Topic 3 - Cognitive Shortcuts and Errors Flashcards
What system are cognitive shortcuts a part of?
They are part of the intuitive system 1
When do cognitive shortcuts turn into errors?
When they mislead us into poor choices
What are framing shortcuts?
We use them to simplify complex problems, when we come up with a solution to the simple problem, we try to apply it to the complex problem and it doesn’t work all of the time.
When do framing shortcuts work?
When the complex problem is closely aligned to the simplified problem (i.e. the solution for the simple problem works with the complex one)
When do framing shortcuts cause errors?
When the solutions to the simplified problems greatly differ from those of the complex ones.
What is negative vs. positive framing?
You could have one statement framed optimistically, and the exact statement framed pessimistically… the optimistic one is more likely to succeed other people.
70% chance of success for this project…
30% chance of failure for this project…
What is an example of how framing is used in mental accounting>?
You will spend money differently if it is income earned (wage), from unearned income (gifts, or obtained with little effort)
Spending gifted money very easily
Having a hard time spending earned money
What did Holt & Lary’s experiment show?
That framing the source of money affects the willingness to take risks
Those who get given $100 will be more risky and make quick choices vs those who earn $100, they will be more patient and less risky.
What is the “winner’s curse”?
A tendency for the winning bid in an auction to exceed the intrinsic value of the item.
The gap in actioned vs. intrinsic value can be attributed to incomplete information, emotions, or cognitive errors.
What shortcut is being used when you predict future events from past events or when you predict outcomes of actions?
Hindsight shortcut
When do you effectively use hindsight shortcuts?
when predictions from past events are reliable and you can reliably predict outcomes of actions.
When do hindsight shortcuts result in errors?
When you mistakenly believe predictions based on past events are accurate and when you incorrectly believe that you can reliably predict outcomes of actions
Where randomness and luck are prominent
This loses associations between past and future events, and between actions and outcomes
What is a confirmation shortcut error?
The tendency to listen more often to information that confirms your existing beliefs. People favour information that reinforces things they already believe.
Assigning more weight to confirming evidence, and less weight to disconfirming evidence.
When do we use confirmation bias/shortcuts well?
When we search for disconfirming evidence as vigorously as we search for evidence confirming them
Assign equal weight to disconfirming and confirming evidence
When do we commit confirmation errors?
Search for confirming evidence while overlooking disconfirming evidence
Assign lower weight to disconfirming evidence that to confirming evidence
What is the bearish sentiment index?
measures the percentage of newsletter writers who are bearish.
What is the formula for the bearish sentiment index?
of bearish / (# of bearish + # of bullish)
How would a contrarian use the bearish sentiment index?
Buy stocks when bearish sentiment is high
Sell when bearish sentiment is low
What did Solt and Statman’s test on the contrarian strategy show?
They found that the index is not a useful forecasting tool because it provides too many bad forecasts
Why do people still believe in the usefulness of this index?
Their beliefs are rooted in confirmation errors, those who overlook disconfirming instances
When do you use anchoring and adjustment shortcuts?
When you estimate prices, distances, weights, and other numerical values
When do you use anchoring and adjustment shortcuts WELL?
When you start with a proper anchor and adjust from them properly
When do you commit anchoring and adjustment errors?
When you begin with faulty anchors and adjust from them improperly
What is the contrast effect?
The contrast effect distorts how we see things by emphasizing their differences when compared
Can impact things like price and return
What was Hartzmark and Shue’s identifiers for the contrast effect for investors in the stock market?
- perceive earnings news today as positive, if yesterday’s earnings surprise was negative
- perceive earnings news today as negative if yesterday’s surprise was positive
When would we use the representativeness shortcuts and error?
When we assess the probability of events by their similarity to other events
When do you use the representativeness shortcut well?
When you consider both representativness information and base rate information
What is representativeness information in representativeness shortcut and errors?
how representative is this particular instance out of all of the instances/situations we have in our mind
How representative is this telemarketer of the group of telemarketers who were worth listening to
What is the base rate information in representativeness shortcut and errors?
The proportion of times that a similar situation happened to you, but it was worthwhile
How many telemarketers who have interrupted dinner have been worthwhile listening to?
When do you commit representativeness errors?
When you assign too much weight to representativeness information and too little weight to base rate information
