HEURISTICS AND BIASES

1
2
4
Heuristics and Biases

Why dumb people do smart things…

and vice versa.

6
Overview
 Definition
 Context
 Heuristics as biases
◼ Availability
◼ Anchoring and adjustment
◼ Representativeness
◼ Cognitive balance and cognitive dissonance
 Conclusion

7
  Mental shortcuts
 Rules of thumb for
decision making
 Make a quick,
satisfactory, but
not perfect
decision
 Optimal behavior

What is heuristics? 8
pp suy nghiem decision making: based on your experience/ beliefs
What is heuristics?
 Using heuristics
often leads to
better decisions
than the models of
“rational” decision-
making developed
by mathematicians
and statisticians

9
Context
 Rational Choice Theory
 Utility Theory
 Probability Theory
 Bounded Rationality

10
Rational Choice Theory
 von Neumann & Morgenstern (1947)
attempted to remove psychological
assumptions from the theory of decision
making:
◼ Individuals have precise information about the
consequences of their actions
◼ Individuals have sufficient time and capability to
weigh alternatives
◼ All decisions are “forward looking” (e.g., the “sunk-
cost fallacy”)
◼ “Game theory” is RCT in practice

11
Rational Choice Theory
 Procedural rationality weight probability

◼ a response to constraints on computational

capacity
◼ the emphasis on problem-solving rather
than optimizing
 Ecological rationality
◼ the match between a heuristic and the
structure of the information in a particular
environment

12
Utility & Probability Theory
 UT determines how preferences are determined
within RCT
◼ A response to the St. Petersburg Paradox (1734)
◼ Strictly constructed, UT assigns a common currency
(utiles) to disparate outcomes
 Probabilistic reasoning
◼ Under uncertainty, the “value” of a choice is the
expected value of probabilistic outcomes
◼ Savage (1972) formalized the conjunction of UT and
Bayesian probabilistic reasoning

13
Bounded Rationality
 Acknowledges several limitations of UT and RCT as
descriptive models of individual choice
◼ People lack:
 Perfect information of outcomes and probabilities
 Consistent utility functions across domains thuc hien
 Time and cognitive capabilities to comprehensively enact the
prescriptions of UT and RCT
◼ Experts and everyday decision makers are error-
prone
◼ Useful in the domain of problem-solving
 Simon (1955) argued for satisficing
◼ Individuals make decisions that are “good enough”
considering the costs of decision-making, the specific
goal, and cognitive limitations

14
Why heuristics?
 RCT & UT are terrible descriptive models in
many cases
 Bounded Rationality’s limitations are
insufficient to explain human behavior
◼ Sometimes information is insufficient even for BR
◼ Many judgments are not goal-directed or encased in
problem-solving tasks
 Human errors are systematic
◼ Discovering heuristic rules of judgment can explain
these systematic errors

15
Heuristics
 Substitute easy questions for difficult ones
(attribute substitution)
 Defined heuristic rules specify the substitution
 Allow judgment and decision making in cases
where specific and accurate solutions are either
unknown or unknowable
 Availability, anchoring and adjustment, and
representativeness are frequently considered
“metaheuristics” since they engender many
specific effects

16
Heuristics as error-generators
 How smart people do dumb things
 Kahneman, Slovic, & Tversky (1974)
◼ Availability
◼ Anchoring and adjustment
◼ Representativeness

17
Availability Heuristic
 “The ease with which instances or occurrences
can be brought to mind” motivates judgment
◼ Retrievability of instances
 “Were there more males or females on a given list?”
◼ Effectiveness of a search set
 “Do more English words begin with r or have r as the
third letter?”
◼ Biases of imaginability in ad hoc categories
 “Which is larger: 10 C 2 or 10 C 8?”
◼ Illusory correlation
 Chapman & Chapman (1969)

18
 Availability Heuristic
 The Availability heuristic is a rule of thumb in which decision
makers assess the probability of an event by the ease with
which instances can be brought to mind
 Individuals overweight the probability of a rare event when:
◼ Examples are easy to recall
◼ There has been a recent, highly publicized, occurrence
 Individuals underweight higher probability risks if:
◼ They are not personally aware of any recent occurrences
 Examples of the impact of the availability heuristic:
◼ Following a rare but significant natural disaster, individuals exhibit
greater willingness to purchase insurance against future such events
◼ A small number of highly public corporate bankruptcies drive investors
away from all risky equities, when the vast majority of corporations
are in strong financial condition

19
 The Impact of Imagination
and Vividness
 If outcomes are easy to imagine, then the act of imagining
them will tend to make them appear more probable
 Insurance salespeople rely on vividness to sell insurance for
low probability (and often low- cost) outcomes
◼ Should you buy product insurance on an electronics item
whose subsequent breakage would neither be a disaster nor
break the bank to replace?
◼ What about all of the insurance add-ons that car salesmen
invite you to purchase? Some level of auto liability insurance
is required by law, but most other add-ons reflect a net gain
to the auto company, for example:
 Personal Injury Protection (PIP): If you (and anyone you are likely to
take with you in the car) already have health insurance, PIP is
worthless bao hiem tai nan
 Seven year service warranty: Even given an uncertain economic
environment, during the last few years, the average American holds
20
onto a new car for about 5 years, and a used car for 4 years. So who
benefits from the 7 year warranty?
Case Study: Earthquake
Insurance
A climatologist and business consultant from New Mexico, Iben
Browning, made news when he predicted there was a 50% chance
that an earthquake with a magnitude of 6.5 to 7.5 on the Richter
scale would occur along the New Madrid fault (a seismic zone in
some southern and mid-western states) on December 3, 1990.
In this particular case, the media were highly responsive to
Browning and his forecast. He made his prediction during “sweeps”
week, when TV stations are competing heavily for viewers – TV
producers know that rare but dramatic news draws ratings.
While expert geologists dismissed Browning’s prediction, insurance
companies began reporting a blitz in earthquake insurance. Many
insurance companies further capitalized on this opportunity by
quickly sending out mass mailings featuring the December 3
prediction.
No earthquake took place on December 3, but the vividness and
salience caused thousands to overestimate the probability, and buy
21
earthquake insurance as a result.
 Please answer
su noi bat
those questions
The Effect of Salience
 Which is more probable: death by
homicide or death by suicide? bi giet hoac tu tu

 Which is more likely: death resulting

from motor vehicle accident, or death
as a result of firearms? sung luc

 In the English language, is it more

likely that a word starts with the
letter K, or that K is its third letter
(not including 3-letter words)?
22
Endorsement su chung thuc/thua nhan

 Along with sports-related endorsement deals

(e.g. Nike Golf), Tiger Woods was paid millions
of dollars to endorse AT&T, Accenture, Gillette,
and Rolex, among others
◼ There is no reason to think that Tiger’s golfing ability
makes him a better judge of technology consulting
firms
◼ Just the association – and constant exposure to
advertisements that place a respected sporting figure
in conjunction with the firm – has been shown to be
beneficial from a marketing perspective
 Tiger subsequently lost many of these
endorsements after his fall from grace in 2009
24
The Additional Impact of
Frequency & Timing
 Vividness song dong/ very clear and detail in your mind.

◼ When managers conduct performance reviews of their staff,

they often rely heavily on memory rather than documented
evidence. Vivid instances that are easy to recall (both
favorable and unfavorable) will appear more numerous,
and hence will be weighted more heavily.
 The Recency Effect anh huong hien tai

◼ Managers carrying out annual performance reviews also

tend to give more weight to performance during the 3
months prior to the evaluation than the 9 months prior to
that.
 The Frequency Effect anh huong do tan suat

◼ While we may be annoyed or bored by repeated exposure

to the same advertisement on TV, evidence suggests that
this bombardment of information makes the product easier
25
to recall, and does, in fact, increase the likelihood that we
will purchase it.
The Sarafem Story: A case
study
 In July 2000, the pharmaceutical company Eli Lilly introduced a new
drug, Sarafem, for Premenstrual Dysphoric Disorder (PMDD). PMDD
was devised by Lilly as a “medicalized” version of Premenstrual
Syndrome (PMS), many women’s normal few days of cramps and
crankiness each month.
 With the label PMDD, Lilly offered millions of woman an honorable
excuse for their monthly moodiness. Behavior that in the past was
brushed off, or attributed to “the time of the month” could now be
classified as a disease. Women now felt entitled to the concern and
consideration appropriate to those with a recognized condition. And
there was only one prescription drug tailor-made and FDA-approved to
cure it. The cure itself, winningly labeled Sarafem (think “seraphim”,
those gentle angels), was nothing more than a re-packaged, pink-
coated version of Prozac, Eli Lilly’s incredibly successful, billion- dollar
anti-depressant.
 Lilly ran a persuasive TV advertisement for Sarafem, depicting an
almost tearful woman fighting a losing battle with a recalcitrant
supermarket cart. A soothing voice-over then assured viewers that
their pre-menstrual “disorder” now has a “cure”. 26
Discussion questions
 How does the Availability heuristic
play into the Sarafem story? preference point

 What other biases is Eli Lilly preying

on?
 What was Eli Lilly’s motivation in
repackaging Prozac for this new
disorder?

27
Availability Heuristic
 There are several categories of availability bias,
of which the four that apply most to investors
are:
◼ Retrievability – Ideas that are retrieved most easily
also seem to be the most credible, though this is not
necessarily the case tin cay

◼ Categorization - People attempt to categorize or

summon information that matches a certain reference
◼ Narrow range of experience - When a person
possesses a too restrictive frame of reference from
which to formulate an objective estimate
◼ Resonance - The extent to which certain, given
situations resonate vis-à-vis individuals’ own,
personal situations can also influence judgment 29
Retrievability de nho nhat - tot nhat

 Which company is the “best”

company to invest in the real estate
field?

30
Categorization
 Kindly pinpoint one country, worldwide,
that offers the best investment
prospects.
 Kindly point out one university,
worldwide, that offers the best
undergraduate business program

32
Narrow range of experience
 Which industry generates the most
successful investments?

34
Resonance
 Value or growth?

36
 Please choose
your response
Availability bias test
Suppose you have some money to invest and you
hear about a great stock tip from your neighbor
who is known to have a good stock market sense.
He recommends you purchase shares in Mycrolite,
a company that makes a new kind of lighter fluid
for charcoal grills. What is your response to this
situation?
A. I will likely buy some shares because my
neighbor is usually right about these things.
B. I will likely take it under advisement and go
back to my house and do further research
before making a decision.
39
 Please choose
your response
Availability bias test
Suppose that you are planning to buy stock in a generic drug
maker called “Generics Plus.” Your friend Marian sent you a report
on the company and you like the story, so you plan to purchase
100 shares. Right before you do, you hear on a popular financial
news show that “GN Pharmaceuticals,” another generic drug maker,
just reported great earnings and the stock is up 10 percent on the
news. What is your response to this situation?
A. I will likely take this information as confirmation that generics
are a good area to be in and proceed with my purchase of
Generics Plus.
B. I will pause before buying Generics Plus and request research
on GN prior to proceeding with the purchase of Generics Plus.
C. I will purchase GN rather than Generics Plus because GN
appears to be a hot stock and I want to get in on a good thing.

40
 “Nothing is as
good or as bad
as it seems”
How to overcome?
 Carefully research and contemplate investment
decisions before executing them
 Focusing on long-term results, while resisting
chasing trends
 Be aware that everyone possesses a human
tendency to mentally overemphasize recent,
newsworthy events;
 Refuse to let this tendency compromise you
 Consider the effects of the availability rule of
thumb
 Can be corrected with updated information.
41
Anchoring and adjustment bias
 Insufficient adjustment
◼ Estimates are made by starting from an initial value
(anchor) and adjusting to yield a final answer

A Demonstration:

42
Condition 1

1×2×3×4×5×6×7×8 = ?

43
Condition 2

8×7×6×5×4×3×2×1 = ?

44
Anchoring and adjustment bias
 Insufficient adjustment
 Condition 1: 1×2×3×4×5×6×7×8
◼ Mean answer: 512
 Condition 2: 8×7×6×5×4×3×2×1
◼ Mean answer: 2250

45
Anchoring and adjustment bias
 When required to estimate a value with
unknown magnitude, people generally
begin by envisioning some initial, default
number—an “anchor”—which they then
adjust up or down to reflect subsequent
information and analysis
 People tend to adjust their anchors
insufficiently and produce
approximations that are biased

47
su kien lien ket vs tach biet

Evaluation bias
A. Simple event of drawing a red marble from a bag
containing 50% red marbles and 50% white marbles.
B. A conjunctive event specifically drawing a red marble
seven times in a row from a bag containing 90% red
marbles and 10% white marbles, with replacement of
the marble after each draw. P: 0.9^7 = 44.78%
C. A disjunctive event specifically drawing a red marble at
least once at some stage in seven draws (with
replacement) from a bag containing 10% red marbles
and 90% white marbles. P = 1 - 0.9^7 = 52.17%
Q1: Between A and Q2: Between A and
B, which one will you C, which one will
bet? you bet?
B 48
A
Anchoring and adjustment bias
 Biases in the evaluation of conjunctive and
disjunctive events
◼ Probability of conjunctive events overestimated su kien lien ket

◼ Probability of disjunctive evens underestimated khong lien ket

 Anchoring in the assessment of subjective

probability distributions
◼ Variance of estimated probability distributions
narrower than actual probability distributions
◼ Common to naïve and expert respondents

50
Investor mistakes recency effect

 Investors tend to make general market

forecasts that are too close to current levels
 Investors (and securities analysts) tend to stick
too closely to their original estimates when
new information is learned about a company
 Investors tend to make a forecast of the
percentage that a particular asset class might
rise, or fall based on the current level of
returns
 Investors can become anchored on the
economic states of certain countries or
companies 51
Anchoring and adjustment bias
test
Suppose you have decided to sell your house and downsize by acquiring a
townhouse that you have been eyeing for several years. You do not feel
extreme urgency in selling your house; but the associated taxes are eating
into your monthly cash flow, and you want to unload the property as soon
as possible. Your real estate agent, whom you have known for many years,
prices your home at $900,000—you are shocked. You paid $250,000 for the
home only 15 years ago, and the $900,000 figure is almost too thrilling to
believe. You place the house on the market and wait a few months, but you
don’t receive any nibbles. One day, your real estate agent calls, suggesting
that the two of you meet right away. When he arrives, he tells you that
Pharma Growth, a company that moved into town eight years ago in
conjunction with its much-publicized initial public offering (IPO), has just
declared Chapter 11 bankruptcy. Now, 7,500 people are out of work. Your
agent has been in meetings all week with his colleagues, and together they
estimate that local real estate prices have taken a hit of about 10 percent
across the board. Your agent tells you that you must decide the price at
which you want to list your home, based on this new information. You tell
him that you will think it over and get back to him shortly.
52
Anchoring and adjustment bias
test
Assume your house is at the mean in terms of quality
and salability. What is your likeliest course of action?
1. You decide to keep your home on the market for
$900,000. initial anchor
2. You decide to lower your price by 5 percent and ask
$855,000.
3. You decide to lower your price by 10 percent, and
ask $810,000
4. You decide to lower your price to $800,000 because
you want to be sure that you will get a bid on the
house.

53
How to overcome?
 Understanding anchoring and
adjustment can be a powerful asset
when negotiating
 Awareness is the best countermeasure
to anchoring and adjustment bias
 Ask yourself: “Is this analyst anchored
to some previous estimate, or is the
analyst putting forth an objective
rational response to a change in a
company’s business fundamentals?”
54
 Representativeness bias
 Representativeness – the human desire to see
some evidence patterns, even where none exist – can
generate a belief that we can predict the
future, based on fallacies about what has
happened in the past.
 Likelihood of a condition is judged by similarity
to a condition, despite of mitigating factors
 People tend to perceive probabilities and odds
that resonate with their own preexisting
ideas—even when the resulting conclusions
drawn are statistically invalid
55
Base-rate neglect
 Investors attempt to determine the potential
success of an investment by contextualizing
the venture in a familiar, easy-to-understand
classification scheme
 Investors often embark on this erroneous path
because it looks like an alternative to the
diligent research actually required when
evaluating an investment. wrong beliefs

 Investors tend to rely on stereotypes when

making investment decisions

57
Base-rate neglect
 What is the probability that Company A (ABC,
a 75-year-old steel manufacturer that is having
some business difficulties) belongs to group B
(value stocks that will likely recover) rather
than to Group C (companies that will go out of
business)?
 What is the probability that AAA-rated
Municipal Bond A (issued by an “inner city” and
racially divided county) belongs to Group B
(risky municipal bonds) rather than to Group C
(safe municipal bonds)?

58
Base-rate neglect
 Suppose that a particular portfolio manager is
known to have beaten her benchmark two
thirds of the time.
 Consider the following three possible short-
term track records for her portfolio’s most
recent performance. “B” denotes “beat
benchmark.” “M” denotes “missed benchmark”.
(1)BMBBB
(2)MBMBBB Which is the most
(3)MBBBBB likely of these
three?
59
 Sample-size neglect bo lo/bo qua = ignore

 Investors, when judging the likelihood of a particular

investment outcome, often fail to accurately consider the
sample size of the data on which they base their judgments.
 Investors incorrectly assume that small sample sizes are
representative of populations (or “real” data) → “law of small
numbers” lap ra

 Investors will quickly concoct assumptions about that

phenomenon, relying on only a few of the available data
points
 Investors are quick to treat properties reflected in such small
samples as properties that accurately describe universal
pools of data
 The small sample may not be representative what of the
data at large.
60
Sample-size neglect
 Investors can make significant financial
errors when they examine a money
manager’s track record. They peruse the
past few quarters or even years and
conclude, based on inadequate statistical
data, that the fund’s performance is the
result of skilled allocation and/or security
selection.
 Investors also make similar mistakes when
investigating track records of stock
analysts.
61
Sample-size neglect
 Which of the following series of coin
tosses appears more “random” (i.e.,
likely to be the outcome of a genuine
series of 21-coin tosses):
A. HTHHHTTTTHTHHTTTHHHTH
B. HTHTHTTTHHTHTHTHHTTTH
Please select which of
the two series you
think is more random

62
Representativeness bias test
Jim is an ex-college baseball player. After
he graduated from college, Jim became a
physical education teacher. Jim has two
sons, both of whom are excellent athletes.
Which is more likely?
A. Jim coaches a local Little League team.
B. Jim coaches a local Little League team
and plays softball with the local softball
team.

64
Representativeness bias test
Suppose there are 3,000 mutual fund managers, each of whom has
been allocated gold, silver or bronze coin. We know that there are
1,000 of each type of coin (i.e., one-third of the managers has each
type), and we also know that the gold coins fall Head 55% of the
time, the bronze falls Head 45% and the silver coins are “Fair”
(Heads 50%). We do not know which manager has which type of
coin.
The mutual fund managers play a game which each tosses his coin
ten times and records whether it falls Head or Tails. For each H, he
receives $1, for each T he receives $0. at the end of the game, a
rating agency evaluates each manager relative to a benchmark of
expected gains from the game. The expected (benchmark) level is, of
course, $5.
Once the first round of this game is complete, we can observe how
much money each manager made relative to the benchmark. On that
basis, we will try to select with which manager to invest our money
for round 2 (of which we assume that each manager keeps the same
65
coin).
Representativeness bias test
Suppose we identify a manager who
earned $7 in the first round: he has beaten
the benchmark by $2. In deciding whether
to invest with him, we need to answer the
following two questions:
A. What is the probability that this
manager does, in fact, have a gold coin?
B. What is the probability that, if he does
have a gold coin, that he will beat the
benchmark again in the next round?
66
CONSERVATISM BIAS
 Conservatism bias is a mental process in
which people tight to their prior views or
forecasts at the expense of
acknowledging new information
 Conservatism bias may cause the
investor to underreact to the new
information, maintaining impressions
derived from the previous estimate
rather than acting on the updated
information
67
 Can a person exhibit
both
representativeness
bias and conservatism
bias?

68
CONSERVATISM BIAS
 Overweight base rates and to
underreact to sample evidence
→ Fail to react as a rational person
would in the face of new evidence

69
 Please write down
your answers

CONSERVATISM BIAS
 Suppose you have 100 bags, each of which
contains 1,000 poker chips: 55 bags contain 300
red chips, and 700 black ones 45 bags contain 700
red chips and 300 black ones.
 One bag is chosen at random:
(i) What is the probability that the bag has
predominantly red chips?
(ii) Now suppose there is a random draw of 12 chips,
with replacement, from the chosen bag. These 12
draws produce 8 red chips, and 4 black ones. What
is your revised estimate of the probability that the
bag has predominantly red chips?
70
Would you like to update your estimate for the probability that
the selected bag has predominantly red chips?

 Suppose you have 100 bags, each of which

contains 1,000 poker chips: 55 bags contain 300
red chips, and 700 black ones 45 bags contain 700
red chips and 300 black ones.
 One bag is chosen at random:
(i) What is the probability that the bag has
predominantly red chips?
(ii) Now suppose there is a random draw of 12 chips,
with replacement, from the chosen bag. These 12
draws produce 8 red chips, and 4 black ones. What
is your revised estimate of the probability that the
bag has predominantly red chips?
71
CONSERVATISM BIAS
 Processing new information and
updating beliefs is cognitively costly
◼ Abstract, statistical and weightless
information
◼ Underreact
 Overreact to information that is easily
processed, such as scenarios and
concrete examples.

72
 CONSERVATISM BIAS
 Conservatism bias can cause investors to
hold
cling to a view or a forecast, behaving too
inflexibly when presented with new
information
 When conservatism-biased investors do
react to new information, they often do so
too slowly
 Conservatism can relate to an underlying
difficulty in processing new information
(mental stress when presented with
complex data)
73
How to overcome?
 Must first avoid clinging to forecasts;
and must also be sure to react to new
information
 Seek professional advice when trying
to interpret information that they
have difficulty understanding
 Ask yourself: How does this impact
my forecast? Does it actually
jeopardize my forecast?
74
Conservatism Bias Test
Suppose that you live in Baltimore, MD, and you make
a forecast such as, “I think it will be a snowy winter
this year.” Furthermore suppose that, by mid-February,
you realize that no snow has fallen. What is your
natural reaction to this information?
A. There’s still time to get a lot of snow, so my
forecast is probably correct.
B. There still may be time for some snow, but I may
have erred in my forecast.
C. My experience tells me that my forecast was
probably incorrect. Most of the winter has elapsed;
not much snow, if any, is likely to arrive now
75
Conservatism Bias Test
When you recently hear news that has potentially
negative implications for the price of an investment you
own, what is your natural reaction to this information?
A. I tend to ignore the information. Because I have
already made the investment, I’ve already
determined that the company will be successful.
B. I will reevaluate my reasons for buying the stock, but
I will probably stick with it because I usually stick
with my original determination that a company will be
successful.
C. I will reevaluate my reasoning for buying the stock
and will decide, based on an objective consideration
of all the facts, what to do next.
76
Conservatism Bias Test
When news comes out that has potentially negative
implications for the price of a stock that you own,
how quickly do you react to this information?
A. I usually wait for the market to communicate
the significance of the information and then I
decide what to do.
B. Sometimes, I wait for the market to
communicate the significance of the
information, but other times, I respond without
delay.
C. I always respond without delay.
77
The year is 2010, and real estate development in your city is on in full
swing. The ad jingles for new project launches promising you your dream
home chime away ubiquitously; wherever you look, a new apartment
complex is mushrooming. All your friends seem to have made a small
fortune flipping their money in and out of “projects” in the past couple of
years. You turn bullish and decide – ‘Hey, it is time to start looking’.
Naturally, it is going to take you some time to zero-in on your investment
– it is a big decision, after all. However, in the months that you spend
scouting for the perfect real estate investment to make, things change.
There is a massive build-up of leverage across the board, several projects
stall, rental yields start correcting, and unsold inventory starts piling up.
In other words, there are clear and present signs of an impending hard
landing for real estate. Would you pause and reconsider your decision, or
simply power through with your purchase?
At around the same time, the Nifty has just made a low of 4624 points in
December 2011, after having heroically recaptured it’s previous high of
6300 barely a year back. Much to your chagrin, your portfolio of stocks
is deep in the red. Newspapers merrily sensationalize the daily
corrections, and so-called experts cry ‘doomsday’ – disregarding the fact
that the index now trades at 17 times current earnings – significantly
lower than its long-term average of 20 times. Some beaten down stocks
now trade at bargain basement prices.
Would you, in your firmly established bearish mind frame, bravely indulge
in some bottom fishing? What bias do you experience and how 78to
overcome?
Cognitive balance &
dissonance
“a person who, for some reason,
commits himself to act in a manner
contrary to his beliefs, or to what he
believes to be his beliefs, is in a state of
dissonance. Such a state is unpleasant,
and the person will attempt to reduce
the dissonance”
(Hirschman, 1965)

79
COGNITIVE DISSONANCE
BIAS bat dong nhan thuc. Nghi mot dang lam mot neo

 When newly acquired information

conflicts with preexisting
understandings, people often
experience mental discomfort
 Cognitions, in psychology, represent
attitudes, emotions, beliefs, or
values; and cognitive dissonance is a
state of imbalance that occurs when
contradictory cognitions intersect.
80
 hop li hoa hanh dong

• People often perform far-reaching rationalizations

COGNITIVE in order to synchronize their cognitions and maintain
DISSONANCE psychological stability. dong bo hoa
BIAS • When people modify their behaviors or cognitions
to achieve cognitive harmony, the modifications that
they make are not always rationally in their self-
interest

moi nguoi co xu huong dong bo hoa hanh vi cua ho de dong bo hoa ve nhan thuc de co duoc
su can bang ve tam ly 81
COGNITIVE DISSONANCE
BIAS
 Selective perception.
◼ Affirm a chosen course, producing a view of reality that is
incomplete and, hence, inaccurate.
◼ Unable to objectively understand available evidence, people
become increasingly prone to subsequent miscalculations
 Selective decision making. de bi

◼ Occurs when commitment to an original decision course is

high.
◼ Enable a person to adhere to that course, even if at an
exorbitant economic cost.
◼ For example, continue to invest in a project whose
prospects have soured in order to avoid “wasting” the
balance of previously sunk funds.
◼ Many studies show that people will subjectively reinforce
decisions or commitments they have already made.
82
COGNITIVE DISSONANCE
BIAS EXPERIMENT

83
COGNITIVE DISSONANCE
BIAS
 Cause investors to hold losing securities position that they
otherwise would sell because they want to avoid the mental
pain associated with admitting that they made a bad
decision
 Cause investors to continue to invest in a security that they
already own after it has gone down to confirm an earlier
decision to invest in that security without judging the new
investment with objectivity and rationality → “throwing
good money after bad.”
 Cause investors to get caught up in herds of behavior -
people avoid information that counters an earlier decision
(cognitive dissonance) until so much counter information is
released that investors herd together and cause a deluge of
behavior that is counter to that decision
 Cause investors to believe “it’s different this time.”
84
COGNITIVE DISSONANCE
BIAS TEST
SCENARIO:
Suppose that you recently bought a new car, Brand A, Model
B. You are very pleased with your purchase. One day, your
neighbor finds you in your driveway washing your new car
and comments on your new purchase: “Wow, love the new
car. I know this model. Did you know that Brand Y, Model Z
(Model Z is nearly identical to Model B), was giving away a
free navigation system when you bought the car?”
You are initially confused. You were unaware, until now, that
Model Z was including a navigation system with purchase of
the car. You would have liked to have it. Perhaps, you
wonder, was getting Model B a bad decision? You begin to
second-guess yourself. After your neighbor leaves, you
return to your house.
85
*he thong dinh vi
COGNITIVE DISSONANCE
BIAS TEST
Your next action is, most likely, which of the following?
A. You immediately head to your home office and page
through the various consumer magazines to determine
whether you should have purchased Model B.
B. You proceed with washing the car and think, “If I had it
to do all over again, I may have purchased Model Z.
Even though mine doesn’t have a navigation system, I’m
still pleased with Model B.”
C. You contemplate doing some additional research on
Model Z. However, you decide not to follow through on
the idea. The car was a big, important purchase, and
you’ve been so happy with it—the prospect of
discovering an error in your purchase leaves you feeling
uneasy. Better to just put this thought to rest and
continue to enjoy the car. 86
How to overcome?
Example:
You believe that it is wrong to hold the losing
investment; yet, somehow, if you find yourself
engaged in the act of holding losing investment,
you will register the inconsistency
Try to reconcile your conflicting cognitions in one
of three ways:
 Modifying beliefs
 Modifying actions
 Modifying perceptions of relevant action(s)

87
COGNITIVE DISSONANCE
BIAS
Consider a Peter is looking to buy a stock of an
ABC limited because he believes that ABC limited
will perform well in the future. ABC limited stock
is currently trading in the market at $100, and
Peter is thinking of buying a stock if it falls a few
dollars to $95. In three days stock price hit to
$98, and John thinks the stock price will come to
$96 sooner. However, after three days, suddenly
Stock Price increased, and it reached to $105
because of buying demand from other investors.
At this point, will Peter probably experience
cognitive dissonance? Explain. How to overcome
this bias? 88
Thiên kin xác nhn (confirmation bias) gii thích vì sao chúng ta vô thc i tìm thông tin cng c cho nim tin sn có.

CONFIRMATION BIAS
 Confirmation bias refers to a type of selective
perception that emphasizes ideas that confirm our
beliefs, while devaluing whatever contradicts our
beliefs
 For example: Imagine that a person holds a belief
that left-handed people are more creative than
right-handed people. Whenever this person
encounters a person that is both left-handed and
creative, they place greater importance on this
"evidence" that supports what they already believe.
This individual might even seek proof that further
backs up this belief while discounting examples that
don't support the idea.
89
CONFIRMATION BIAS
if just take 8 and red -> confirmation bias => only want to confirm the claim is true
Avoid=> Choose 3 and red or 8 and orange => prove that claim may false or true

dont want to confirm the opposite information

Avoid: 16 and beer or 25 and coke

90
CONFIRMATION BIAS
 Cause investors to seek out only information that
confirms their beliefs about an investment that they
have made and to not seek out information that
may contradict their beliefs
 Use information that confirms their beliefs → blind
themselves to information that demonstrates that a
stock breaking through its 52-week high may not
make a good investment.
 Can cause employees to overconcentrate in
company stock.
 Cause investors to continue to hold under-
diversified portfolios
92
CONFIRMATION BIAS TEST
Suppose you have invested in a security after
some careful research. Now, you come on a press
release that states that the company you’ve
invested in may have a problem with its main
product line. The second paragraph, however,
describes a completely new product that the
company might debut later this year. What is your
natural course of action? confirmation bias: avoid the potential losing money

A. I will typically take notice of the new product

announcement and research that item further.
B. I will typically take notice of the problem with
the company’s product line and research that
93
item further. free from bias: whether some problems
CONFIRMATION BIAS TEST
Suppose you have invested in a security after some
careful research. The investment appreciates in value
but not for the reason you predicted (e.g., you were
enticed by some buzz surrounding a new product, but
resurgence by an older product line ultimately buoyed
the stock). What is your natural course of action?
A. Since the company did well, I am not concerned.
The shares I’ve selected have generated a profit.
This confirms that the stock was a good
investment. confirmation bias
B. Although I am pleased, I am concerned about the
investment. I will do further research to confirm
the logic behind my position. further search for contraction for original beliefs.
94
CONFIRMATION BIAS TEST
Suppose you decide to invest in gold as a hedge
against inflation. You performed careful research to
determine the relationship between gold values and
inflation levels. Three months after you invest, you
realize that gold prices have risen with no
commensurate change in inflation. This is not what you
expected. How do you react? only care about result => same with original belief

A. I will just “go with it.” The reason that an

investment performs well is not important. What’s
important it that I made a good investment.
B. I will do research to try and determine why gold
prices and inflation aren’t correlating in the manner
I’d predicted. This will help me determine if I
95to original
should remain invested in gold. search belief.
for further infromation why it contrast
How to overcome?
 Recognize that the bias exists.
◼ Selection bias - an investment decision is based on
some preexisting criterion
◼ Overconcentration - overconcentrating in company
stock is inadvisable for numerous reasons
 Seek out information that could contradict—not
just confirm—their investment decisions.
 When investors make sure to consider all
available contingencies and perspectives, they
are less likely to make mistakes.

96
CONFIRMATION BIAS
Susan is an investor in the stock market for a long
time. She does invest by researching and
screening the stock by himself. One of the stocks
that he has recently shortlisted is TTC Power, and
he has learned about the bankruptcy of the firm
and is considering selling the stock.
A few days later, a piece of news is published that
TTC power is getting help from a brother of the
chairman of TTC power and is the firm is expected
to revive back. Still, however, Susan prefers to
avoid the information and looks for information
that signs towards bankruptcy.
97
What kind of bias is Susan suffering from?
 ILLUSION OF
CONTROL BIAS
 The tendency of human
beings to believe that they
can control or at least
influence outcomes when,
in fact, they cannot
 The tendency of a personal
success probability
inappropriately higher than
the objective probability
would warrant
 For example:
◼ People actually cast the dice more
vigorously when they are trying to
attain a higher number.
◼ Some people, when successful at trying
to predict the out- come of a series of
coin tosses, actually believe that they
are “better guessers,” and some claim
that distractions might diminish their 98
performance at this statistically
arbitrary task
ILLUSION OF CONTROL
BIAS
 Illusions of control as determined by
the intersection of two common
impulses:
◼ the desire for control
◼ the belief in good luck as a controllable
attribute

99
ILLUSION OF CONTROL BIAS
 Illusion of control bias can lead investors to trade more than is
prudent.
◼ Especially online traders, believe themselves to possess more control over
the outcomes of their investments than they actually do.
◼ An excess of trading results in decreased returns
 Illusions of control can lead investors to maintain under-diversified
portfolios.
◼ Investors hold concentrated positions because they gravitate toward
companies over whose fate, they feel some amount of control.
 Illusion of control bias can cause investors to use limit orders and other
such techniques in order to experience a false sense of control over
their investments.
◼ The use of these mechanisms most often leads to an overlooked opportunity
or, worse, a detrimental, unnecessary purchase based on the occurrence of
an arbitrary price.
 Illusion of control bias contributes to investor overconfidence.

100
HOW TO OVERCOME?
 Recognize that successful investing is a probabilistic
activity.
◼ Take a step back and realize how complex U.S. and global
capitalism actually is
◼ Even the wisest investors have absolutely no control over
the outcomes of the investments that they make.
 Recognize and avoid circumstances that trigger
susceptibility illusions of control
◼ Don’t permit yourself to make financial decisions on what
you can logically discern is an arbitrary basis
 Seek contrary viewpoints
◼ Ask yourself: Why am I making this investment? What are
the downside risks? When will I sell? What might go
wrong?
 Keep records 101
ILLUSION OF CONTROL BIAS
TEST
Question 1: When you participate in
games of chance that involve dice—
such as Backgammon, Monopoly, or
Craps—do you feel most in control when
you roll the dice yourself?
A. I feel more in control when I roll the
dice.
B. I am indifferent as to who rolls the
dice.
102
ILLUSION OF CONTROL BIAS
TEST
Question 2: When returns to your
portfolio increase, to what do you
mainly attribute this turn of events?
A. The control that I’ve exercised over
the outcome of my investments.
B. Some combination of investment
control and random chance.
C. Completely random chance.

103
ILLUSION OF CONTROL BIAS
TEST
Question 3: When you are playing
cards, are you usually most optimistic
with respect to the outcome of a hand
that you’ve dealt yourself?
A. A better outcome will occur when I
am controlling the dealing of the
cards.
B. It makes no difference to me who
deals the cards.
104
ILLUSION OF CONTROL
BIAS TEST
Question 4: When and if you purchase
a lottery ticket, do you feel more
encouraged, regarding your odds of
winning, if you choose the number
yourself rather than using a computer-
generated number?
A. I’m more likely to win if I control the
numbers picked.
B. It makes no difference to me how the
numbers are chosen 105
HINDSIGHT BIAS
 The impulse that insists: “I knew it all along!”
 Once an event has elapsed, people afflicted with
hindsight bias tend to perceive that the event was
predictable—even if it wasn’t.
 People tend to overestimate the accuracy of their own
predictions
 People cannot make accurate predictions, but merely
that people may believe that they made an accurate
prediction in hindsight
 People tend to remember their own predictions of the
future as more accurate than they actually were because
they are biased by having knowledge of what actually
happened
106
HINDSIGHT BIAS
 Hindsight bias is a serious problem for market
followers.
 Once an event is part of market history, there
is a tendency to see the sequence that led up
to it, making the event appear inevitable.
 It can prevent learning from mistakes.
 People with hindsight bias connected to
another psychological bias, anchoring, find it
difficult to reconstruct an unbiased state of
mind
 Hindsight bias leads people to exaggerate the
quality of their foresight. 107
HINDSIGHT BIAS
 When an investment appreciates, hindsight-biased
investors tend to rewrite their own memories to portray
the positive developments as if they were predictable →
this rationale can inspire excessive risk taking, because
hindsight-biased investors begin to believe that they
have superior predictive powers, but, in fact, they do
not.
 Hindsight-biased investors also “rewrite history” when
they fare poorly and block out recollections of prior,
incorrect forecasts in order to alleviate embarrassment.
❑ Hindsight-biased investors can unduly fault their money
managers when funds perform poorly
 Hindsight bias can cause investors to unduly praise their
money managers when funds perform well
108
HINDSIGHT BIAS TEST
Suppose you make an investment, and it goes down.
What is your natural reaction to this situation?
A. Generally, I don’t fault myself—if an investment
doesn’t work out, this may simply be due to bad
luck. I’ll sell the stock and move on, rather than
pursuing the details of what went wrong.
B. I would want to investigate and determine why my
investment failed. In fact, I’m very interested in
finding out what went wrong. I put a lot of
emphasis on the reasons behind my investment
decisions, so I need to be aware of the reasons
behind my investment’s performance.
109
HOW TO OVERCOME?
 “Rewriting History”—Predicting Gains
 “Rewriting History”—Predicting Losses

110
 CATEGORIZATION OF
BEHAVIORAL BIASES
1. Cognitive errors, heuristics, 2. Emotional biases
mental shortcuts i. Loss aversion
a) Biases pertaining to rigidity of ii. Over-optimism
opinions (cognitive dissonance) iii. Overconfidence
i. Conservatism iv. Illusion of knowledge
ii. Confirmation v. Status quo
iii. Representativeness vi. Self-control
iv. Illusion of control vii. Status quo/Endowment
v. Hindsight
viii.Regret aversion
b) Biases pertaining to information
processing
ix. Home bias
i. Anchoring and adjustment
ii. Mental accounting
iii. Framing
iv. Availability
v. Self-attribution