7. Illusion of Control Bias

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Del curso dictado por Indian School of Business

Behavioral Investing

88 calificaciones

Indian School of Business

Behavioral Investing

88 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

[MUSIC]

Learning outcomes, after completing this video you'll be able to explain what

illusion of control bias means,

list the ways in which one can overcome illusion of control bias.

Illusion of control bias describes the tendency of investors to believe

that they can control or at least influence outcomes in financial markets

when in fact they cannot.

Relevant analogy or humorous analogy can be found in

one of the anecdotes that's pretty prevalent in India.

In a small town, in a small village in India, a man marches

to the town square everyday at a designated time.

Let's say, 6 o'clock in the evening carrying a flag and a trumpet and

when the man reaches the appointed spot, he brandishes the flag and

blows a few notes on the trumpet then he returns home to the delight of his family.

A regular person notices this person's activity every single day and

eventually asks him, what are you doing?

The man replies, I'm keeping elephants away and

the village elder says, but there aren't any elephants in our village.

>> The person says well, then I'm doing a very good job, aren't I, aren't I?

So at this person the rolls his eyes, and laughs.

This rather absurd tale illustrates the fallacy

inherent in the illusion of control bias.

So in the investment world,

illusion of control bias can lead investors to trade more than is prudent.

It's been found that online traders believe themselves to

have more control over the outcome of the investments than they actually do.

And in the end an excess of trading results in decreased returns.

A leisure of control can also lead investors to maintain

under diversified portfolios.

Researchers found that investors hold concentrated positions because they

gravitate towards companies over whose fate they feel somewhat control.

So if I'm an investor and I feel somewhat of control over the fate of a particular

company, then I gravitate towards that particular company's stock.

In fact that control almost always proves illusionary and

the lack of diversification eventually hurts the investor's portfolio.

Illusion of control buys can also cause investors to use limit orders and

other such techniques which we have discussed in the first course.

And the expedience of falls control over the investment.

In fact, the use of these mechanisms most often leads to

an overlooked opportunity and even worse,

a detrimental unnecessary purchase based on the occurrence of an arbitrary price.

Illusion of control bias contributes in general to investors overconfidence.

So how to avoid this?

Basically, there are four advisors or suggestions that investors can

implement to stem the detrimental effects of illusion of control.

First, is to recognize that successful investing

is even in the best of times, a probabilistic activity.

So the first step on the road of recovery from

this particular illusion is to take a step back and

realize how complex the global financial markets actually is.

The financial markets are fairly complex,

even the wisest of investors don't have much of a chance and

have absolutely no control over the outcome of the investments that they make.

The second suggestion is to recognize and

award circumstances that trigger illusion of control.

So the example that I give of the villager blowing his trumpet every

day at a designated time and no stampede of elephants happen.

Now we know that the trumpet of course doesn't really keep the elephants away.

So applying the same concept to investing, just because I

as an investor have deliberately determined to purchase a stock.

Do I really control the trade of that stock or

the outcome of that particular purchase?

Rationally, if I think about it,

it becomes clear that some correlations are actually arbitrary rather than causal.

So I shouldn't permit myself to make financial decisions on what I

logically discern as an arbitrary correlation which is essentially,

the basis is quite arbitrary.

The third position is to actually seek contrary viewpoints.

Let's say, I contemplate a new investment.

I should take a moment to ponder whatever

considerations might weigh against the trade.

I should ask myself, why am I making this particular investment?

What are the downside risks?

When will I sell it?

What might go wrong?

These questions can help me to screen the logic behind the decision

before implementing that decision.

The last suggestion is that once I have decided to move forward with

an investment.

One of the best ways to keep the illusion of control at bay is

to maintain records of my transaction, including reminders and

spelling out the rationale that underlie each trait.

Sometimes if you write down some of the important features of each of

the investments that you mean, and emphasize the attributes that you

have determined to be in favor of the investment success.

I've had the chance for looking at some very good investors, and normally give

the example of the renowned former Fidelity Microfund Manager, Peter Lynch.

Peter Lynch was a meticulously record keeper, was a very good record keeper and

would document his opinions on different companies at every opportunity possible.

When I was in Western Bank or JP Morgan our team along with our

managing director had the occasion to visit fidelity and

meet Mr. Lynch, who was an acquaintance of her MB.

So our team basically just went up to say hello, and

we had a fairly long conversation with Mr. Lynch.

And what I saw and heard was quite astounding to me

because I realized that Lynch actually made things.

A very good archive of notebooks filled with information.

His office is literally filled with research papers.

It's not a very clean place, it's actually filled with research papers.

And he shared with us that he expects his subordinates to be equally tough as he is.

So when analysts would make a recommendation lecture actually that

require a written presentation outlining the details and

the basics of each recommendation.

Now, I think all investors should strive to get to that level.

We may not be able to reach that level of standard sophistication and

metaclystic art giving that Lynch has done and

the standards that he has set for himself and others.

But at least, an average investor should strive to reach to at least

a considerable, a certain amount of level that Lynch has set,

the standard that Lynch has set for himself.

Rationally, we know that returns on long term investments are in turn impacted by

Immediate things that surround a financial transaction.

So profit or loss on investment thereof is usually a result of uncontrolled

factors like corporate performance and general economic conditions.

So an illusion of control on those corporate performances or general economic

conditions is actually more often than not or almost always misplaced.

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