Behavioral finance FAQ / Glossary (Preference)

A    B    C    D    E    F    G-H    I-L    M    N-O    P-Q    R    S    T-U    V-Z

Full list

This is a separate page of the P-Q section of the Glossary.

 

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

(economic) Preferences interactions, reversal, (in)transitivity

01/1i,2i,7i - 03/6i,11i + see
utility, ophelimity, transitivity,
need + bfdecis

Our preferences are sovereigns reigning on our mind.

They invade it consciously or sneakily.

They pretend to know what can make us happy, they try to
decide
for us.

But the hierarchy among them is rather messy, they often
fight one another.

Better watch to which preferences you give a crown and
when it uses it!

Definition:

Preferences are criteria used by people:

* to make as well simple choices as more elaborate decisions,

* and which reflect their wants, tastes and expected satisfactions.


The notion is closely related to the human needs and their purported
hierarchy
(see the "need" article).

Those decision criteria are:

Either

Or

Recurrent ( habits,
    heuristics...) 

Occasional /
one shot.

Conscious

Unconscious
(reflex...),

Basic / direct wants / needs,

    pain avoidance or
   pleasure seeking  

More elaborate
motives.



 

Well thought, clearly hierarchized

("transitive") and entailing
precise goals and
guidelines

Just purely
instinctive /

emotional tastes



  Personal necessities or
      tastes / habits 

Linked to social
practices
(common
preferences).

 

Practically, those preferences

Intervene in making choices between several
  
courses of actions, in money decisions as well as in
   other life situations (tea or coffee?).

Are our main drives that foster our behaviors.

Common preferences

I want what you want.

Preferences normally differ from one person to the other.

Thus there are some common preferences, at a given moment or
permanently.

This is because:

Basic preferences are widespread among human
   beings .

Even in less basic ones, there are mental and behavioral
   contagions (see imitation, herding) between people,

as tastes can contaminate temporarily or durably.

Rational assumptions about preferences

Getting maximum satisfaction?

People are supposed to be rational (see that word), by some economic

pundits among other thinkers.  They consider that they follow an ideal /
logical / meticulous step by step process by which they:

Choose their preferences in direct relation with the expected 

satisfactions (*) that would fulfill what they lack or feel
they lack
(wants, needs: see that last word).

(*) pleasure seeking or pain avoiding, emotions are an

     important factor in preferences)

Give a value (a moral one or ...a monetary one) to

things or actions in direct relation with their preferences

Transform their preference into clear intentions, goals

and criteria to be used in decision making (see "decision")

Follow strictly their preferences / goals, so as to optimize the
   
related satisfactions, when making decisions about a move or
    a course of actions.

Practically, in that respect, people, and among them investors,
consumers, workers, borrowers, etc. are considered to:

Have "transitive" preferences (if I prefer A to B
    and B to C,
I normally choose A over B).

+   = 


See the "transitivity" glossary article

"Maximize" their satisfactions, by acting:

Either in favor of the highest preferences in that hierarchy
   A, B, C...

Or, if not, to satisfy in a much higher degree a lower
    preference.

This last aspect differs from simple transitivity / hierarchy:
it supposes that people give each preference a given value (*) /
weight in their preference scale (see below).

   (*) Value can be taken here in the psychological and ethical sense
          linked to a personal "scale of value".

 
But for economics goods and for financial assets, this above
 mentioned value ranking phenomenon applies in a similar way to
their 
monetary values, or more specifically to their utility (see
that word) or their utility / price ratio.

In real situations, preferences might be biased

Chaotic and fuzzy preferences.

Those transitiveness, scaling, maximization effects
are far from being clear-cut in real-life decisions.

This is because:

An "hyper choice" might be available between too many
   solutions (see cognitive overload).

This can bring chaos in the interaction between personal
preferences.

It makes the choice criteria quite fuzzy.


Mental limitations and cognitive or emotional biases
   create
often inconsistencies between preferences 
   and actions (see rational / rationality),


They might distort unconsciously not only the analysis
of the situation (data, events)
but also the application of
preferences
in making decisions based
on that situation.

Many perturbations can happen:

Conflicts of preferences,

as well as circularity, intransitivity

Preference reversals in the heat of areal
   situation (from risk
averse to risk seeker for
   example,
see below investor preferences)

Preferences are not stable and can differ 
from oneday to the other.

Anyway, preferences might differ between areas of activity
(taking risk on the road
but not in markets...) and situations.

Preferences in economics and finance

Giving a price to what we prefer.

Being lavish or stingy towards what we like?

The pocket depth is a factor of course.

Economic preferences incite people to commit
themselves  to some deals involving money, or to renounce it.

As seen above, this notion is close to "utility" (see that word), a
personal monetary "value".

Many economists (and psychologists) focus on the link between
preferences, satisfactions and needs, and thus tend to classify most
appetites / tastes /
wants as needs (see that word).

An additional factor intervene in economic preferences: arbitrages
are obviously conditioned by the availability and price of the
means offered
to satisfy them, compared to their utility (yes,
supply and demand).

Identifying economic preferences

To identify preferences when dealing with money, psychographic
is used sometimes  It tries to classify people according to their recurrent
preferences and attitudes (see "style").

But the snags mentioned above are at plays and does not make this "profiling"
fully reliable.

Economists are interested in revealed preferences when observing
actualpeople behavior and not just in what those people declare to
prefer.

Investor preferences, and preference reversals

Market tastes.

Your tasting homework: can you list your preferences ?

Preferences intervene obviously in asset picking and evaluation by investors.

Everyone has its own attitudes (see that word), concerning risk for
example
, and its own conscious or less conscious criteria linked to its tastes
and preferences.

This has an effect on investor styles (see that phrase, you might
      recognize yours!).

Occasional investor preference biases might explain why some investors
do not respect their plans, or on contrary do not change them, without clear
reasons (except maybe a blind attempt at adaptability, well-founded or not).


For example, temporary (or definitive)
preference
reversals or detours   might happen when:

Those who prefer safety might sometimes on the contrary get tempted 

by speculative stocks (if for example the general mood contaminates them).

Those looking for big gains get assailed by doubts on some occasions

and, as a result, fall back on more mundane or overcautious investments.

The prospect theory (see that phrase) shows that people are usually

loss averse but risk tolerant when their assets lose money and risk averse
when they show a gain.

This is a dent in the "expected utility theory" (see that phrase)

Economic and marketing preferences

A peek into the economic research labs,
seeing test tubes filled with money

We have seen how preferences apply to investment.

But other branches of economics than behavioral finance are interested in
preferences. Here are the main ones:

Microeconomics - a rising branch of economics - builds some

"agent-based models" (see this phrase) that take into account
those agents' preferences.

Experimental economics and neuroeconomics make also
    various research in that field.

Likewise, marketing studies try to segment people by
    types of preferences, to adapt the range of products offered

and to target their distribution and advertisement.

All those applications have their limitations, because preferences are unstable
and therefore can always change.

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

Members of the BF Group, please
 vote on the glossary quality at
BF polls

separ

This page last update: 06/09/15       

    P-Q section of the Glossary
Behavioral-Finance Gallery main page

  Disclaimer / Avertissement légal