Cognitive Biases in Property Investment

Abstract

Understanding the way investors think and take decisions in the face of the hazards of investment is crucial to evaluate the risks stemming from the same decision. During the process of risk assessment, investors focus on the information available, which can be sometimes quite extensive and of diverse quality. Investors are typically capable to observe and process only a certain amount of information per given time. Instinctively this leads them to use judgment rules, to reduce the amount of information, and make conjectures to project some scenarios before making decisions. This heuristics process is specific to every single investor, according to their own personal profile (i.e. different risk perception and exposure), preferences, and expectations. This paper analyses cognitive bias in property investment. Judgment rules may be affected by the amount of product available in the market, liquidity issues, the momentum of the property cycle, and the asymmetric information between property sellers and buyers, during the negotiation process. Persistent biases will affect expectations and, as a result, property premia. Availability heuristic, overconfidence effect, anchoring, and ambiguity effect are some common biases that appear during the investment process.This paper analyses cognitive bias in property investment. Judgment rules may be affected by the amount of product available in the market, liquidity issues, the momentum of the property cycle, and the asymmetric information between property sellers and buyers, during the negotiation process. Persistent biases will affect expectations and, as a result, property premia. Availability heuristic, overconfidence effect, anchoring, and ambiguity effect are some common biases that appear during the investment process.