Detecting Biases

Biases in Myself

In this week’s reading Thaler and Sunstein (2009) speak about resisting temptation and more specifically self-control. I will be very honest with you all, I suffer from many biases and I truly try to adapt to emotional deficiencies that I may have. But the one bias that I know is routinely present is that of self-control bias. I always come out of tax season saying next year I’m going to put money aside for taxes over the course of the year instead of getting hit with a big burden come April. I never do.

Every New Year’s Day is the start of a diet and exercise program that lasts about two weeks. I smoke and will go to happy hour on Thursdays (although I’m socially distant these days due to COVID-19). I know I shouldn’t do these things because they are bad for me but I do anyway.

Thaler and Sunstein say we have our inner Planner and our inner Doer. My inner Planner has all these goals to achieve but my inner Doer just won’t listen. When my inner Planner and Doer work together, then good things happen.

Biases in Others

I have a story about a very good friend of mine. He too suffers from several biases. His biggest bias in my opinion is regret aversion bias. According to Pompian, “People exhibiting regret aversion avoid taking decisive actions because they fear that, in hindsight, whatever course they select will prove less than optimal. Basically, this bias seeks to avoid the emotional pain of regret associated with poor decision making.”

If I tell him that he should buy a stock – say Disney. The stock price is $92.50. I say it seems like a good value at this level. We agree that it is a good buy and he wants to add it to his portfolio. He takes it literal when I it seems like a good value at this level. Meaning if the stock goes to $92.60, it is not a good value anymore. His response will be I’ll wait for it to come back to $92.50. To counter this, I started to rephrase my initial interaction.

I started saying Disney looks like a good value anywhere under $95.00. Now if it goes from $92.50 to $92.60 – he says I’d better get it before it reaches $95.00.

I guess that’s my best example of a personal nudge.

Can Biases be Eradicated

There are some cognitive biases that we could learn to overcome, in my opinion. We could be taught to recognize and change our emotion when it comes to certain biases such as mental accounting, anchoring, availability, and recency.

I also believe there are certain emotional biases that are part of our DNA that will never be changed. Biases like loss aversion, status quo and endowment effect. With these biases, we will never be able to rid them within ourselves, but we can recognize and learn to cope with them.

Bounded and Procedural Rationality

Bounded Rationality goes against traditional economics that assumes what the author referred to as Global Rationality and says our rationality is limited to the confines of our cognitive abilities at the time and place of our decision-making process (Barros, 2010).

Procedural Rationality as I understand it is less concerned with the outcome of the decision but the cognitive process that led to the ultimate decision. The author notes that this is the study of how the choice is made.

But understanding the process of how choice is made seems to be a daunting excursion. It brings to mind today’s evolving study in AI. Not just super-computing with the sheer computing power to mimic the human mind (like Deep Blue vs. Kasparov), but real understanding of the mental process that goes into the decision-making process.

We’ve seen attempts at it. Knight Trading using Algo and AI in equity trading until it glitched and the firm went bankrupt. Uber was trying to make a splash with driver-less vehicles until they started running over pedestrians. Amazon tried AI in the HR department to hire the perfect candidates until they realized it wasn’t hiring women (AI with a bias…that’s something).

It seems to me that AI at its best is a carbon copy (albeit faster version) derivative of human thought. It’s not really thinking, its copying.

I bring this up because I was really impressed with the history around H.A. Simon at the RAND Corp and his attempts at this in the 1970’s. Pretty cutting-edge stuff.

But here we are in 2020, and even though they say jet airplanes basically fly themselves, I for one would never get on one unless there is at least one human brain in the cockpit.

Joseph S. Kalinowski, CFA

Barros, G. (2010). Herbert A. Simon And The Concept Of Rationality: Boundaries And Procedures. Revista de Economia Politica, 30(3), 455-472.

Pompian, M. M., & Pompian, M. (2012). Behavioral finance and wealth management : How to build investment strategies that account for investor biases. Retrieved from http://ebookcentral.proquest.com (Links to an external site.) Created from tcsesl on 2020-03-17 12:36:03.

Thaler, R., & Sunstein, C. (2009). Nudge: Improving Decisions about Health, Wealth, and Happiness. New York NY: Penguin Group USA