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Thursday, 19 April 2012

To Boldly Go: Risk and the Prime Directive

Danger of Exposure

If you prime people by exposing them to information that advocates taking risks it causes them to boldly go out and start taking more risks with their investments. This is no real surprise.  Of course, if they’re a professional their behavior is different.

They’re more likely to take risks.  

Unconscious Non-tranquillity

This experiment, documented in Dalia Gilad and Doron Kilger’s paper, Priming the Risk Attitudes of Professionals in Financial Decision Making, is an example of priming; the process by which various memories and cognitive mechanisms are activated prior to a task. This activation causes people to change their behavior: it’s a pervasive human quality, and is probably a trait evolved to short-circuit difficult bits of mental processing by pre-preparing us to take action.

The idea of priming was first developed by the psychologist Karl Lashley back in 1951, who observed, in The Problem of Serial Order in Behavior, that to comprehend a whole sentence you have to anticipate what the end of the phrase will be – we don’t wait until a sentence is completed before deciding what is being ... said. This idea has spawned a vast, sprawling empire of research which suggests that there’s a whole world of unconscious behavior beneath our tranquil surfaces.

Halos, Cocktail Parties and Sex

We’ve actually met priming before, in disguise. In The Halo Effect: What’s In a Company Name? we saw that during the dotcom boom if companies changed their name to add “.com” to the end of it their share prices soared. That’s a simple example of priming at work: it’s a “click, whirr” process, where we don’t actually have to think about what we’re doing, we simply react.

This idea of non-conscious behavior is right at the heart of priming and it leads to some very odd results. Take, for instance, the cocktail party effect: you can be happily engaging in spontaneous and witty repartee in a noisy room while sipping a garishly colored drink with a dangerously pointy umbrella in it, when your attention is suddenly diverted to a nearby conversation. Someone has mentioned your name, and despite the fact you’ve been completely engrossed in trying to appear suave and sophisticated while holding the mental equivalent of a pink Chihuahua in a tutu, your brain will snap into full consciousness, and strain to catch the gossip.

The other thing that can make the brain do this is a mention of sex. In both of these cases something very odd is happening. Somehow our brain is attuned – primed – for these types of external inputs and can focus on them even when we’re not conscious of doing so. It’s like there’s some kind of continuous monitoring process going on in our heads which we’re not aware of.

Physical Priming

Priming is obviously associated with mental processes, but it can have bizarre physical consequences as well. Way back in 1852 William Carpenter identified it as the mechanism behind the relative success of Ouija Boards: the unconscious motor effects that cause people to unknowingly push tokens around and create messages from beyond the grave, or at least from beyond the conscious brain. This is the ideomotor effect and its greatest modern exponent is the psychologist John Bargh.

In Bargh’s best known experiment he got his participants to engage in a task to unscramble words. Unbeknownst to the subjects the real experiment was nothing to do with creating proper sentences but was measured by timing how quickly they left the laboratory facility. Some of the people were given word combinations that suggested old age, and they were significantly slower to walk to the exit: they’d been primed to act old. Priming prepares us for physical activities, as well as mental ones.

Money Priming

Meanwhile priming people with the concept of money leads to another range of consequences:
“Reminders of money, relative to non-money reminders, led to reduced requests for help and reduced helpfulness toward others. Relative to participants primed with neutral concepts, participants primed with money preferred to play alone, work alone, and put more physical distance between themselves and a new acquaintance”
That’s from The Psychological Consequences of Money by Kathleen Vohs, Nicole Mead and Miranda Goode. It fits neatly with previous research we’ve seen suggesting that an economics education makes you mean, but perhaps indicates that it’s not exposure to the self-interested meme behind the subject that causes the problem, but simply spending too much time talking and worrying about money.

As this isn't the way the rest of the world works it offers an explanation for economists, bankers and investment professionals as to why they're so misunderstood.  They're simply too selfish, self-obsessed, and boring for anyone else to take any interest in them; which is why they spend so much time talking to each other.

Goal Priming

What’s particularly odd, and interesting, and scary, about priming is that it hints at the idea that we can set goals for ourselves without even being aware of them, and then pursue them completely non-consciously. To put it another way, priming may change the way we behave over long periods of time, not just for isolated events. Which rather brings the whole idea of free-will, democracy and capitalism into question.

In The Effect of Non-conscious Goals on Investor Choice Colleen Kirk and Bernard McSherry looked at investment choices dependent on priming people with various cues. People primed with ideas of luxury were the small matter of 248 times more likely to choose a high risk investment plan than a conservative risk equivalent. So far, so unexpected. However the effect of the luxury prime didn’t wear off - it actually increased with time, although the effect of a thrifty prime didn’t. All of which suggests that some kind of underlying non-conscious goal has been activated – a scary thought, because it adds to the evidence that we’re not fully in control of what we’re attempting to achieve.

Professional Priming

So, back to the Gilad and Kilger paper we started this article with. The findings there indicate that professional investors are more likely to fall victim to the power of priming than their amateur equivalents. This is in line with the theories behind priming which suggest that the deeper the knowledge of a subject that a person possesses the more likely they are to use that knowledge to use it to interpret new information.

This idea is far from new; it can be traced back to Jerome Bruner’s work on perception in the 1950’s, where he argued that people learn about the likelihood of certain events occurring through experience, and then use this experience to minimize the possibility of future surprise. Which means that the more experience you have of a situation the easier it is to prime you to, incorrectly, expect certain outcomes.

This explains why professional investors are more apt to be primed for risky investments than amateurs – they’re simply more experienced, and their memory structures pertaining to these experiences are more easily activated. Which shouldn’t come as any surprise, but adds to the weight of knowledge that professional experience doesn’t make people any less likely to be impacted by behavioral bias, but changes the way in which they’re affected.

Ineradicable Priming

Many of the underlying cognitive biases we’ve met can be ameliorated with training or experience but priming, along with hindsight bias, seems to be virtually ineradicable. Worse still, priming can activate deep processes and beliefs that lead to longer-term, non-conscious goal directed behavior that we aren’t even aware of.

We can’t avoid being directed by priming, it’s part of the way we operate, so the best we can do is try to use it to our advantage. Developing a deeper understanding of investing process, and using it in an unemotional framework is about as good as you can get: you are the enemy within, even if you don’t know it.



Related articles:
Priming, Ideomotor effect and Cocktail Party effect added to the Big List of Behavioral Biases

3 comments:

Blographia Finance Blogs said...

Great blog, very original. I'm not sure whether you are aware but your blog got a mention in this week's Money Week magazine.

I've tried to give you more exposure by adding your RSS feed to Blographia.

Bloggers of the World United

John Berkowitz said...

Very interesting blog. I have downloaded the psychological consequence of money and I´m gonna read it! I just wanted to know if there is any relation between the "sheep mentality" and priming? Because you pointed out that banker tend to do the same things, while debating them. Many "normal" people are more like sheep, because they follow the (supposedly) smartest one.

I can observe this behavioral pattern in the real estate market in Canada, where even the overpriced housing does´t lead to market downturn. Many people, when they decide To Buy or Not to Buy?, as explained, decide to get the mortgage and jump into the market with no security that it won´t fall down in the next few months/years.

I´m curious what is the explanation for that behavior?

timarr said...

Hi John

There are a bunch of behaviors implicated in this. The first is simple over-optimism, it seems to be a standard human trait to be optimistic about the future, it’s good for our mental health but means we tend to be far too confident about our ability to foresee the future. The second is a tendency to extrapolate recent trends into the future – so house prices have gone up recently, we can expect them to continue to go up, if we don’t buy soon we’ll never be able to afford them, and so on. We tend to operate on what are called “observed frequencies” – the stuff we see around us – rather than the statistical evidence from the wider world.

Herding trends are also implicated, there’s a definite tendency for people to copy others when they don’t know exactly what to do. In boom times there’s also social issues, where we hate to see people “just like us” becoming richer than us, so we are attracted to whatever the bandwagon is. All too often these biases overwhelm a more sensible approach based on the numbers.

Example: how many people do you know who, while at work, buy expensive coffee from a coffee shop when they could make it themselves? Costs about ten times as much; say two coffees a day, 200 days a year, $3 a coffee = $600 a year. Make it yourself, save the money, buy yourself a nice experience :)