Loss Aversion Affects Tiger Woods, Too

Behavioral Biases (3): Loss Aversion

Loss aversion, the tendency for people to be more risk adverse when protecting a gain than when chasing a loss, is a pervasive psychological bias. Indeed, it appears not even Tiger Woods is immune:

“Although the very best golfers are slightly less biased than their peers, even the best golfers—including Tiger Woods—exhibit loss aversion. This is a costly mistake. If any one of the top 20 golfers in 2008 was able to overcome this bias, his expected annual tournament earnings would have increased by $1.2 million dollars (a 22% increase).”

Put simply golfers play better when attempting to avoid dropping a shot than when trying to gain one, when they consistently leave their shots short. Yet this doesn’t make any sense – “bogey”/loss” and “birdie”/“gain” are purely relative concepts – all that should matter is the overall score or portfolio value.

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Hindsight Bias

Behavioural Biases (2): Hindsight Bias

The CIA reports that hindsight biases are:

attributable to the nature of human mental processes, not just to self-interest and lack of objectivity, and that they are, therefore, exceedingly difficult to overcome.

And, after some years searching for weapons of mass destruction in the wrong country, as the North Koreans have demonstrated by actually exploding nuclear weapons, the CIA really ought to know about this.

In fact, if you replace “exceedingly difficult” with “impossible” you’ve basically got the point – hindsight bias, the tendency to believe that events that have already occurred were more predictable than they were before they took place, is endemic and a built-in part of the human psyche. It’s one of a multitude of factors that leads to investor overconfidence and underperformance.

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Seven Psychological Quirks That Destroy Investment Returns

Posted over on www.monevator.com with thanks to The Investor. I recommend having a good browse around.

I’ll soon be starting a more detailed investigation into behavioural biases in dealing with a negative sum market, starting with: Behavioural Biases (1): Overconfidence and Over Optimism


Related Posts: Newton’s Financial Crisis

Technical Analysis, Killed By Popularity

Heisenberg’s Investment Principle

In quantum mechanics the Heisenberg Uncertainty Principle expresses the finding that in attempting to measure anything at the sub-atomic level you inevitably change what you’re measuring. You can determine a particle’s position or its speed but never both at the same time.

In stockmarket investment a similar thing happens whenever someone identifies a sure-fire way of making money. No sooner do they publish their findings then their technique fails. It’s all down to human psychology and it’s the same reason why popular technical analysis techniques can’t reproducibly produce above average market returns. Heisenberg rules, OK?

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The Death of Homo economicus

Active Stockmarket Investment is not for the Inexperienced

Economists and political philosophers from Adam Smith to John Stuart Mill long held fast to the idea of the human being as a rational creature, one wishing to maximise their own self-interest at least effort and risk to themselves. This creature – dubbed Homo economicus by its opponents – is some kind of perfect calculating machine, weighing up risks and rewards and making logical choices in its own self-interest.

Basically it’s what an economist imagines themselves to be. Like Mr. Spock without the ears, green blood, mind melding and curious eyebrows.

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Darwin’s Stockmarkets

Reagan's Revolution

Ronnie Reagan, when asked for his beliefs about the Theory of Evolution, shrugged and replied; “Hey, it’s only a theory”. Which it is, I guess, in the same way that the Theory of Gravity is “only a theory” although somehow I doubt my pet dog will start exhibiting signs of weightlessness anytime soon. In fact Darwin’s great intellectual jump wasn’t evolution itself but an insight into what underlay the concept – an idea applicable to financial markets and sobering in what it suggests about our ability to predict anything, let alone something as complex as the screamingly mad world of finance.

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Perverse Incentives are Daylight Robbery

The Wrong Carrots

An awful lot of what goes wrong in the human world is connected to perverse incentives. These are the carrots that leaders use to encourage people to behave in particular ways only, through the law of unintended consequences, they work in more or less the opposite fashion to that intended.

We often misunderstand the nature of incentives because it’s difficult to figure out what they are or even whether they affect us – but if our business leaders get this wrong we see businesses doing extraordinarily stupid things. Worse, if our business leaders’ own incentives aren’t kept in check they themselves do extraordinarily stupid things. We’ve seen plenty of both in recent times and unwinding the mess that badly designed incentives have done to the world is going to take time, patience and thoughtful appreciation of the issues by the world’s leaders, both political and commercial.

So let’s not hold our collective breath, then.

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Newton’s Financial Crisis: the Limits of Quantification

Issac Newton's Nail

“To the man with only a hammer, every problem looks pretty much like a nail”

The blame for the crisis in today’s financial markets lies, in my opinion, with one man. Isaac Newton.

The observant among you may spot a potential flaw in this theory. The great English scientist has been dead for two hundred and eighty two years. But let’s not let a matter of such insignificant detail delay us, the genesis of the credit crunch can clearly be traced back to the man whose balls swing so freely on many a stressed executive’s desk.

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Money and Minds

Beginnings

As any good blog should be this one is about my main interests – psychology (Psy), finance (Fi) and, in particular, the way they interact to cause strange things to happen out in that odd place known as the "Real World". Not all of these things are entirely good mind you – think nuclear weapons, credit crunches and reality T.V. – but many of them make you wonder exactly what it was that people were thinking. Or if they were thinking at all.

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