Behavioral finance FAQ / Glossary (Cognition - Cognitive)

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Dates of related message(s) in the
Behavioral-Finance group (*):

Year/month, d: developed / discussed,
i: incidental

Cognition

See cognitive...asymmetry ...bias
...dissonance
...overload ...trap,
neuroscience + bfdef2

Cognition, as you might know, ...is what you know.

Cognition, as you might think, ...is what you think.

Cognition is the stuff that fills and fuels your mind.

Definition:


Cognition
is related to the intellect and to knowledge.
Superior thing, thus located upstairs!

It is the mental process that uses perception, analysis, reasoning and
memory. It includes:

    Perceiving (seeing, hearing, tasting, feeling...). This is

is more the sensorial level than the cognitive level

   Learning (storing in the memory) and recalling.

Cognition and knowledge are near-synonyms.

But cognition, as seen just below, goes further.

      Processing, sorting, interpreting (representation,

belief and - more generally - thinking and
producing ideasand decisions - choices.

Cognition is thus a highly practical theme,
not just an academic topic.

Cognition can take wrong, even disastrous,
paths,
for example in economic behavior.

This topic deserves the attention of all decision-makers,

like you, me and all other human beings

We better check if our cognition engine is working well!


This glossary might help detect what cognitive gears are deficient
and need repair,

Those deficiencies are called "cognitive biases" (see that phrase).

As they impact human decisions and actions, they cause various

"behavioral biases" (see bias).

The mental duet: cognition and emotion

Duet or duel?


Usually, in mental processes, psychologists make a practical distinction
between cognition and emotion (see that word),
even if emotions have
cognitive traits
and cognition emotional traits.

Neurosciences have found that those mental duettists:

Are located in different parts of the brain (*).

Each one has its own offices in the premises.


Play both a role in decision making,

Interact

either by feeding and supporting each other,

or by opposing or influencing each other

 as if competing for leadership.

(*) The "cognitive" sector of the brain, the cortex to oversimplify
      things,
might - or not - filter basic emotional impulses that come from
      other parts.

Also neuronal connections can bridge different sectors

As a consequence of those traits, cognitive biases - which are commented
below -and emotional biases (commented in the "emotion" article) are often
interrelated.

Cognitive psychology

Straight or bent cognition.


A school of psychology (cognitive psychology) has made important research
on how cognition plays its role on how we decide and behave, like the music
on how we dance. It shows:

How this process can lead to rational and sound

decisions that take into account realities,

But also how it can go astray, affected by cognitive
    biases,


=> Those biases bring mental distortions of reality, erroneous
      perceptions we would say, that lead to flawed decisions.

 

Dates of related message(s) in the
Behavioral-Finance group (*):

Year/month, d: developed/ discussed,
i: incidental

Cognitive asymmetry

01/9i + see asymmetry

People are not equal, cognition-wise.

Definition:
Cognitive asymmetry is:

On the social side, the difference of reasoning, perception or knowledge
  
between individuals, for example between investors (see asymmetry).

On the individual side, a cognitive (but also emotional) bias that
   privileges
some memories or responses and neglect

others.

For example favoring negative ones over positive ones, or the other way
round.

Cognitive bias / distortion / flaw


 


00/8i,10i,11i - 01/2i,8i,9i -
02/7i,9i - 03/3i,11i -
04/1i,4i,8i
- 07/12i - 08/1i
+ see cognitive dissonance
- overload - trap - asymmetry
+ bfdef2

The mind might take the wrong road.

Definition:

Cognitive biases are mental phenomena that give a wrong perception of the
issues at stake.

Those biases usually get exacerbated in cases of uncertainty,
which are rather frequent as well in human and social life as in economic and
financial situations.

Origins of cognitive biases

Those cognitive biases are linked to one or several of the
factors below: 

Bounded individual cognition

From collecting to understanding and then recalling,

a long chain of pitfalls

Imperfect information identification and gathering (see lack

of attention, cognitive overload...),

Defective understanding of the meaning of such information,

(see framing, representativeness, cognitive dissonance, cultural
 bias, unfounded beliefs...),

Wrong appreciation of their consequences (see illusion, loss
    aversion),

Flawed reasoning about the relations between facts, and about
   
the probable evolutions
of the state of things (see information
    processing,
heuristic, logical fallacy, small numbers, gambler's

fallacy,halo effect,
range estimate, story, scenario),

Improper learning (insufficient or misunderstood or maladapted

knowledge), and failures in the memory process in general.

Also the failure to "de-learn" wrong or obsolete knowledge /
beliefs that distort decisions.


Not to forget:

Emotional biases (see emotion).

Although they can be considered as a category of biases in
themselves, emotional biases
play a part in cognitive distortions.

For example, some cognitive biases reult from emotional
defaults of attention
, when emotions take the leading role
within cognition.

Social factors (see social), among them cultural ones 

(see culture,l earning, consensus...) and emotional factors
(herding...),

They obviously influence also personal cognition.

Economic and financial consequences

Money blunders

Cognitive biases are one of the two main sources - together with emotional
biases - of erroneous economic / financial decisions.

Such biases, when they spread to the bulk of economic
players, can cause important anomalies:

On assets markets.
    Prices and returns depend on how investors perceive
    information
.

This perception is often subjected to cognitive distortions.

=> This creates wrong valuations and investment
      mistakes.

Cognitive flaws can empty your purse!

Those flaws can become collective and as a result they
   influence market evolutions.

=> Then anomalies in market prices and returns strike!

Cognitive flaws can make markets wild!


More generally, such anomalies can find their way in many

economic phenomena (inflation, economic development,
business cycles...),

Marketing and advertising, including financial marketing,
    sometimes
play on mental biases.

 

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

Cognitive consonance / dissonance



00/6i - 02/9i - 03/11i + see
selective perception, denial,
conservatism,
status quo bias,
confirmatory bias, selection
bias + bfdef2

Closing the door to alien thoughts and facts,
and staying with our beliefs in our grotto.

Cognitive dissonance is a common mental process / bias in which people
feel uncomfortable
when facing new facts and
 situations that contradict:

Their existing knowledge

Their existing beliefs, prejudices and preconceived ideas,

(cognitive dissonance is sometimes called also "belief persistence"),

Their preferences, expectations, needs and tastes

(here some emotional aspects might intermingle with purely cognitive
ones)

Their habits and commitments (resistance to change, status quo bias),

Related behaviors

Facts or beliefs?
Adjust or reject?
But adjust how?

When facing that situation, people can have two different reactions:

Sometimes, and with difficulty, they try to adjust

their beliefs to the facts (cognitive consonance),

More often, they reject, consciously or unconsciously,

those new facts (this phenomenon can be called a
cognitive dissonance "bias" or a "denial").


In that later case, the person:

Looks for, and admits only, information that confirm its own belief 

(confirmatory bias, selection bias) instead of those that
contradict it,

Uses it to reestablish a consistency with those beliefs (cognitive 

consonance, here again) but in a biased way.

For example, it might invent an explanation that avoids to feel
pain and that fits its expectation more than reality (see attribution,
rationalization
, wishful thinking...)

This bias can disappear suddenly when the shock due to new events is so
strong that it cannot be ignored anymore.

In money management, cognitive dissonance can lead to a "status quo bias"
(see that phrase) for investors who do not accept what has changed in the
market situation.

Cognitive manipulation

03/12i + see manipulation,
neurosemantics, logical fallacies,

deception, propaganda, spin

Tinkering with people's minds.

Cognitive manipulation is making other people believe
some - often dubious - things (for example that a stock is worth buying) by
using perverse cognitive techniques.

One form is, of course, to state plain lies (disinformation).

But others are subtler conjurer tricks:

Creating artificial "coincidences",

Using logical fallacies, deviations of word meaning (neuro-

linguistic) and other speech effects (rhetoric, but also intonations...),

Repeating over and over the same wrong information or biased

opinion, until it seems like a truth,

Even, in our world where pictures are kings, creating optical
   illusions
,

Planting red herrings that divert the attention from digging further
    into  the issue.

This is distinct from emotional manipulation (playing on sentiments).

But manipulators and propagandists usually combine the two sets of techniques.

 

Dates of related message(s) in the
Behavioral-Finance group (*):

Year/month, d: developed/ discussed,
i: incidental

Cognitive overload


00/8i,9i - 01/3i + see (limited
or availability) heuristic
+ bfdef2

Drowned in the knowledge pool.

Definition:

Cognitive overload / information overload is the mental inability
to gather and handle too many information, in other words the
equivalentof the mental difficulty to "walk and chew gum at the
same time".

Related behaviors

Following the first scent among the pool of others.

As it leads to "filter" the information flood, often in a purely instinctive
way, cognitive overload is, together with lack of attention, anchoring and
rationalizing), one of the causes that make investors:

Follow the most apparent "red herrings",

Discard weak signals,

Take decisions on wrong assumptions.

General effects

Picking the best apples, or those that look so.

Situations of cognitive overload tend to spread nowadays. Information is more
and more present:

As a result of modern communication technologies,

And because things get more and more

   complex and changing.

We are nowadays better informed, but have
problems to sort the gems from the thrash,
and also to understand the whole picture.

The overload can affect individual people but also many professions in which
information is king, among them managers, economists, lawyers, scientists,
politicians...

A countermeasure might be "rational ignorance" (see ignorance).

This is screening information and knowledge with rational criteria,

neglecting areas where they are not worth the cost and effort.

Cognitive psychology

See cognition

Cognitive trap



See anchoring, certainty
effect, overconfidence,
illusion,
fallacy, lack of
attention, availability /
limited heuristics

Being convinced that we know and understand

what we don't know and don't understand.

A cognitive trap is most of the time a form of illusion of knowledge (see that
phrase),a belief or representation that does not fit realities and that can bring

wrong decisions (that could result for example in  money
losses, or worse...).

Who has the most chance to be struck by the illusion?

Some people are more prone than others to it.

This is the case of those who overconfide / are anchored in their own
knowledge.

They might not bother to check, before deciding and acting, if that
knowledge is not outdated, insufficient, wrong,
irrelevant or misleading.

And do not feel immune (which would be ...overconfidence)! That illusion
can affect anybody, some traps / fallacies are quite common (for example
the base rate fallacy).

Not only our one-way personal mental alleys, but also social influence
can be at work with biased common knowledge, paradigms or urban
legends
.

(*) 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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