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Showing posts with label conjunction fallacy. Show all posts
Showing posts with label conjunction fallacy. Show all posts

Saturday, 3 July 2010

Behavioural Finance’s Smoking Gun

Linda

Here’s a classic demonstration of behavioural finance in action, proving the irrationality of humankind. It’s the (in)famous Linda problem:

Linda is 31 years old, single, outspoken and very bright. She majored in philosophy. As a student, she was deeply concerned with issues of discrimination and social justice, and also participated in antinuclear demonstrations. Which of these two alternatives is more probable?
(a) Linda is a bank teller.
(b) Linda is a bank teller and is active in the feminist movement.
Most subjects choose (b) and are informed that they’re irrational because the conjunction of two events – Linda is a bank teller and active in the feminist movement – is less likely than her just being a bank teller, regardless of her leisure interests. This is known as the conjunction fallacy. Unfortunately there’s a teensy little problem with this finding.

It’s wrong and it’s the smoking gun of behavioral finance.