Topic 4 - Emotional Shortcuts and Errors Flashcards
What are emotional shortcuts based on?
Feelings, not logic
What system are emotional shortcuts from
System 1
What can we confuse with emotional shortcuts?
We can confuse it with cognition shortcuts
Where did emotional shortcuts evolve from?
They evolved from our ancestor’s responses to environmental challenges
What are some examples of how emotions evolved from our ancestors?
Fear - from threats in the environment
Love - strengthened group cohesion and protection
communication - before language emotions conveyed messages
reinforcement - positive and negative emotions rewarding/directing our behaviours
Can humans learn to set aside emotions when investing?
No
True or false: professional investors are able to set aside their emotions, which is why they are called professional
false, no one can set aside emotions
How would you describe “emotions”?
Short-lived, intense reactions to specific events
How would you describe “moods”?
longer-lasting feelings with no specific cause
Less intense than emotions
Can have subtle influence on investors perspective and decisions
How would you describe “affect”?
A subtle positive/negative emotional/mood tone
an overall emotional state or mood (that is either positive or negative)
How can emotions affect investing?
can lead to impulsive decisions
often resulting in buying high and selling low
How can moods affect investing?
prolonged moods can influence risk tolerance
positive mood –> more risk-taking
How can “affect” affect investing?
It can shape an investor’s overall approach to investing
positive affect –> optimism –> bullish outlook
negative affect –> pessimism –> bearish outlook
What is a negative emotion in response to danger?
Fear
What is a positive emotion in anticipation of reward?
Hope
What do fear and hope have in common?
they are both out of our control (other people have the control)
Example: the pilot flying the plane
When does fear turn into an emotional shortcut?
When fear is absent or when exaggerated?
When does fear guide us correctly?
When it prevents us from buying a stock of a company likely to go bankrupt
When does fear guide us wrongly?
When it compels us to sell all our stocks in a financial crisis
What does fear do to risk tolerance?
Increases risk aversion
(They are less likely to take risks)
What is VIX? (CBOE Volatility Index)
is a measure of market volatility (risk) and investor sentiment
If VIX (CBOE volatility index) is high, what does that mean?
the market preception is there is a lot of risk in the future
What does fear cause investors to expect?
low returns with high risk
What does hope cause investors to expect?
high returns with low risk
What did Gallup’s study show? (Overvalued vs time to invest)
That when large proportions of investors believed the stock market was overvalued, they also believed that “now would be a good time to invest”… these two things contradict each other
What happens when happy people give to charity?
It increases their happiness
What do people who donate to charity want to talk about and what do they not want to talk about
They want to talk about: the utilitarian benefits for those receiving the money, the emotional benefits they gain
They do not want to talk about the tax benefits
What did Oswald study find? (regarding happiness and productivity)
If someone is happier they are more productive
people who watched a 10-minute comedy sketch were more productive than those watching a neutral clip
They also found that those who were unhappy (death, family illness) were less productive
What did Ifcher and Zarghamee find in their study? (in regard to happiness and savings)
Happiness promoted delayed gratification and increased savings
What did Lerner’s study find? (in regard to sadness and patience) (2013)
Sadness results increases impatience and intensifies short term focus
Those who were sadder were less patient
Sadd people would accept less money today to avoid waiting three months for more (13-14% more)
What did Liu’s study find? (in regard to sadness and investors performance)
Sadness among mutual fund managers following the death of a parent results in worse performance –> leading to taking less risk –> leading to losses
What did Lerner study find? (in regard to sadness and systems)
Sadness promotes reliance on reflective system 2, instead of the intuitive system 1. And counters a rang of cognitive and emotional errors
What did Faraji-Rad and Lee’s study find? (in regard to sadness and banking happiness)
People will bank happiness when anticipating a future sad event
Accumulated happiness is a resource to draw from in times of sadness
What did Schulze’s study find? (in regard to cognitive load and evaluating)
Participants under cogitive load showed strong disgust for eating dog food, and undervalued the sandwich (due to system 1)
Participants without cognitive load balanced their disgust with its nutritional value (using system 2). Making them more open to purchasing it or requiring less money to eat it
What are the consequences of chronic anger?
negative outcomes in personal relationships and health
What is chronic anger?
a persistent emotional state characterized by frequent episodes of anger
Is occasional anger okay?
occasional anger can serve as a tool for better decision-making
It can also counter cognitive errors
What can anger do in regard to negotiation?
It can enure fair treatment and improve ones bargaining position
What is an example of the use of anger on purpose?
Debt collectors faking anger to elicit a sense of urgency in debtors
What is moral anger?
It arises when witnessing unfair actions, even if one isn’t directly affected
What is a cognitive emotion?
Emotions that arise from the interaction between our thinking (cognition) and our feelings (emotion)
What is the disposition effect? (important)
An emotional bias where the pleasure of realizing gains (pride) and the pain of realizing losses (regret) influence selling behaviours
When individuals feel they are directly responsible for their investment choices, the emotional weight of potential regret or pride is amplified
What does the disposition effect look like for rational investors?
Rational investors are quick to realize losses (reduce taxes)
and slow to realize gains (add taxes)
What does the disposition effect look like for normal investors?
Normal investors are quick to realize gain (for the emotional benefit of pride)
slow to realize losses (for the emotional costs of regret)
How can positive or negative past experiences influence future decisions? (in professional investing)
Positive & negative past experiences with stock can influence future decisions
Fund managers tend to repurchase stocks based on past outcomes
When a fund manager transitions to a new role, what happens? (with their emotional bias)
Their emotional bias persists even after the transition to a new role.
this indicates deeply ingrained behavioural patterns
What is the currency hedging method of minimizing regret?
Currency hedging shows the desire to avoid full regret, so portfolio managers feel that they have made at least one right decision.
What is dollar cost averging (strategies to minimize regret)
This strategy is where investors spread out their market entry or exit of a stock, this reduced the potential sting of regret if prices drop or rise shortly after liquidation
don’t buy $1000 of a stock one day, buy $100 of a stock for 10 days
What does self-control center on?
It centers on the interaction between the hot emotion of system 1 and the cool cognition of system 2
When can self control be insufficient?
when hot emotion urging immediate gratification overcomes cool cognition urging delayed gratification
When can self-control be excessive?
When hot emotion urging delayed gratification overcomes cool cognition urging immediate satisfaction
When is self-control insufficient? (what happens)?
Emotions can compel us to spend too much now and save little for later, cognition does not counter that emotion sufficiently
When is self-control excessive? (what happens)
Emotion compels us to spend too little now (common when we are old)
cognition does not counter that emotion sufficiently
What can help individuals with their self-control?
Setting predetermined guidelines to help individuals govern their own actions can help
Especially in situations that test their discipline
What is a “daily settlement rule”
some trading systems require traders to settle their positions at the end of each day
this means realizing gains / losses on a daily basis
What is the prisoner’s dilemma?
A example where two prisoner must decide to trust each other or act in self interest
Ths outcome varies based on mutual trust or lack of trust
If both prisoners testifies against one another they both get 3 years,
If one prisoner testifies and the other stays silent one goes free and one goes to jail for 5 years.
If both of them are silent then they both serve just one year
What is the relationship between trust and risk tolerance?
Those with higher levels of trust tend to have a higher risk tolerance, and therefore a lower natural tendency to regret
What can happen with misplaced trust?
Misplaced trust can lead to financial disasters (ponzi schemes)
Which states are more susceptible to ponzi schemes?
those with higher trust
What facilitates ponzi schemes?
trusting environments
How would you describe “mood”?
is a less intense but longer-lasting emotion that can influence financial behaviour and decisions
What can sunshine influence in regard to financial decisions?
Sun shine can influence positive moods and can lead to increased spending
On cloudy days, what happens to financial officers?
Financial officers become more stringent with credit approvals when it is cloudy
What is optimism and pessimism considered as?
They are considered as moods
Is optimism less intense or more intense than hope or happiness?
Optimism is not as intense as hope and happiness
Is pessimism less intense or more intense than fear or sadness?
Pessimism is not as intense as fear or sadness
What is tied with high levels of trust?
Higher risk tolerance
higher regard for ethics
Fewer agency problems
