Cognitive Biases in Decision Making

The tendency to sell assets that have increased in value too early while holding assets that have lost value for too long.

A behavioral model of decision-making under risk that describes how people make choices when faced with uncertain outcomes.

The tendency to prefer a sure gain over a gamble with a higher possible gain.

The tendency to feel losses more strongly than equivalent gains.

The influence of the way information is presented on decision-making.

Choosing investments that focus too heavily on minimizing short-term losses, instead of maximizing long-term gains.

The persistent difference between the return on stocks (equities) and other investments.

The tendency for people to place a higher value on things they already own.

A classic behavioral economics experiment that demonstrates how the way a problem is framed (presented) affects how people respond to it.

People tend to avoid risks when evaluating potential gains.

People are more willing to take risks when evaluating potential losses.

In the example experiments results demonstrate a violation of expected utility theory (EU).

The way investment options are presented significantly affects investor choices.

How retirement plan choices are framed (e.g., opting in or out) influences enrollment rates.

How frequently information is presented influences decision-making.

The increased volatility and randomness of returns observed when looking at investments over very short time periods (seconds, minutes, hours).

The perception of risk changes depending on the time frame over which you observe investment returns. Short-term views amplify losses and minimize gains.

The pain experienced from a loss is stronger than the pleasure of an equal gain, especially when observed frequently.

The more often you check your investment returns, the more likely you are to encounter losses, leading to stronger feelings of pain.

The difference between the returns on stocks and risk-free assets (like Treasury bonds) is consistently higher than expected based on traditional financial models.

The maximum amount you'd pay to acquire a good.

The minimum amount you'd accept to sell a good you already own.

Standard economic theory assumes that the amount someone is willing to pay for something is roughly equal to the amount they'd accept to sell it.

People may be more hesitant to sell a stock that has gone up in value than to buy the same stock at the same price.

Making decisions in a series of isolated situations, ignoring the bigger picture.

Considering all possible options and their consequences as part of a single, holistic decision.

People tend to make decisions based on limited information and consider options in isolation, rather than in the context of the overall decision.

If an option is preferable in every possible scenario, it should be chosen even when the specific outcome is uncertain.

People violate the Sure-Thing Principle, making decisions based on uncertainty instead of choosing the option that's best in all circumstances.

In this experiment, people were more likely to buy the vacation package after failing the exam, even though the price and their situation were the same in both scenarios.

People might buy lottery tickets even though the chances of winning are slim, but they might not invest in a guaranteed low-risk investment with a smaller return.

It violates the Sure-Thing Principle, which states that if an option is always preferable, it should be chosen regardless of uncertainty.

WTA (willingness to accept) is the minimum amount someone is willing to sell an item for. WTP (willingness to pay) is the maximum amount someone is willing to pay for an item.

The Endowment Effect stems from Loss Aversion - we feel the pain of a loss more strongly than the pleasure of an equal gain. This makes us unwilling to part with something we own, even at a 'fair' price.

The Endowment effect stems from Reference Dependence - our current state becomes the baseline, and any changes are seen as gains or losses.

The Choosers group in the study received money or a mug based on prices. They behaved more like buyers than sellers, showing that the Endowment Effect comes from sellers not buyers.

Prospect Theory suggests that we make decisions based on potential losses and gains relative to a reference point. The Endowment Effect fits this - selling something we own is framed as a loss, making us want more money.

The Endowment Effect is a real phenomenon, observed in various situations where people value things they own more than similar things they don't. This may explain why we keep things we don't use or sell things at higher prices than they're really worth.