Behavioral finance FAQ / Glossary (Adjustment)
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(under- / slow) Adjustment
See anchoring, under-reaction,
latency, delaying tactics, status
quo bias, Bayesian probabilities
Updating our 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.Application to investment
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.
The investor starts carrying an umbrella instead of
sunglasses, or the other way around.
That implies a "de-learning" of the old approach.
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
relevant 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.
=> 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):
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 / over-
adjustment when prior beliefs (and the probability that
future events confirm them) do not correctly match new
occurrences and the possibilities left after them.
Adjustment in economic and financial markets
Prices sometimes wait before really moving,
and then suddenly they might hurry.
That is the signal that potential trend followers are expecting
while 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 situations (for example their earnings estimates) and their
Their attitude is often frozen by anchoring, limited heuristic, cognitive
dissonance, habits, beliefs or other biases.
Mental under-adjustment and behavioral under-reaction (see under-) go
hand in hand.
Two typical phenomena to illustrate this:
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
Some people (and organizations) do not even adjust their estimates or
behavior at all whatever happens, even if their economic interest is at
They stay anchored on their ancient beliefs and practices or, we could
say, dogmas and ruts.
All this contributes to delay the whole market adaptation process:
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, and then persist and grow.
This behavioral phenomenon is known also in the marketing of innovations.
After the "early adopters" customer segment has jumped into using the new
product or service, 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, not seeing
that their survival can be at stake. See prospective analysis.
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