Bias: Framing

Bias: Framing

Quick Definition:(Via Wikipedia & Behavioral Finance Net)

“The term frame dependence means that the way people behave depends on the way that their decision problems are framed.”
Shefrin (2000)

Framing biases affecting investing, lending, borrowing decisions make one of the themes of behavioral finance. Preference reversals and other associated phenomena are of wider relevance within behavioural economics, as they contradict the predictions of rational choice, the basis of traditional economics.

Extended Definition: (Via Behavioral Finance. Net)

“Empirical studies show that decisions deviate from the predictions of expected utility theory and violate their axiomatic foundations. Hence, many generalizations to non-expected utility theory have been developped. But empirically they did not provide an improvement over the standard approach. In this paper random errors are integrated in an expected utility framework. Such errors occur when agents have limited information processing capacities. A performance criterion is provided to measure the expected success of behavioral strategies. A special class of robust decision rules and its properties are analyzed. It is argued that in case of bounded rationality the evolution will select heuristics from an open class of decision rules due to performance differences.”
Pasche

Additional Papers & Research On The Framing (Bias):

The Framing of Decisions and the Psychology of Choice - By Tversky, Amos; Kahneman, Daniel
On the Limits of Framing Effects: Who Can Frame? - Via Druckmann
Effects of Framing on Evaluation of Comparable and Noncomparable Alternatives by Expert and Novice Consumers - Via
James R. Bettmanand & Mita Sujan
Rational choice and the framing of decision. Journal of Business. - TVERSKY, A. and D. KAHNEMAN, 1986

Bias/ Heuristic: Representative Heuristic

Bias/ Heuristic: Representative Heuristic

Quick Definition (via Behavioral Finance Net)

When people are asked to judge the probability that an object or event A belongs to class or process B, probabilities are evaluated by the degree to which A is representative of B, that is, by the degree to which A resembles B.

Extended Definition:

“The best explanation to date of the misperception of random sequences is offered by psychologists Daniel Kahneman and Amos Tversky, who attribute it to people’s tendency to be overly inflenced by judgments of “representativeness.”⁸ Representativeness can be thought of as the reflexive tendency to assess the similarity of outcomes, instances, and categories on relatively salient and even superficial features, and then to use these assessments of similarity as a basis of judgment. People assume that “like goes with like”: Things that go together should look as though they go together. We expect instances to look like the categories of which they are members; thus, we expect someone who is a librarian to resemble the prototypical librarian. We expect effects to look like their causes; thus we are more likely to attribute a case of heartburn to spicy rather than bland food, and we are more inclined to see jagged handwriting as a sign of a tense rather than a relaxed personality.”
Gilovich (1991), page 18

Classic Examples/Studies (Via Wikipedia):

1. Taxi Cab Problem (Kahneman & Tversky)

“A cab was involved in a hit and run accident at night. Two cab companies, the Green and the Blue, operate in the city. 85% of the cabs in the city are Green and 15% are Blue. A witness identified the cab as Blue. The court tested the reliability of the witness under the same circumstances that existed on the night of the accident and concluded that the witness correctly identified each one of the two colors 80% of the time and failed 20% of the time. What is the probability that the cab involved in the accident was Blue rather than Green knowing that this witness identified it as Blue?”

2. Tom W Case

“Tom W. is of high intelligence, although lacking in true creativity. He has a need for order and clarity, and for neat and tidy systems in which every detail finds its appropriate place. His writing is rather dull and mechanical, occasionally enlivened by somewhat corny puns and by flashes of imagination of the sci-fi type. He has a strong drive for competence. He seems to feel little sympathy for other people and does not enjoy interacting with others. Self-centered, he nonetheless has a deep moral sense.”

Additional Papers & Research On Representative Heuristic

Representative Heuristic Via Changing Minds

Testing bayes rule and the representativeness heuristic: Some experimental evidence - Via Ideas Repec

Representative Heuristic Extended Bibliography - Via Behvioral Finance

Bias: Overconfidence

Definition:

“People are overconfident. Psychologists have determined that overconfidence causes people to overestimate their knowledge, underestimate risks, and exaggerate their ability to control events. Does overconfidence occur in investment decision making? Security selection is a difficult task. It is precisely this type of task at which people exhibit the greatest overconfidence.”
Nofsinger (2001)

Relevant Quotes (Via Behavioral Finance Net):

“To understand speculative bubbles, positive or negative, we must appreciate that overconfidence in one’s own intuitive judgments plays a fundamental role.”

“There are two main implications of investor overconfidence. The first is that investors take bad bets because they fail to realize that they are at an informational disadvantage. The second is that they trade more frequently than is prudent, which leads to excessive trading volume.”

“Psychological studies show that most people are overconfident about their own relative abilities, and unreasonably optimistic about their futures (e.g. Neil D. Weinstein, 1980; Shelly E. Taylor and J. D. Brown, 1988). When assessing their position in a distribution of peers on almost any positive trait—like driving ability (Ola Svenson, 1981), income prospects, or longevity—a vast.

“No problem in judgment and decision making is more prevalent and more potentially catastrophic than overconfidence”.
Plous (1993)

Additional Papers On Overconfidence

1. Trading performance, disposition effect, overconfidence, representativeness bias, and experience of emerging market investors

2. “I think I can, I think I can”: Overconfidence and entrepreneurial behavior

3. Boys Will be Boys: Gender, Overconfidence, and Common Stock Investment

4. Overconfidence and Speculative Bubbles

5. OVERCONFIDENCE IN CASE-STUDY JUDGMENTS.

6. Overconfidence, Arbitrage, and Equilibrium Asset Pricing

Bias: The Illusion Of Control

Bias: The Illusion Of Control

Definition: “The illusion of control is the tendency for human beings to believe they can control or at least influence outcomes which they clearly cannot.”

Theory of Illusion Of Control (Via Yorku.Ca):

The theory of the illusion of control (IOC) was first defined by Ellen Langer (1975) as an expectancy of a personal success probability that exceeds the objective probability of the outcome. This type of overconfidence is likely when an event that is at least partially determined by chance is characterized by factors that normally lead to enhanced outcomes under skill-based situations, such as choice, stimulus or response familiarity, competition, and passive or active involvement (Langer, 1975). These skill-related cues thus give rise to individuals’ perceived control over an outcome, which in turn leads to an unrealistic subjective probability of success. While this effect was originally demonstrated with predominantly chance-driven events, the illusion of control can be even more pronounced in situations that have elements of both skill and chance, since individuals are even more apt to attribute success in the outcome due to skill factors.
Seminal articles: On Illusion Of Control

Langer, E. J. “The Illusion of Control,” Journal of Personality and Social Psychology (32:2), 1975, pp. 311-328.

Langer, E. J. and Roth, J. “Heads I Win, Tails It’s Chance: The Illusion of Control as a Function of the Sequence of Outcomes in a Purely Chance Task,” Journal of Personality and Social Psychology (32:6), 1975, pp. 951-955.

Presson, P. K. and Benassi, V. A. “Illusion of Control: A Meta-Analytic Review,” Journal of Social Behavior and Personality (11:3): 1996, pp. 493-510.

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