Behavioral finance FAQ / Glossary (Preference)
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,
(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!
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:
Recurrent ( habits,
Basic / direct wants / needs,
pain avoidance or
Well thought, clearly hierarchized
("transitive") and entailing
precise goals and
Personal necessities or
tastes / habits
Linked to social
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.
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
This is because:
Basic preferences are widespread among human
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
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
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"
Economists are interested in revealed preferences when observing
actualpeople behavior and not just in what those people declare to
Investor preferences, and preference reversals
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
This has an effect on investor styles (see that phrase, you might
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