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 + behavioral
economics / finance definition in
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 at
least not fully rational mental processes.
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
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 / irrationality.
The limited rationality phenomenon can be detailed as a series of
various cognitive / emotional biases as well as unchecked reflexes,
habits and heuristics (see those various phrases).
They bring errors in judgment and behavior distortions.
Also, individual and social psychology shows that the human mind is also
influenced by groups ans society.
Nothing wrong of course for the individual to take into account common
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, memory flaws...
Collective biases: systemetic dependence on social
learning, on external behaviors...
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 they bring a majority of contra-productive outcomes,
even if luck in some cases saves the day.
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
Also, biased investment behaviors, when shared by many
investors, can make asset prices and returns
diverge from standard economic
paradigms, focused on rationality and utility.
To be fair, markets have (very) long term (progressive or violent) self-
correction mechanisms. In them an illusion or habit might survive
less time than in other social systems, such as administration or
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
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, as sources
of insufficient returns or excessive risk-taking for an investor,
2) Collective / macro behavioral biases, when
investors get influenced by one another and act as an emotional
Individual biases do not always average out, as some are
common to many investors either "naturally" or because mimicry
3) Market anomalies / inefficiencies,
such as mispricing or return anomalies between various assets,
This micro / macro semantics is not stabilized.
Some reclassify the above as:
1-2) Investor biases,
3) Market anomalies,
Micro / BFMI,
if said more simply.
"Behavioral Finance Macro
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
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 adaptation process.
Within such a process, things find their way gradually .
In parallel this improves the knowledge of economic players
(learning process) such as producers, workers, investors,
This evolution is done via 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?
from Galapagos tortoises to market players.
Some researches have found behavioral biases
relatively less present in seasoned investors
(although some get narcissist after a streak of
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 BF group and, once there,
1) click "messages", 2) enter your query in "search archives".
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