Behavioral finance FAQ / Glossary (Bias)
This is a separate page of the B section of the Glossary
Dates of related message(s) in the
Behavioral-Finance group (*):
Year/month, d: developed / discussed,
Behavior / behavioral
Behavioral biases in finance / economics / management
Many messages about "bias" in the BF group
+ see anomalies, rational, cognitive, emotional,
behavioral finance, social psychology
+ bfdef site link + pages of behavioral economics
/ finance definitions in this glossary.
Choose your proverb:
Hard and cruel: "You always win if you bet on human stupidity"
Soft and lenient: "Perfection does not belong to this world"
Definition: behavioral biases are:
reactions or inactions
caused by erroneous decisions (this
excludes of course harms due to pure uncertainty).
Those blunders, a more explicit word, happen because of irrational, or not fully rational
Irrationality or bounded rationality (see rational / irrational) is a rather
common human trait that cannot be totally avoided.
It would even be inhuman and irrational to expect full rationality!
Like in many aspects of nature or society, in which nothing is 0% or 100% true, sorry
Aristotle and your binary logic, let us talk about "degrees" of rationality /
The limited rationality phenomenon can be detailed as a series of various
cognitive / emotional biases (see those phrases), which bring errors
in judgment and behavior distortions.
Also, individual and social psychology shows that the human mind is influenced by
Nothing wrong of course for the individual to take into account common issues.
But often it is takes the form of a contamination that makes us skip rational
analyses and lose our free will.
Examples of behavioral biases
(and related market anomalies):
Individual biases: anchoring, representativeness or
availability heuristic, unfounded beliefs, logical fallacies,
Collective biases: dependence on social learning, on
Individual biases: loss aversion, affect heuristic,
overconfidence, hope and fear...
Collective biases: mimicry, herding...
Autopilot / reflexive biases
(that go beyond cognition and emotion)
Individual biases: inertia, addictions, compulsions,
bad reflexes or habits...
Collective biases: rules, rites, taboos...
Market anomalies: mispricing, price / return clusters,
momentum, fat tails / rare events...
The case of economics and finance:
biases or anomalies?
When the wrong foot steps on the market's paw
and the biases' footprints lead to the cave of anomalies.
In finance / economics, among other fields of activities, behavioral biases are teeming
and bring a majority of contra-productive outcomes, even if luck in some cases save
Even when they deal with money, people are not
fully "rational". Money is even a human / social
field particularly prone to goofs. unless luck saves the day.
Economic players' decisions, and among them investors' decisions, are often
shallow-based (heuristic, anchoring)
and/or "under influence" (habits, groupthink, conformity and mimicry).
Decisions rarely match exactly what economists call
the decider's "utility" (see that word).
The gap might be small, but in some cases it is an abyss.
The results can even be the opposite of what could be seen as the person's interest.
Also, biased investment behaviors, when shared by many investors,
can make asset prices and returns diverge
from standard economic paradigms, based on rationality and utility.
To be fair, markets have (very) long term (progressive or violent) self-correction
Therefore an illusion or habit might survive less time than in
other social systems, let us say such as administration or politics.
Following the distinctions made in the "social psychology" article, we can consider
separately investor psychology, consumer psychology and the behavior of markets.
This leads to analyze the differences and relations between:
Human behavioral biases or flaws that damage their money-related activities,
as individual psychological deficiencies.
Market anomalies (see that word), as quantitative consequences on prices
or returns when those biases become collective.
Some dogmatism can interfere in considering as anomalous a price or return
that just does not fit the standard valuation rules and criteria.
A typical criteria in those standard models is economic "utility"
(see that word) (*)
(*) OK, such a set of references to judge what is normal and rational might be
itself biased, but references and benchmarks are practical tools to help study
some phenomena, don't they?
The case of asset markets
Micro / macro blunders
To take more specifically the example of asset markets (a key research area
of behavioral economic and finance), irrationalities leads to:
1) Individual / micro investment mistakes, which are sources of
insufficient returns or excessive risk-taking for an investor,
2) Collective / macro behavioral biases, when investors get
influenced by one another and start acting as an emotional crowd (herding...).
Individual biases do not always average out, as some are "naturally"
common to many investors and also because mimicry contaminates them.
3) Market anomalies / inefficiencies,
such as mispricing or return anomalies between various assets, periods, etc.
This micro / macro semantics is not stabilized.
Some reclassify the above as:
1-2) Investor biases, aka
3) Market anomalies, aka
"Behavioral Finance Micro / BFMI,
"Psycho(socio)logical behavioral finance",
"Investor psychology", if said more simply.
"Behavioral Finance Macro / BFMA",
"Quantitative behavioral finance".
Are all biases really biases?
Tentative adaptation, with a few finger burnt,
more than immediate perfection.
It is not certain that all behavioral biases are ...biased, and all market anomalies ...anomalous.
Here are two aspects that can make think otherwise:
1) As seen above, the criterion to define market rationality usually addresses
only "economic utility". There is a puzzle here: it seems rather reductive to
consider always irrational a decision that just strays from this narrow criterion.
2) Also, a school of thoughts, called evolutionary economics, considers that
what is labeled anomalies, biases or irrationalities are elements of an
Within such a process, things evolve and find their way gradually .
In parallel this improves the knowledge of economic players (learning
process) such as producers, workers, investors, consumers.
This process is done by heuristics (simple rules), approximations, trials
and errors, more than by reaching immediately an optimum solution.
It does not means that the same biases will not reappear later,
when memory fades (see memory).
Are some investors less biased than others?
Darwinian process, from Galapagos tortoises to market players.
Some researches have found behavioral biases relatively less present
in seasoned investors (although some become narcissist after a streak
of good luck) than in tenderfeet.
This immunity to market bugs might be:
Because they learnt by experience, by burning their fingers, improving their market
culture, creating an asymmetry of knowledge in their favor (see asymmetry),
Or because of natural selection (see adaptable market) which makes that investors
who are still in the game are those who where smart enough to survive ;-),
Or just by chance: beware of the "survivor bias" (see that word).
(*) To find those messages: reach that Behavioral-Finance group and, once there,
1) click "messages", 2) enter your query in "search archives".
Members of the Behavioral Finance Group, please vote
on the glossary quality at Behavioral-Finance/polls