Tuesday, June 24, 2008

Behavioral Finance - Bias from Deprival, super-reaction syndrome

This is the eleventh in a series of posts about common human misjudgments. The series is based on a Charlie Munger speech at the Harvard Law School in 1995.

Why study human behavior in relation to finances?
Recognizing and understanding why people do the things they do, what drives them, and what are innately human tendencies is the first step in overcoming your own self and making sound decisions! We want to make rational, logical decisions, but emotions and irrational tendencies get in the way.

These behaviors are not all bad, many are good in some way - that is why they survived. In fact, these behaviors served some purpose that helped extend life at some time in the evolutionary process.

11. Bias from Deprival, super-reaction syndrome
Have you ever noticed that when there is a perception of scarcity, people totally over react to the situation? It seems that when people believe some item or thing might run out they tend to hoard that something. This behavior would probably be a pretty good survival instinct. For instance, if grain was running in short supply, early humans might try to stash away as much as they could to prepare for more lean times. That is probably a good trait in that type of situation.

Problem is, that behavior also permeates into other areas – like gambling and stock market speculation. Charlie provides the example of slot machines. Casino owners know that a slot machine that provides a lot more near misses than another machine that has the same probability of winning will translate into more collections for the casino. Its the near misses that keep enticing players to put more money in. If you weren't coming close to winning, you would probably give up a lot sooner.

As for stock speculation, a lot of the motivation is to get in on a stock that is moving up so as not to miss the boat. There is nothing worse for a stock trader than to miss out on a big move. These folks are motivated not so much by what they have to gain but what they stand to lose if they don’t do something.

I see this type of bias on a regular basis and have recently experienced it myself. The most recent case involved my dealings with my home insurance company. The insurance adjuster was late making an assessment of my damaged roof and then late getting the estimate to me. I didn’t really get upset until a couple of my co-workers with similar claims for hail damage with the same insurance company told me they got their estimate the same day as the assessment. One even had a check within a week of filing. It had been over two weeks since I filed my claim - Why wasn’t I getting the same level of service? It prompted me to start calling the adjuster, then the agent, then the corporate claim office to get my estimate. I got motivated once I realized I was missing out on something.


2 comments:

  1. I guess this comment will date me somewhat but I remember Johnny Carson on his late night Tonight Show when he proclaimed there was a toilet paper shortage (Dec. 1973). LOL because people bought into it and there was a shortage as a result of his comment!

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  2. I really liked the article as it is very clearly explained... Thanks a lot.. :-)
    --- Sambhav (sambhavy2k@yahoo.com)

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