Behavioral finance FAQ / Glossary (Adjustment)

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This is a separate page of the A section of the Glossary

	Dates of related message(s) in the Behavioral-Finance group (*): Year/month, d: developed / discussed, i: incidental
(under- / slow) Adjustment	See anchoring, under-reaction, latency, delaying tactics, status quo bias, Bayesian probabilities + bfdef2
Updating the brain software Definition: to do a mental adjustment is To adapt our interpretation of an issue to the real situation and to its evolution (new events). This might lead to adapt also our behavior. When investment decisions are at stake, to perform a mental adjustment is to Admit that something has changed in a company prospect, or in the general stock market climate. Change accordingly the expectations , valuations and decisions. In other words the investor starts carrying an umbrella instead of sunglasses, or the other way around. That implies a "de-learning" of the old practice. Anchoring, reaction and adjustment Going from too slow to normal speed and then to wild bolting. An adjustment is normally an immediate and proper reaction to new information and realities. Everything fine, then ...except that it does not work always that way: The "anchoring and adjustment" phrase stresses that mental adjustments are usually slow. => This means that, whatever is said about speed as a trait of our civilization, what is often seen in real life is under-adjustment, The change of perception / understanding / attitude / behavior is usually a gradual and delayed reaction to a previously neglected or even denied event, a slow evolution from a previous mental anchoring (see that word). This is not the end of the phenomenon. The momentum that is created tends later to overreach itself. The fine tuning is often transitory as evolutions do not usually stop with the adjustment to new realities. Actually, adjustment is usually only the intermediate part of a three-step chain of "reactions to information" (see that phrase): 1) Under-reaction   2) Adjustment    3) Over reaction. By the way, "adjustment" is also the keyword in Bayesian probabilities (see that phrase). In that respect, we could talk about under-adjustment or over-adjustment when prior beliefs (and the probability that future events confirm them) do not correctly match new occurrences and the possibilities left. Adjustment in economic and financial markets Prices sometimes wait before really moving, and then they might hurry. That is what trend followers are expecting on their starting blocks. When facing new information that contradicts their beliefs, economic agents, investors, and analysts, take often a long time to adjust their assessment of the situation (for example their earnings estimates) and their behavior. Their attitude is often frozen by anchoring, limited heuristic, cognitive dissonance, habits, beliefs or other biases. Mental under-adjustment and behavioral under-reaction (see that word) go hand in hand. This can be illustrated by two typical phenomena: Often, analysts change their earnings estimates and recommendations only after seeing that the market price moved. A belated conversion, waiting that things happen before predicting them! Some people (and organizations) do not even adjust their estimates or behavior at all whatever happens, even if their economic interest is at stake. They stay anchored on their ancient beliefs and practices or, we could say, dogma and ruts. All this contributes to delay the adaptation process of the whole market: The full adjustment of market prices occurs only once the mass of converted players becomes large enough. And - above some "percolation threshold" - the adjustment can become an overreaction. This is often why market trends (see that word) get born, then persist and grow. This behavioral phenomenon is known also in the marketing of product innovations. After the "early adopters" customer segment has jumped into using the new product, it might take a long time before the "critical mass" (see "percolation", and also "herding") of potential users get converted. Well, the innovation might even abort! On the other hand traditional businesses are often too slow to adapt to products and techniques developed by innovative outsiders.