5) Heuristics and Biases

3) Status Quo bias

The preference to keep things the way they are rather than change them

Bayes' Theorem

The probability of an event occurring based upon other event probabilities.

Anchoring vs Representativeness

*- Anchoring*: paying too little attention to sample data *- Representativeness*: giving too much weight to sample data

Seminal Heuristics

*Heuristic* = A problem-solving approach in finding a satisfactory solution where searching for an optimal or exact solution is impractical or impossible. A systematic error that results from the use of a heuristic is called a *cognitive bias*. It's usually speedier but also more error-prone than algorithms. Heuristics are an irrational response to some form of information overload *TYPES of SEMINAL HEURISTICS:* 1) Availability & related biases 2) Representativeness & related biases 3) Anchoring 4) Adjustment 5) Affect heuristic

2) Representativeness heuristic & related biases

A common fallacy where people determine the probability or frequency of an event based on assumptions, past experience or stereotypes. *- conjunction fallacy* *- base rate fallacy/neglect* *- gambler's fallacy & hot hand phenomenon*

1) Availability heuristic & related biases

A mental shortcut that relies on immediate examples that come to a given person's mind when evaluating a specific topic, concept, method or decision. Sample data are given too much importance compared to population parameters. *- Recency bias* overemphasizes the most recent behaviors when evaluating individual performance; *- Salience bias:* the person who is most salient is seen as more influential.

Collecting and interpreting information

If we do not decide according to EUT, it must mean that we collect, interpret and process information in a way that is not rational in the neoclassical sense of the term. Homo economicus has potentially infinite ability to collect and process all the available information. *How information by real individuals is read and understood:* - we often "see" what we expect to see and what we desire to see - we unconsciously distort information to avoid psychological inconsistencies.

Familiarity heuristics

Involves inferring that past behaviour will continue to the present. They lead us to believe that familiar items are superior to those that are unfamiliar. *TYPES of FAMILIARITY HEURISTICS*: 1) Ambiguity Aversion 2) Diversification heuristic 3) Status Quo Bias 4) Endowment effect

Conditional Probability

It's the probability of an event ( A ), given that another ( B ) has already occurred.

Law of small numbers

Judgmental bias which occurs when it is assumed that the characteristics of a sample population can be estimated from a small number of observations or data points.

- Hot hand phenomenon (or hot hand fallacy)

The belief that a person, who experiences a successful outcome, has a greater chance of success in further attempts.

- Gambler's Fallacy

The belief that the odds of a chance event increase if the event hasn't occurred recently

2) Diversification heuristic

The strategy of investing equal amounts of money in a portfolio of randomly selected stocks

- Base rate fallacy

The tendency to ignore information about general principles in favour of very specific but vivid information. If presented with base rate information (i.e. generic, general information) and specific information, the mind tends to ignore the former and focus on the latter.

1) Ambiguity Aversion

The tendency to prefer choice options whose outcome probabilities are known over options with unknown probabilities.

3) Anchoring

The tendency, in making judgments, to rely on the first piece of information encountered or information that comes most quickly to mind, even when the reference point is not relevant to the decision task. Anchoring can lead to paying too little attention to sample data. Possibly explained by: • uncertainty about the true value: individuals tend to move away from the anchor until they reach a plausible range • economizing on cognitive effort: anchor acts a further trigger for recollection of information that supports the anchor as an estimation