HEURISTICS AND BIASES IN DECISION MAKING

HEURISTICS VS ALGORITHMS

 Algorithm: A formalized set of steps or transformations intended to solve a specific problem. Algorthms are
correct by definition and if followed properly they should always lead to the correct answer.
 A mathematical equation is an algorithm
 Medical diagnosis based on symptoms and test results is an algorithm
 Rigorous deductive reasoning is an algorithm
HEURISTICS VS ALGORITHMS

 Algorithms have drawbacks:

 They often require a lot of effort, time and cognitive resources
 They need a complete set of information in order to lead to a single conclusion
 They need to be learned beforehand
 Each algorithm is applicable to a narrow set of decisions, hence many algorithms are required even within a single field or
specialty
HEURISTICS VS ALGORITHMS

 Heuristics are informal, ‚natural’ and quick forms of reasoning which often lead to correct conclusions, but may
not always be correct. They often focus on a single aspect of the problem, rather than a complex analysis
 With old CRT TVs, hitting the TV often fixed issues. However the cause was unknown, and the TV may have broken more.
This is a heuristic-based action
 So is resetting your router or computer when you lose connection
 When selecting a beverage in a shop, choosing the one in the prettiest bottle is a heuristic-based action
 Choosing IT as a field of study because „I heard IT sepcialists earn well” is based on heuristics (unless you actually
investigate earnings and career development of IT alumni, in which case you propbably use an algorithm)
HEURISTICS VS ALGORITHMS

 Why we use heuristics, even if they are not always correct

 They are easy to apply, often applied automatically and without cognitive control (System 1 – Kahneman, 2011)
 A single heuristic can be applied to nearly all situations
 They enable problem solving and decision making without a complete dataset, even when nearly no data is available
 They are quick
 In real-life situations, the benefits from a quick and effortless decision outmatch the costs of mistakes, and the slow and
effortful use of algorithms is inefficient (Gigerenzer & Todd, 1999; Gigerenzer, 2004)
FAST AND FRUGAL HEURISTICS

 Gigerenzer and Todd (1999) describe the following case:

 A patient with a heart attack is delivered to a hospital
 In some hospitals as many as 19 bits of medical information are collected upon admission (HR, blood pressure, age, blood
type, medical history, other symptoms, etc.)
 The doctor needs to assess risk very quickly (time pressure)
 An algorithm would consist in analyzing all of the 19 measurements, categorizing them by importance, and calculate a
conclusion using statistics
FAST AND FRUGAL HEURISTICS

 The algorithm would take too much time

 The simple decision tree (right) is proven to
classify patients just as well or better, based on
3 criteria
 Ignoring a lot of data, this is not an algorithm,
but more of a heuristic
 It is fast, and it is effective.
THE MAIN REASON WHY WE USE HEURISTICS: MAXIMIZING VS
SATISFICING

 The rule of maximizing (von Neuman & Morgenstern, 1944) assumed that we as decision makers choose options
which maximize (optimize) our gains, providing the highest benefits over losses – utility maximization based on
EUT/EVT models
 Simon (1956) stated that maximization is impossible in the natural environment, as information processing
capabilities are limited, and access to a complete set of data is a rare occurence
 Hence instead of maximizing, our goal is to „satisfice”
SATISFICING

 The rule of satisficing states that agents:

 Place the options on a scale in terms of the degree of satisfaction they provide (some factors may be ignored)
 Consider options above a subjective threshold of acceptability
 If an option exceeds the threshold, it can be accepted and the decision making process ends
 An incomplete set of options is acceptable for the rule of satisficing
 If none of the options exceed the acceptability threshold, the agent searches for more options
SATISFICING

 If the agent has chosen an acceptable option, other options may appear
 The agent will try to switch from the worse option to the better, leading towards maximization without assuming it as a
deliberate goal
 Therefore satisficing explains both settling for the bare minimum, acting under an incomplete set of choices or information,
and still accounts for utility maximization as the ultimate goal under optimal conditions
THE CASE OF TOO MUCH CHOICE

 In EUT/EVT maximizing, the complete set of choices is the best possible set
 A rational agent should analyze all options and then choose the best
 It is unthinkable that fewer options would be better (or is it?)
TOO MUCH CHOICE
TOO MUCH CHOICE

 Iyengar & Lepper (1999, 2000) researched the willingness to buy a gourmet food item (exotic jam or chocolate),
selected from either:
 6 items, or
 30 items

 A selection of 30 items led to a lower purchase rate than 6 items

 Regret aversion (Tversky & Kahneman, 1979)
 Too difficult a decision task (Schwartz et al., 2002)
A SELECTION OF HEURISTICS AND BIASES
IN DECISION MAKING
COGNITIVE BIAS CODEX

Benson (2016) categorize 188 biases and heuristics into the Codex. We shall try to learn about a few of these.
AVAILABILITY HEURISTIC (BETTMAN, 1979; TVERSKY & KAHNEMAN,
1973)

 Availability is the ease of access to a mental representation of an event (an outcome, a choice…)
 How easily can you remember a situation?
 How many such events can you easily recall?
 The availability heuristic is basing one’s estimates that an event will/will not occur based on how mentally available
it is

 What are the chances of being a victim of a terrorist attack? Are they higher than the chances of your spouse
killing you?
 Is homicide more common than suicide?
 Is it more likely to get hurt in a car accident or a plane crash?
AVAILABILITY HEURISTIC

 Availability is driven by several factors:

 More atypical (weird, surprising, shocking, unusual, distinctive) = more available
 More recent = more available
 More relevant to Self = more available
 „A lie repeated a thousand times becomes the truth”: the sheer exposure effect
AVAILABILITY HEURISTIC AND PREFERENCES

 Availability heuristic influences our probability estimates of risky actions

 If representations of failure are available, we are less likely to undertake the action
 If representations of success are available, we are more likely to undertake the action
 Will you buy insurance…?
REPRESENTATIVENESS HEURISTIC (KAHNEMAN & TVERSKY, 1972)

 Representativeness means a subjective fit of a situation (person, outcome, event, choice…) to a clear category
 Is John a typical hooligan?
 Is a company a typical scam?
 The representativeness heuristic is usually employed to tasks when one has to judge the probability that an object
X belongs to class Y. (or an event X belongs to a class of events Y). The more typical the object or event seems,
the more probable it seems for us that it belongs to the given class.
 It has significant consequences when the class in question is perceived as risky, dangerous, or opportune.
REPRESENTATIVENESS HEURISTIC

 Which person is more likely to hurt you?

1 2 3
 REPRESENTATIVENESS HEURISTIC

 Which person is more likely to hurt you?

James Holmes, mass murderer Eric Calderon, MMA Fighter Ice Cube, rapper
REPRESENTATIVENESS: THE GAMBLER’S FALLACY

 You are playing coin toss. The last four times it turned out Heads. Would you
 A) bet on Heads
 B) bet on Tails
GAMBLER’S FALLACY

 If you were to play a lottery, which of these numbers would you prefer on your ticket?
 A) 1, 6, 15, 22, 31, 45
 B) 1, 2, 3, 4, 5, 6
GAMBLER’S FALLACY AND OBJECTIVE PROBABILITY

1
 In a coin toss, the chance that Heads will turn out four out of four times is ( )4, which is 1 in 16.
2

 The chance that it will now turn out Heads for the fifth time is 1 in 32
 It is therefore correct to choose Tails, as the remaining chance is 31 in 32, right?
GAMBLER’S FALLACY AND OBJECTIVE PROBABILITY

 Incorrect.
 We tend to compare the chance that a coin toss yields Heads five times with „the rest”, ignoring the fact that four tosses
already happened and have no impact on the subsequent toss.
 We need to compare the chance that Heads comes out 5 times in a row with the chance that Heads comes out 4 times in
a row and then Tails comes out. This chance is exactly 1 in 32
HOT HAND FALLACY

 The opposite of gambler’s fallacy.

 In gambler’s fallacy we assume that the longer a series continues, the more probable it is that it will end
 In the hot hand fallacy we assume that the longer a series copntinues, the more probable it is that it will continue

 The hot hand fallacy is visible in casinos, where a gambler who won several times in a row assumes to have a ‚hot
hand’ or ‚luck on their side’, urging them to gamble more
 Until the luck inevitably reverses
ANCHORING BIAS (TVERSKY & KAHNEMAN, 1974)

 When a relevant value is available, we tend to „anchor” our predictions of probability (price, other numbers) to
this value. It is subsequently difficult to move away from the value.

 Is the probability of getting hurt in a car accident more or less than 10%? How much is it exactly?
 Do investments in stocks yield more than 5% profit annually? How much is it?
ANCHORING BIAS

 Is this car worth more than $300 000? How much is it?
ANCHORING BIAS

 The Agera XS costs $3 000 000

ANCHORING BIAS IN RESEARCH

 Anchoring is proven to influence:

 Stock analysts and their forecasts of earnings based on past earnings, prices based on past prices, etc. (Cen, Hilary & Wei,
2013)
 Macroeconomic surveys (Hess & Orbe, 2013)
 Online voting (based on previous ratings; Zimo, Zi-Ke & Tao, 2012)
 Willingness to pay for goods in auctions (Beggs & Graddy, 2009)
 Judges’ sentences in court (Mussweiler, 2001)
 Real estate pricing (Northcraft & Neale, 1987)
 Recall of previously declared self-generated data (Fraser, Greene & Mole, 2007)
And many others
 A SPECIAL CASE OF ANCHORING: STARTING POINT BIAS (BOYLE,
BISHOP & WELSH, 1985)

 In an auction (or a contingent valuation bidding game), the starting point (e.g. entry bid) acts as an anchor for
subsequent bids

Starting bid $10 000 Starting bid $100

NEXT WEEK

 More biases and heuristics