Behavioral finance FAQ / Glossary (Rationalization)
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+ see heuristic, framing, story,
illusion of knowledge + bfdef2
- I can explain it all, Your Honor, my intentions were pure.
- OK, read me your script, I love imaginative yarns.
Rationalization (in the psychological sense) is a tendency to build a
seemingly rational and logical story to explain (to oneself or to
other people) an event, a result, a situation, but without any real basis to
Why to rationalize and tell stories?
People tend to invent and tell themselves (and other people) such stories
in order to:
Justify (or excuse) a personal flawed behavior
(an action or inaction), or a poorly based belief.
Here, mental rationalization is a psychological defense mechanism
against the pain of admitting a mistake.
It allows to keep one's self pride / self love.
Or, if we extend the concept, to try to explain some non
understood event with little attention given to relevancy and truth.
The aversion to uncertainty makes people prefer often an
apparently good story, whatever its flaws, to something left without
an answer or explanation.
They feel more comfortable with a imaginary narrative that gives
them an illusion of knowledge than with the anguish of doubt and
a feeling of ignorance.
Rationalization is either done immediately as a knee-jerk response,
or built after a long and elaborate research for explanations.
The various forms
Choosing the most "convenient" story,
It will make things look more beautiful or dramatic.
....when truth is not the main goal,
Mental rationalization comes from human tendencies towards:
1) Attribution (whodunit?)
Justify an inappropriate decision that we took, did not take, or
are going to take. This "covers up" our real motives if they were / are
irrational, or rational but perverse.
People tend to avoid embarrassment, and even
to delude themselves about why they do or did
something stupid or wicked.
Or name a culprit (see attribution bias),
Or attribute a good outcome to our own wisdom even if
it was a pure luck effect (another case of attribution bias, self-
attribution, hindsight bias)
Or conversely attribute to bad luck the consequences of
one's mistakes (or misconducts).
2) Explanation or theory (good story)
Explain whatever event (inventing a good story: see
storytelling) that we just discover, even if the event / situation is of
This human need to find an apparently satisfactory explanation is
driven by a fear of
ignorance or an aversion to uncertainty.
Or driven by the pride to appear as somebody "in the know".
It results also, on the public side, to the media pressure for a
constant newsflow, even if it just brings "noise" (see that word)
Market commentators have to find a story every day
to explain why the market rose of fell, even if
it was because of the pure random noise.
Or find (collectively) an apparent new paradigm by which transient
events would show the way to the eternal future (see overreaction).
3) Denial (it cannot be!)
Justify a denial of a new reality to soothe the pain of
cognitive dissonance. To simplify, cognitive dissonance (see that
phrase) is a mental rejection of what does not fit our beliefs.
One example of that myopia is the attempt to prove that the
event is just an exception to the great scheme of things as
we understood once for all.
Betting money on fairy tales?
Investors and market pundits try often to find good explanations
(good stories) which:
Seem to confirm the wisdom of some market movements,
however excessive they might be (bubbles, panics...)
Or support some of their investment beliefs and/or
behaviors in spite of their poor results
Or just make them look smart and in the know.
Those fanciful narratives are among the factors that bring trend following,
loss aversion and other investor biases that can delay or hinder
market price adjustments.
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