Emotional Bias Flashcards
Loss Aversion
Loss-aversion bias was identified by Daniel Kahneman and Amos Tversky in 1979 while they were working on developing prospect theory.8 In prospect theory, loss-aversion bias is a bias in which people tend to strongly prefer avoiding losses as opposed to achieving gains. A number of studies on loss aversion suggest that, psychologically, losses are significantly more powerful than gains. When comparing absolute values, the utility derived from a gain is much lower than the utility given up with an equivalent loss.
Overconfidence
Overconfidence bias is a bias in which people demonstrate unwarranted faith in their own intuitive reasoning, judgments, and/or cognitive abilities. This overconfidence may be the result of overestimating knowledge levels, abilities, and access to information. For example, people generally do a poor job of estimating probabilities; still, they believe they do it well because they believe that they are smarter and more informed than they actually are. This view is sometimes referred to as the illusion of knowledge bias. Overconfidence may be intensified when combined with self-attribution bias. Self-attribution bias is a bias in which people take credit for successes and assign responsibility for failures. In other words, success is attributed to the individual’s skill, while failures are attributed to external factors. Illusion of knowledge and self-attribution biases contribute to the overconfidence bias.
Self-Control
Self-control bias is a bias in which people fail to act in pursuit of their long-term, overarching goals because of a lack of self-discipline. There is an inherent conflict between short-term satisfaction and achievement of some long-term goals. Money is an area in which people are notorious for displaying a lack of self-control, but it is not the only one.
Endowment Bias
Endowment bias is an emotional bias in which people value an asset more when they hold rights to it than when they do not. Endowment bias is inconsistent with standard economic theory, which asserts that the price a person is willing to pay for a good should equal the price at which that person would be willing to sell the same good. However, psychologists have found that when asked, people tend to state minimum selling prices for a good that exceed maximum purchase prices that they are willing to pay for the same good. Effectively, ownership “endows” the asset with added value. Endowment bias can affect attitudes toward items owned for long periods of time or can occur immediately when an item is acquired. Endowment bias may apply to inherited or purchased securities.
Regret-Aversion
Regret-aversion bias is an emotional bias in which people tend to avoid making decisions that will result in action out of fear that the decision will turn out poorly. Simply put, people try to avoid the pain of regret associated with bad decisions. This tendency is especially prevalent in investment decision making. Regret aversion can cause FMPs to hold onto positions too long. They are reluctant to sell because they fear that the position will increase in value and then they will regret having sold it.
Regret bias can have two dimensions: actions that people take and actions that people could have taken. More formally, regret from an action taken is called an error of commission, whereas regret from an action not taken is called an error of omission
Status-Quo
Status quo bias, coined by Samuelson and Zeckhauser (1988), is an emotional bias in which people do nothing (i.e., maintain the “status quo”) instead of making a change. People are generally more comfortable keeping things the same than with change and thus do not necessarily look for opportunities where change is beneficial. Given no apparent problem requiring a decision, the status quo is maintained. Further, if given a situation where one choice is the default choice, people will frequently let that choice stand rather than opting out of it and making another choice. Thus, the process in presenting choices can influence decisions.
