3. Anchoring and adjustment bias

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Del curso dictado por Indian School of Business

Behavioral Investing

83 calificaciones

Indian School of Business

Behavioral Investing

83 calificaciones

Curso 3 de 5 en SpecializationFinancial Markets and Investment Strategy

Through this course, you will learn how individuals and firms make financial decisions, and how those decisions might deviate from those predicted by traditional financial or economic theory. We will explore the nature of these biases and their origins, using insights from psychology, neurosciences and experimental economics on how the human mind works. From these biases, you will be able to examine how the insights of behavioral finance complement the traditional finance paradigm. We also look at the micro and macro biases. Finally, we will explore how these insights describe more complicated topics such as fat tail events and financial crises.

De la lección

Behavioral Biases in Finance - Part 1

This module discusses the common behavioral biases experienced by individuals. All the biases are divided into 3 parts. After completing this module you will be able to explain different biases such as Overconfidence, Base rate neglect, Anchoring and adjustment, Cognitive Dissonance, Availability, Self-Attribution and Illusion of Control Bias.

0. Introduction11:55

1. Overconfidence Bias6:43

2. Representativeness Bias - Base rate neglect9:20

3. Anchoring and adjustment bias7:01

4. Cognitive Dissonance Bias9:43

5. Availability bias9:07

6. Self-Attribution Bias9:56

7. Illusion of Control Bias8:41

Conoce a los instructores

Vaidya Nathan
Lecturer
Finance

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Learning outcomes.

After completing this video you'll be able to to explain what anchoring and

adjustment bias means.

Discuss various example of anchoring and adjustment bias.

Understand how to emulate anchoring and adjustment bias.

When required to estimate a value with unknown magnitude, investors generally

begin by envisioning some initial default number, an anchor.

Which they then adjust up or down, due to subsequent information, and

analysis about a particular stock, or index.

The anchor, once fine tuned and

reassessed, then matures into a final estimate.

Research has demonstrated that regardless of how the initial anchors are chosen,

investors tend to adjust their anchors insufficiently, and

produce approximations that are consequently biased.

Investors are generally better at estimating directive comparisons

rather than absolute figures.

Just to give an example, suppose I asked you whether the valuation of Uber,

which is basically a cab service provider,

is greater than $8 billion or less than $8 billion.

Obviously, you will answer that it is either about 8 or less than 8.

And if I were to then ask you to guess an absolute valuation for Uber,

your estimate would probably fall somewhere near $8 billion.

And not anywhere close to $50 billion or $1 billion,

because you are likely to subject to anchoring by your previous response,

and you're likely to anchor your number to the $8 billion mark.

So anchoring and adjustment is essentially a psychological heuristic

that influences the way investors intuit about probabilities.

Investors exhibiting this kind of a bias are often influenced by

arbitrary levels of price indices, and then cling onto these

numbers when they face questions like, should I buy or sell the security?

Or, is the market overvalued or undervalued, and so on.

This is especially true when introduction of information regarding the security or

the index further complicates the assessment situation.

Rational investors,

on the other hand, treat these new pieces of information objectively, and

do not reflect on purchase prices or target prices in deciding how to act.

Anchoring and adjustment bias, however, implies that investors

perceive new information through essentially a warped lens.

So they place undue emphasis on statistically

arbitrary and psychologically bit of mind anchor points.

Such investor decision making therefore

tends to deviate from the neoclassical proscribed rational norms.

Let me give you an example for anchoring and adjustment bias.

Suppose I owned a stock in Apple, and

let's say that I am a fairly astute investor.

And I have recently discovered some good information about Apple.

So my task is, so what I'm trying to do is essentially to evaluate this information

for the purpose of deciding whether I should be increasing my stock holding, or

decreasing my stock holding, or simply maintaining my holdings in Apple stock.

So let's say that I bought Apple stock way back in August 2015 when

the price was $103.

And the Apple stock price of course reached a level of $122 in November 2015,

and the stock price since then has come down, and it's about $100 in March, 2016.

So essentially what I've done is I bought stock at $103,

it went up to $122 in November, and it's come down to $100 in March, 2016.

So I may have contemplated selling the stock in November, but

I did not sell it, and unfortunately Apple stock has dropped by $22.

And if I rationally feel that I've lost close to 20%,

I've lost $22 on an investment of $100 over these

five months then, and I prefer to sell my shares in Apple

only after they return to the recent highs of $122.

Then I maybe suffering from anchoring and adjustment bias.

So now let's basically analyze this case.

Most investors are confronted with situations similar to this one.

They decide to invest in a stock.

The stock price goes up, and then declines, and

then investors become conflicted.

And therefore, most evaluate the situation to determine

whether to hold on to the stock or to sell it off.

A rational investor would examine the firm's performance,

the company's performance, and make an objective assessment

of its business fundamentals and then decide to buy, hold or sell the stock.

However, an irrational investor, like me, say, even after going through the process,

and the trouble of performing the analysis that a rational investor will do, and

perform all the rational analysus that I may perform.

I may still permit cognitive errors to cloud my decision.

So I may irrationally disregard the results of my research and

anchor myself to the $122 figure, refusing to sell Apple

stocks unless Apple share price, once again, achieves that price.

This type of response results in an irrational behavior and should be avoided.

And how to basically ameliorate this kind of a bias, anchoring and adjustment bias.

So, from an investment perspective, awareness is the best counter-measure for

anchoring and adjustment bias.

I should be asking myself the question, am I analyzing the investment

situation rationally, or am I holding out to attain an anchor price?

So when making forecasts about the magnitude or direction of markets or

securities, I should ask myself, is my estimate rational or

am I anchoring to some past performance figures?

Taking these sorts of actions is very likely to root out any anchoring and

adjustment bias that may have taken hold in my investment decisions.

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