions to low-probability catastrophes, a democratic government is likely to act accordingly, either because it is responding to the public, or because its officials suffer the same proclivities. Our discussions of Three Mile Island and the arsenicstandard above are salient examples of such responsiveness.

Conclusion:Our central goal here has been to understand overreactions to fearsome risks. We have suggested that when risks are vivid, people are likely to be insensitive to the probability of harm, particularly when their emotions are activated.15 If terrible outcomes are easy to visualize, large-scale changes in thought and behavior are to be expected, even if the statistical risks are dramatically lower than those associated with many activities where the stakes are equivalent but do not raise public concern. This claim about action bias helps explain public overreaction to certain highly publicized, low-probability risks, including those posed by sniper attacks, nuclear power, abandoned hazardous waste dumps, anthrax, and perhaps terrorism more generally. With financial crises, as late 2008 made tragically clear, fears and anxieties, and the action bias they induce, may dramatically magnify both the likelihood and size of a severe adverse outcome. It follows that government regulation, affected as it is by the public demand for law, is likely to stumble on the challenge of low probability harms as well. The government should not swiftly capitulate if the public is demonstrating action bias and showing an excessive response to a risk whose expected value is quite modest. A critical component of government response should be information and education. But if public fear remains high, the government should determine which measures can reduce it most cost effectively, almost in the spirit of looking for a placebo that may do little for risk but do a lot to reduce fear. Valued attributes for such measures will be high visibility, low cost, and perceived effectiveness. Reducing fear offers two major benefits: (1) Fear itself imposes significant costs. (2) Both private and public responses in Theface of fearsome risks is likely to be far from rational. These observations lead to the difficult questions of how to monetize and reduce public fear. The answers lie well beyond the current topic. Research Paper 2: The Facebook Investor You Never Want to Become by Rebeca Waber June 12, 2012 Availability bias is the mental rule-of-thumb whereby we call to mind our personal knowledge of a topic in order to work out how important it is. It's the reason so many people overestimate the danger of flying in airplanes or of having their children abducted, and underestimate the risk of getting cancer from lack of sunscreen or getting in a car accident. Airplane accidents and abductions are big news; they are memorable and easy to call to mind, so we overestimate their importance. Facebook is likewise vividly top of mind for many people, who use it so frequently and so very personally. This meant that Facebook loomed larger in investors' minds than it deserved to, given the facts.


Rather than compare the benefits of a wide set of possible investments like other individual stocks, or bonds, or index and other exchange traded funds people selected among the much smaller set of highly familiar investment choices. Availability bias distorts business investments in the same way, particularly when corporations seek new growth. In deciding where to allocate new-product or new-business development funds, they all too often view their core or high-profile markets as the safest bets only because they are familiar. Sure they've been told "Invest in what you understand." But is what's familiar really what they understand? Consider, for example, the tablet market over the last few years, which has seen a glut of undifferentiated and ultimately unsuccessful me-too products. In the wake of the sexy, mediagrabbing iPad, everyone wanted to get into the game, and so for many companies, creating a tablet felt like a no-brainer, low-risk decision. But was that so? Creating and marketing a tablet is quite expensive. So unless you have some evidence that you'll be putting out a strong, differentiated product, this is in reality quite a risky decision. Just think of HP's TouchPad, Lenovo's IdeaPad Tablet, or BlackBerry's PlayBook. The alternative to constraining your decisions to the familiar (or the famous) is to ground your investments in a decision-making process that is deliberate, not reactive: Focus on discovering customers' needs. When you discover unmet customer needs, you naturally create a differentiated offering with true market value. Easy to say, but the trick here is to make sure you really are looking for customers' needs not just convincing yourself that customers need what you, or everyone else, want to make. Pursue a long-term strategy. In an effective strategy, short-term moves should be leading you toward a desired outcome in the long term. A collection of opportunistic bets, no matter how sure they seem in the moment, is not a strategy. Would any solid personal financial plan have advocated liquidating mutual and bond funds to bet the farm on Facebook? Don't follow the herd. We're all human, and there's emotional comfort in doing what everyone else is doing. Recognize that feeling and then make sure that you're not letting it cloud your judgment. Be vigilant and actually evaluate each investment opportunity on its merits, not on its media profile. Following such a process will help protect against the risk that comes with the availability bias.


Two of the precepts of behavioral finance are overreaction and availability bias. Studies have shown we overreact to newer information, both on good news and bad news. Studies have demonstrated our overreaction sends prices up or down as the case may be, but over time the surge diminishes and erodes. Availability bias means newer information is overweighed versus older information. In the 24/7 cycle of business news there is always something new. We are at greater risk because of this bias and the potential for making bad decisions has increased. The lesson here is to have a longer term perspective when investing. Understand the risks inherent in reacting to current news. Continue to focus on your long-term plan. Here is one week on the stock market as reflected by the DJIA. The period covered is from September 30th, 2011 to October 6th, 2011. The closing value of the index was 10,913 on September 30th and the closing price on October 6th 11,123.

Source, Globe and Mail

This graph illustrates that the index fell significantly on Friday and the following Monday. If we think of the headlines, the emotions investors felt, this graph probably is a good reflection


of their feelings. Despair, anxiety, at the beginning, it isnt as bad as we thought. Had they reacted out of fear and sold they would have lost the recovery. Reliance Power IPO RPower had hit the primary market in January 2008 to raise $ 3 billion to fund 13 power projects. The IPO, which was so far the biggest public issue in India, had got overwhelming response from the investors and saw applications worth over $ 21 billion. Most of this overreaction was backed by the investors hope of getting a good listing gain. The hopes were fuelled by the premium figures in the grey market. However, by the time the scrip got listed, the bull-run was almost replaced by the bear hug. Still, many investors were hopeful that Mr. Ambani would use all his might to keep the stock floating above the offer price of Rs 450. To the disappointment of many, the stock closed 17% lower on its listing day. It got pummeled further in the next few days. At the end of the third trading session, it had lost 22% from its offer price. In this case, Investors clearly overreacted to the IPO offering and didnt do analysis before investing. Many investors blindly invested in the IPO only because of the Reliance Tag. This is a perfect example of overreaction bias in which the Investors overreacted to the information of IPO offering without understanding the fundamentals.

Indian Governments Recent Reform measures: The availability bias states that people tend to heavily weight their decisions toward more recent information, making any new opinion biased toward that latest news. The recent surge in Indian market is an example of availability bias. After the recent news of reform measures announced by Mr. Chidambaram, the Indian stock market started entering into the bull phase. The investors reacted to this news without considering the Macroeconomic factors prevalent in the economy. These factors have remained more or less the same before and after the announcement of the reform measures. There hasnt been any significant change in the Current account deficit nor in the GDP growth rate. The market gave heavy weightage to this reform measures. In coming days,the market might again go to its previous levels if announcement of measures arent converted into actions. Thus, dont be a victim to these two biases. Take a long-term approach and focus on your plan. Emotionally you will feel better and have more peace of mind.


In this Project,we have covered Key concept of Behavioral Finance ie. Overreaction and Availability bias. The report discusses the overreaction and availability biases theories of behavioral finance and their implication on financial markets. We have analyzed different research papers and live examples to understand in detail the Overreaction and Availability bias. Thus, according to the phenomenon of Overreaction and Availability bias, Investors do react erratically at times and loose heavily on their investments. Investors should take decisions rationally and should take a long term view before making their investments so as to become a successful investor and not get evoked by the Overreaction and Availability bias.


1. Overreaction to Fearsome Risks by Cass R. Sunstein and Richard Zeckhauser 2. The Facebook Investor You Never Want to Become by Rebeca Waber June 12, 2012