Behavioral finance FAQ / Glossary (Anchoring)

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Dates of related message(s) in the
Behavioral-Finance group (*):
Year/month, d: developed / discussed,
i: incidental

(mental) Anchor / Anchoring



00/6i,8i,9i,11i- 01/5i,8i - 02/8i,11i
- 03/3i,6i - 04/5i;7i - 06/11i
+ see
adjustment, tunnel vision, dominant
mental interest, reference point,

selection bias + bfdef2

Not bothering to look for several ideas,
when the mind has already one in store.

Not bothering to navigate in the sea of numbers
when cozily harbored in one.

Definition

Mental anchoring is a bias in which the mind stays focused
on
only one simplified reference point, that is linked to a past data,
situation,experience, learning, reasoning, prevision, decision...

This single reference / anchor can be:

One single numerical value

 Number anchoring is a phenomenon in itself.
 If a number, even if it is highly exaggerated, fanciful or
 irrelevant
with  the topic
is stated
before an analysis, negotiation,
 valuation, spending, investment, it has a strong unconscious
 influence on the reasoning.

 This bias is often seen in economics and finance, as
 detailed  further in this article.


One set of facts, traits or information coming from the
    past.
(typical cognitive anchoring)

Often a past standard: previuus schema, practice,
    events, information or belief.

Also a past experience or solution / decision or analysis,

related to a non reproducible situation. In other words an obsolete

heuristic (see that word)


One single idea / belief / mental interest.
    This can verge on monomania / fanaticism.


Or even one settled / stubborn emotion / attitude (liking or 

dislike): here we have an affective anchoring.


Anchored with the eyes, the brain or the heart?

This reductive psychological phenomenon (an extreme form of heuristic,
see that word) is also called
anchoring bias / focalism / focus effect...

Being limited to an exclusive mental reference to make decisions goes against
an objective and complete observation and analysis .

Normally (but not always) after a while, as it starts to prove unsustainable, an
anchoring is followed by a mental adjustment (see that word).

Effects of anchoring

Not easy to sail when the anchor gets stuck.

When the mind is anchored on a reference it tends to

solidify into a tunnel vision

be blind to signals that contradict that reference.

neglect oe even reject (cognitive dissonance) facts and ideas that do
   not confirm this "prior", which often has no logical and objective basis.

The brain does not adjust (**) that reference
to new events, or it adjusts it only slightly.

(**) The phrase "anchoring and adjustment" is often used to stress the

opposition (and also continuity) between the two notions (see
"adjustment").

It is one of the causes of underreaction (see that word) that can affect either
an individual or the whole collectivity ("dominant anchoring"), and have an
effect on social events

Examples can be found in "stubborn" market evolutions,
or also in political blindness

Anchoring in economic and finance

Anchored in a number.
Does that number means something ?
Or is it drawn from a hat?

Economic and financial prospects (see "prospect theory") are areas in which
the anchoring notion is mostly used.

In those fields the "reference point" is most of the time a precise number,
   a value, a price.

Number anchoring is a phenomenon in itself, as seen above

In financial markets, investors are often anchored on a past asset price.

More specifically, in investment, the reference can be:

A previous peak stock (or index) price,

Or (quite often) the price

at which the asset was purchased.


Or a previous price trend,

Or a previous estimate. Yes an anchoring can
    relate to an expected price / gain, with a sense of
    loss if it is not reached (see loss aversion) ,


Or also a round number,

Or even a "magical" number (see mysticism).

Whatever the facts or beliefs that led to that anchoring number, it became a
reference point of "value"
(see also prospect theory).

=> Mental anchors in investing are those reference values that people keep
      stubbornly in mind
and that keep influencing their decisions.

Origins of anchoring:
     the role of primacy / priming

The first one to take hold of the neuron
keeps the neuron.

Those references can come from gradual learning.

But gradual learning is not the only source of anchoring,

often that people create instantly their mental anchor

  In such cases they base it on their first perception (primacy / priming
  effect
) of  things (or of people), what is at first for them the most salient
  information (see saliency) without waiting for enough data


=> Their mind gets stuck in their initial understanding whatever new data
      they get later (see selection bias).

In finance, the initial price of the asset an investor bought stays obviously

vivid in its mind. A romantic remembrance of its first date with the asset.

What might also be an anchor is the estimate the investor had done 

from the start about what price that asset would reach.

Why does the anchoring persist?

Committed? Stubborn?
Or too lazy to reassess?


1)
One way to explain that anchoring persist after the first perception is that
     people

people could feel committed (see commitment) to their first move.

They prefer to rationalize (= find good reasons for) this commitment than to
change their belief (see cognitive dissonance).

2) Another motive of anchoring is that people can balk at the complex
     cognitive task
that is needed to reanalyze and adjust one's prior
     estimate of
prospects and risks.

This reassessment would need to dig deep into various aspects
such as:

What is the real incidence of the new events?

What flaws might have distorted the initial analysis?

Oversimplified perception (see availability heuristic) of the factors
involved?

How to avoid such a myopic way to observe and analyze things
in the future?

Investor anchoring

When the investment sea changes,
why stay anchored in old waters?

Investors are often mentally anchored on past prices, but
also on past market situations, past estimates or past practices /
strategies.

This has an incidence, as a brake or as an accelerator, on their behavior

1) Those investors stay anchored on a past reference, stick to a

previous over-simple or over-elaborate analysis / decision
process (*).

But the world, and specifically the financial world, is not static
and the present state of affairs usually differs, slightly or largely,
from previous ones,

  Those investors, when facing those changes, at first tend to 

under-react, by keeping more or less their

same behavior (see also "status quo bias") although it
became inadequate.

Going to the disco with obsolete clothes


2) Later those investors adjust their attitude,

3) But they do not stop there, they tend after that to
    overreact

Thus their anchoring changes into a new one that takes into
account  more recent events (see recency effect, short
memory...).

(*) However useful you might find those thought habits, they have a "best
     
before" date when to scrape them.

More seriously, look closely at their assumptions.

Between you and me, the old market trends, practices, assumptions
and paradigms that become obsolete might come back much later.

Markets often evolve in spirals.

Negotiation reference

Starting blocks for haggling.


A business negotiation starts normally when one of the sides (seller or
buyer)  offers - wisely or imprudently - a price
, which becomes a
kind of anchor.

A two-edged practice can be to propose at the start an unrealistic price.
Here, two possibilities:

Either the counterpart
immediately
runs away,

He sees it an insult,

This breaks any chance
    of making a deal.


Or it becomes the reference point
for haggling
.

Here, the counterpart tends to
   under-adjust.

He ends up paying more (or get
    paid less) than what he should
    have rationally got.

(*) To find those messages: reach that BF group and, once there,
      1) click "messages", 2) enter your query in "search archives".

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This page last update: 20/08/15            

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