Irrational Biases Research Articles

What drives the tail risk effect in the Chinese stock market?

In this paper, we investigate the existence and source of the tail risk effect in the Chinese stock market. The cross-section relationship between the tail risk and stock returns in China is mixed in the literature. By using data over the time period from January 2000 to December 2020, we observe that the tail risk is negatively related to expected returns only when excluding stocks with the bottom 30% market capitalization. Through market mechanisms' analysis, we identify that the negative tail risk effect can be induced by the investors’ irrational biases and limits to arbitrage. In addition, our research demonstrates that implementation of the margin trading system not only mitigates tail risk but also suppresses the negative tail risk effect for targeted stocks.

Echo Chambers: Social Learning under Unobserved Heterogeneity

Abstract People are often more influenced by opinions similar to their own and even seek information from those with whom they expect to most agree—behaviours often attributed to irrational biases. In this paper, I argue that these behaviours can be understood within the context of rational social learning by accounting for the presence of unobserved heterogeneity in preferences or priors. Individuals display local learning by placing greater weight on opinions that are closer to their own. When individuals choose whom to learn from, local learning leads to the development of echo chambers.

Conservative Treatment of Evidence

AbstractThis paper discusses two conservative ways of treating evidence. (I) Closing inquiry involves discounting evidence bearing on one's belief unless it is particularly strong evidence; (II) biased assimilation involves dedicating more investigative resources to scrutinizing disconfirming evidence (than confirming evidence), thereby increasing the chances of finding reasons to dismiss it. It is natural to worry that these practices lead to irrational biases in favor of one's existing beliefs, and that they make one's epistemic condition significantly path-sensitive by giving a bigger role to batches of evidence obtained earlier in the course of inquiry compared with those subsequently acquired. However, I argue that both practices are demanded by considerations of practical rationality. I also argue that, contrary to initial appearances, there is little reason to worry about the effects of these practices on the dynamics of one's beliefs.

Observers penalize decision makers whose risk preferences are unaffected by loss-gain framing.

A large interdisciplinary body of research on human judgment and decision making documents systematic deviations between prescriptive decision models (i.e., how individuals should behave) and descriptive decision models (i.e., how individuals actually behave). One canonical example is the loss-gain framing effect on risk preferences: the robust tendency for risk preferences to shift depending on whether outcomes are described as losses or gains. Traditionally, researchers argue that decision makers should always be immune to loss-gain framing effects. We present three preregistered experiments (N = 1,954) that qualify this prescription. We predict and find that while third-party observers penalize decision makers who make risk-averse (vs. risk-seeking) choices when choice outcomes are framed as losses, this result reverses when outcomes are framed as gains. This reversal holds across five social perceptions, three decision contexts, two sample populations of United States adults, and with financial stakes. This pattern is driven by the fact that observers themselves fall victim to framing effects and socially derogate (and financially punish) decision makers who disagree. Given that individuals often care deeply about their reputation, our results challenge the long-standing prescription that they should always be immune to framing effects. The results extend understanding not only for decision making under risk, but also for a range of behavioral tendencies long considered irrational biases. Such understanding may ultimately reveal not only why such biases are so persistent but also novel interventions: our results suggest a necessary focus on social and organizational norms. (PsycInfo Database Record (c) 2022 APA, all rights reserved).

What Drives the Tail Risk Effect in the Chinese Stock Market?

In this paper, we reveal that in the Chinese stock market, the significant negative relationship between tail risk and expected returns only exists when excluding the bottom 30% market capitalization (small-cap) stocks, a finding that helps to reconcile the mixed result of the tail risk effect in China. In mechanism exploration, irrational biases of investors (including underreaction to bad news, preference for tail risk of stocks in capital loss, and overoptimism) and limits to arbitrage in the market may induce the negative tail risk effect in the Chinese stock market. In addition, we also find that implementing the margin trading system reduces the tail risk and suppresses the negative tail risk effect for target stocks.

Contextual Complications in Analytical Modeling: When the Problem is Not the Problem

In this essay, I describe 10 critical complicating factors that directly affect the six basic modeling components of problem definition, assumptions, decision variables, objective functions, constraints, and solution approach. The proposed 10 contextual complicating factors are (1) organization, (2) decision-making processes, (3) measures and key performance indicators, (4) rational and irrational biases, (5) decision horizon and interval, (6) data availability, accuracy, fidelity, and latency, (7) legacy and other computer systems, (8) organizational and individual risk tolerance, (9) clarity of model and method, and (10) implementability and sustainability of the approach. I hypothesize that the core analytical problem cannot be adequately described or usefully solved without careful consideration of these factors. I describe detailed examples of these contextual factors’ effects on modeling from six published applied prescriptive analytics projects and provide other examples from the literature. The complicating factors are pervasive in these projects, directly and dramatically affecting basic modeling components over half the time. Further, in the presence of these factors, 23 statistically significant correlations tend to form in three clusters, which I characterize as culture, decision, and project clusters. Unrecognized, these factors would have hampered the implementation and ongoing use of these analytical models; in a sense, the models themselves were wrong, absent consideration of these contextual considerations. With these insights, I hope to help practitioners identify the effects of these common complications and avoid project failure by incorporating these contextual factors into their modeling considerations. Future research could seek to better understand these factors and their effects on modeling.

Are Sports Bettors Biased toward Longshots, Favorites, or Both? A Literature Review

A large body of literature on the favorite–longshot bias finds that sports bettors in a variety of markets appear to have irrational biases toward either longshots (which offer a small chance of winning a large amount of money) or favorites (which offer a high chance of winning a small amount of money). While early studies in horse racing led to an impression that longshot bias is dominant, favorite bias has also now been found in a variety of sports betting markets. This review proposes that the evidence is consistent with both biases being present in the average sports bettor. Sports betting markets with only two potential outcomes, where the favorite therefore has a probability >0.5 of happening, often produce favorite bias. Sports betting markets with multiple outcomes, where the favorite’s probability is usually <0.5, appear more consistent with longshot bias. The presence of restricted odds ranges within any given betting market provides an explanation for why single studies support, at most, one bias. This literature review highlights how individual sports bettors might possess biases toward both highly likely, and highly unlikely, events, a contradictory view that has not been summarized in detail before.

A pupillary index of susceptibility to decision biases.

The demonstration that human decision-making can systematically violate the laws of rationality has had a wide impact on behavioural sciences. In this study, we use a pupillary index to adjudicate between two existing hypotheses about how irrational biases emerge: the hypothesis that biases result from fast, effortless processing and the hypothesis that biases result from more extensive integration. While effortless processing is associated with smaller pupillary responses, more extensive integration is associated with larger pupillary responses. Thus, we tested the relationship between pupil response and choice behaviour on six different foundational decision-making tasks that are classically used to demonstrate irrational biases. Participants demonstrated the expected systematic biases and their pupillary measurements satisfied pre-specified quality checks. Planned analyses returned inconclusive results, but exploratory examination of the data revealed an association between high pupillary responses and biased decisions. The findings provide preliminary support for the hypothesis that biases arise from gradual information integration. PROTOCOL REGISTRATION: The stage 1 protocol for this Registered Report was accepted in principle on 19 December 2018. The protocol, as accepted by the journal, can be found at https://doi.org/10.6084/m9.figshare.c.4368452.v1 .

Choosing what we like vs liking what we choose: How choice-induced preference change might actually be instrumental to decision-making.

For more than 60 years, it has been known that people report higher (lower) subjective values for items after having selected (rejected) them during a choice task. This phenomenon is coined "choice-induced preference change" or CIPC, and its established interpretation is that of "cognitive dissonance" theory. In brief, if people feel uneasy about their choice, they later convince themselves, albeit not always consciously, that the chosen (rejected) item was actually better (worse) than they had originally estimated. While this might make sense from an intuitive psychological standpoint, it is challenging from a theoretical evolutionary perspective. This is because such a cognitive mechanism might yield irrational biases, whose adaptive fitness would be unclear. In this work, we consider an alternative possibility, namely that CIPC is -at least partially- due to the refinement of option value representations that occurs while people are pondering about choice options. For example, contemplating competing possibilities during a choice may highlight aspects of the alternative options that were not considered before. In the context of difficult decisions, this would enable people to reassess option values until they reach a satisfactory level of confidence. This makes CIPC the epiphenomenal outcome of a cognitive process that is instrumental to the decision. Critically, our hypothesis implies novel predictions about how observed CIPC should relate to two specific meta-cognitive processes, namely: choice confidence and subjective certainty regarding pre-choice value judgments. We test these predictions in a behavioral experiment where participants rate the subjective value of food items both before and after choosing between equally valued items; we augment this traditional design with both reports of choice confidence and subjective certainty about value judgments. The results confirm our predictions and provide evidence that many quantitative features of CIPC (in particular: its relationship with metacognitive judgments) may be explained without ever invoking post-choice cognitive dissonance reduction explanation. We then discuss the relevance of our work in the context of the existing debate regarding the putative cognitive mechanisms underlying CIPC.

Post-earnings announcement drift and parameter uncertainty: evidence from industry and market news

Post-earnings announcement drift (PEAD), one of the most prominent and robust return anomalies, is often attributed to investor naivete or irrationality. A competing explanation is parameter uncertainty, which posits that PEAD may occur as rational investors encounter parameter uncertainty and must learn about the true values of a firm’s pricing parameters over time. This study extends the parameter uncertainty explanation for PEAD and hypothesizes that industry or market news arriving during the drift period affects drift strength. Consistent with our hypothesis, we find that the prices of high surprise firms show stronger responses to industry/market news in the drift period. Hence, the drift becomes stronger (weaker or reversed) when drift-period industry/market news agrees (disagrees) with a firm’s prior earnings news. The evidence helps to distinguish the parameter uncertainty theory from competing behavioral explanations based on investor naivete or irrational biases, a task previous studies find difficult. Overall, our findings indicate that asset pricing anomalies need not imply investor irrationality—anomalies could arise from rational investors learning about pricing parameters over time.

Moderators for Partition Dependence in Prediction Markets

Every investment decision by organizations is an implicit expression of a prediction on the future state of companies, demand trends, future challenges, or politics. Usually, decision makers can chose between different options to invest and also tend to diversify investments in order to reduce risk. Research on cognitive processing, however, showed that unconscious heuristics triggered by “heuristic cues” influence such decisions in an irrational manner. Partition dependence, the partition of the state space, is such a heuristic cue that leads to an irrational bias in the assessment of probabilities towards a uniform distribution. This work demonstrates that this bias is also persistent in group-based forecasting. We explain and predict the occurrence of the partition dependence bias by applying the Dual-Process Theory of cognitive processing. The results of our three consecutive experiments suggest that besides task complexity, individual expertise, and motivation are moderators for the occurrence of partition dependence. We contribute to the research of biases in forecasting by applying approaches of the Dual-process Theories to explain the occurrence of partition dependence for the first time and shed light on future pathways in this research field.

False Equivalence: Are Liberals and Conservatives in the United States Equally Biased?

On the basis of a meta-analysis of 51 studies, Ditto et al. (this issue, p. 273) conclude that ideological bias is equivalent on the left and right of U.S. politics. In this commentary, we contend that this conclusion does not follow from the review and that Ditto and his colleagues are too quick to embrace a false equivalence between the liberal left and the conservative right. For one thing, the issues, procedures, and materials used in the studies reviewed by Ditto and his colleagues were selected for purposes other than the inspection of ideological asymmetries. Consequently, methodological choices made by researchers were systematically biased to avoid producing differences between liberals and conservatives. We also consider the broader implications of a normative analysis of judgment and decision making and demonstrate that the bias examined by Ditto and his colleagues is not, in fact, an irrational bias, and that it is incoherent to discuss bias in the absence of standards for assessing accuracy and consistency. Other conclusions about domain-general asymmetries in motivated social cognition have suggested that epistemic virtues are more prevalent among liberals than conservatives, and these conclusions are closer to the truth of the matter when it comes to current American politics. Finally, we question the notion that the research literature in psychology is necessarily characterized by liberal bias, as several authors have claimed.

Making Sense of the Numbers: The Shift from Non‐consensual to Consensual Debt Relief and the Construction of the Consumer Debtor

This article analyses trends in the number of individual insolvency proceedings in England and Wales, particularly a shift from non‐consensual debt relief to consensual Individual Voluntary Arrangements (IVAs) and, connected to that, an increased privatization of the process. Seeking to conceptualize IVA users, it builds on American scholarship linking the development of bankruptcy rates to the construction of the consumer debtor. Based on this theory and empirical evidence, its findings broadly indicate that a majority of IVA users do not match the image of a strategic actor. Rather, they belong to the most vulnerable groups, whose decision in favour of IVAs is the result of external constraints and irrational biases, which commercial providers tend to exploit. Building on this characterization of IVA users, the article contributes to the critical discussion of aforementioned trends, arguing that reforms should be contemplated to partially reverse them.

When Irrational Biases Are Smart: A Fuzzy-Trace Theory of Complex Decision Making.

I take a decision-making approach to consider ways of addressing the “unresolved and dramatic problems in the world”. Traditional approaches to good decision-making are reviewed. These approaches reduce complex decisions to tradeoffs between magnitudes of probabilities, and outcomes in which the quantity and precision of information are key to making good decisions. I discuss a contrasting framework, called “fuzzy-trace theory”, which emphasizes understanding the simple gist of options and applying core social and moral values. Importantly, the tendency to rely on meaningful but simple gist increases from childhood to adulthood (or, in adulthood, as people gain experience in a domain), so that specific irrational biases grow with knowledge and experience. As predicted theoretically, these violations of rationality in the traditional sense are associated empirically with healthier and more adaptive outcomes. Thus, interventions that help decision makers understand the essential gist of their options and how it connects to core values are practical approaches to reducing “unresolved and dramatic problems in the world” one decision at a time.

Exploring the Efficacy of Using Theatre Techniques in Teaching Business Communication

In recent times, more and more teachers in their reinvention of the course, drop the lecture model and are finding alternatives to help students draw a connect between the knowledge acquired in the classroom to their day-to-day life's problems and challenges. The present paper reports about the students' experiences in learning various aspects of communication through theatre techniques. The analysis of the content revealed that the learning through theatre medium was a liberating experience for them that helped them to overcome their negative consciousness and experience the sense of freedom from those archaic irrational biases and prejudices that prevent them from achieving their best. The students reported that this participatory art form helped them in heightening their self-awareness and in developing confidence.

Perceptions of institutional quality: Evidence of limited attention to higher education rankings

Rankings of colleges and universities provide information about quality and potentially affect where prospective students send applications for admission. We find evidence of limited attention to the popular U.S. News and World Report rankings of America’s Best Colleges. We estimate that applications discontinuously drop by 2%–6% when the rank moves from inside the top 50 to outside the top 50 whereas there is no evidence of a corresponding discontinuous drop in institutional quality. Notably, the ranking of 50 corresponds to the first page cutoff of the printed U.S. News guides. The choice of college is typically a one-time decision with potentially large repercussions, so students’ limited attention to rankings likely represents an irrational bias that negatively affects welfare.

Knowledge of Deaths in Hotel Rooms Diminishes Perceived Value and Elicits Guest Aversion.

Guest deaths are an inevitable aspect of the hospitality industry. In Study 1, participants read a vignette in which the previous guest died of natural causes, suicide, or homicide. Those who learned of a death (a) saw the room as less valuable, (b) opted to stay in a more basic room in which no death occurred, despite both rooms being offered for free, and (c) anticipated feeling uneasy when imagining an overnight stay. In Study 2, we investigated the persistence of this bias. Perceived room value and anticipatory well-being can be expected to return to baseline levels only many years after the death event. Similar to "stigmatized properties" in real estate, these data confirm an irrational and recalcitrant cognitive bias surrounding consumers' views of death-affected hotel rooms.

Perceptions of Institutional Quality: Evidence of Limited Attention to Higher Education Rankings

Rankings of colleges and universities provide information about quality and potentially affect where prospective students choose to send applications for admission. We find evidence of limited attention to the popular U.S. News and World Report (USNWR) rankings of America’s Best Colleges. We estimate that applications discontinuously drop by 2% to 6% when the USNWR rank moves from inside the top 50 to outside the top 50 whereas there is no evidence of a corresponding discontinuous drop in in institutional quality. This threshold is likely the most salient to students because it corresponds to a page break in the printed USNWR guides but we also find some evidence of a discontinuity at the rankings threshold of 100. The choice of college or university is typically a one-time decision with potentially large repercussions, so students’ limited attention to rankings likely represents an irrational bias that negatively affects welfare.

Enhancing Rationality: Heuristics, Biases, and The Critical Thinking Project

Abstract: This paper develops four related claims: 1. Critical thinking should focus more on decision making, 2. the heuristics and bias literature developed by cognitive psychologists and behavioral economists provides many insights into human irrationality which can be useful in critical thinking instruction, 3. unfortunately the “rational choice” norms used by behavioral economists to identify “biased” decision making narrowly equate rational decision making with the efficient pursuit of individual satisfaction; deviations from these norms should not be treated as an irrational bias, 4. a richer, procedural theory of rational decision making should be the basis for critical thinking instruction in decision making.

Adaptable history biases in human perceptual decisions

When making choices under conditions of perceptual uncertainty, past experience can play a vital role. However, it can also lead to biases that worsen decisions. Consistent with previous observations, we found that human choices are influenced by the success or failure of past choices even in a standard two-alternative detection task, where choice history is irrelevant. The typical bias was one that made the subject switch choices after a failure. These choice history biases led to poorer performance and were similar for observers in different countries. They were well captured by a simple logistic regression model that had been previously applied to describe psychophysical performance in mice. Such irrational biases seem at odds with the principles of reinforcement learning, which would predict exquisite adaptability to choice history. We therefore asked whether subjects could adapt their irrational biases following changes in trial order statistics. Adaptability was strong in the direction that confirmed a subject's default biases, but weaker in the opposite direction, so that existing biases could not be eradicated. We conclude that humans can adapt choice history biases, but cannot easily overcome existing biases even if irrational in the current context: adaptation is more sensitive to confirmatory than contradictory statistics.