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Thursday, 24 July 2014

Y is for Yawn Effect

The Yawn Effect occurs when you yawn in response to someone else yawning. In fact you can even get your dog to do it (or get coerced into yawning by your pooch). Yawning is contagious, and contagion is an inevitable unconscious consequence of people interacting with each other - and, as usual, when we behave automatically as investors it doesn't make for a good financial outcome.

Wednesday, 23 July 2014

X is for Xenophobia

OK, Xenophobia isn't really a behavioral bias, but Home Bias is its equivalent - the tendency of investors to favor their home markets over foreign ones and to damage their returns, or at least increase their risks, in the process.

Monday, 21 July 2014

Mistrust the Financial Storytellers

Homo narratus

Homo sapiens is the storytelling ape. We make sense of the things that happen in the world, of the things that happen to us, and even of ourselves, through stories and narratives. Consciousness is perhaps best defined as the stories we tell of ourselves as coherent individuals passing through time.

So it's not surprising that we're inclined to favor people who tell stories over those who crunch data. Words are human, numbers - somehow - are not. But the real stories lie in the numbers and, in investment, people who tell stories without the numbers are mystics and shamans, or worse.

Friday, 18 July 2014

W is for Winner's Curse

The Winner's Curse occurs when in order to win a competitive pricing situation such as an auction we overpay. By overpaying we destroy the investment case for buying in the first place and the losers turn out to be the winners. Of course, overpaying for anything is unfortunate, but competition has strange effects on our brains.

Thursday, 17 July 2014

V is for Von Restorff Effect

The Von Restorff Effect states that something that stands out is more likely to be remembered. So a highlighted item on a list is more likely to be recalled than the remainder of the list items. The effect demonstrates the unreliability of memory, which isn't any kind of photographic process but is a more complicated affair, generated on the fly from bits and pieces of information we can bring to mind.

Wednesday, 16 July 2014

U is for Uncertainty

Uncertainty is the reality of the unknown unknowns. We don't know what we don't know: we can't even measure it. And we don't like it, not at all. In fact we don't like it so much we're prepared to ignore it, which is unfortunate as it's an 800 pound gorilla sitting in the corner. Painted blue, wearing a tutu and playing a bassoon.

We really hate uncertainty.

Tuesday, 15 July 2014

T is for Texas Sharpshooter Effect

The Texas Sharpshooter Effect is a doozy, although it's less of a bias and more a sleight of hand trick. Impressed by that fantastic mutual fund history? Amazed by that stock tipping sheet performance? Dumbfounded by that guru's record of predicting market movements? Roll up, roll up and see the Texan Sharpshooter in action ...

Monday, 14 July 2014

The Nudge Unit Goes EAST; Investor Funds Go West

Applied Psychology

As we saw in SCOTUS Breaches the Efficient Frontier, behavioral finance is (finally) beginning to be applied to the real world. Over in the UK the Behavioural Insights Team, aka the "Nudge Unit", has been using behavioral techniques to help improve citizens' responses to various government initiatives: getting people to pay their taxes, improve their health, increase the number of organ donors and so on. 

Since being spun out into the private sector the unit's range of programs has broadened and the results of their work look increasingly impressive, if not downright worrying. However, what is really interesting for us is how the insights the team is revealing are applicable to investors. Because, when you really think about these methods it turns out that they're already being applied. To us.

Friday, 11 July 2014

S is for Self-Enhancing Transmission Bias

Self-Enhancing Transmission Bias is what everyone does when they talk about themselves: they big themselves up and conveniently forget about their mistakes. And as everyone does this across a network you will get an amplification effect: everyone is great at investing and no one ever gets stuff wrong. And the more we broadcast, the greater the effect.

Thursday, 10 July 2014

R is for Representative Heuristic

The Representative Heuristic is our trick of comparing whatever happens to be under consideration to whatever we can bring to mind. It's an effect of availability, but we can be primed into triggering the heuristic by clever manipulators or not-so-clever psychologists.