Behavioral finance FAQ / Glossary (Reductionism)

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Reductionism


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See heuristic, generalization,
stereotype, selective

Seeing the tree and being blind to the forest.

Definition

Reductionism is an oversimplified ("reductive") explanation of a phenomenon
or a selective choice of arguments for a decision.

It focuses on one single trait - or a narrow set
of traits
-
of a situation, instead of seeing the whole picture and all
the interactions. It is a form of

* generalization of a single aspect,

* or focalisation on only one benefit or disadvantage.

=> This is a recipe for wrong decisions.

It belongs to the heuristic / framing family of biases (see the related articles).

Examples related to investment

Flavor of the month

For example, investors might:

Focus on only one business / economic parameter

(or on one objective) and forget / neglect others.

- In some periods, they look collectively only at interest rates.

- In other periods they look only at unemployment, or GDP growth, or

   profit growth, or trade deficits, or country debts or whatever other

   single indicator.

This hypnotic attention leads to inefficiencies in market prices and returns.

The 2007 - 2011 recession has been attributed nearly exclusively to
the subprime financial crisis. This was ignoring other factors:

* Negative savings in the US as a symptom of overspending,

* Commodity / energy price bubbles as a symptom of economic
   overheating,

* Foreign trade imbalances,

* Budget deficits and growing sovereign debt...


The financial crisis might have sparked or accelerated it, but deeper
causes
might be behind as well the economic crisis as behind the
financial
crisis.

* For example that a lax US monetary policy seems to have
   played
a crucial part in both.

  Or be interested only on some assets:

* "value stocks" or "growth stocks",

* or momentum / flavor of the month assets or industries,

* or whatever definition and content that can be attributed to such asset
   types (see also rotation).

Or look only at the most recent
  
information (see recency effect)

And/or focus on short time goals only
   (see time horizon).

Causes of such a narrow approach

Lost in complexity and uncertainty.

Reductionism can come from:

Cognitive biases, such as (see those
   words) 
availability heuristic, representativeness heuristic,

   rationalization, framing, anchoring, selective attention....


Also of course an affect heuristic (usual emotional prism) might

   interfere as well as an habit and ...laziness


The fact that the world is highly complex and ever changing 

     (cognitive overload),

    Therefore it is hard to grasp all aspects and to describe its
     state fully and precisely.

Thus people might consider stereotypes, as prepackaged /
presorted
/ ready-to-use simple categories, sufficient

     to make their everyday reasoning.


And of course, in some cases, deliberate manipulation,

intentional framing and baiting with logical fallacies (see those
words).

How to avoid it?

Be fuzzy!

An antidote to reductionism might be : 

* Not only a highly needed watchfulness for inconsistencies and fallacies,

* But also to include fuzzy logic (see that phrase) in analysis models, as a type
  
reasoning based on the ideas that:

Notions about things, events, situations are
   rarely entirely true or false.


To classify things in clear-cut general categories
    with simple criteria
(or even assumptions) has a practical
    interest, but also
limitations.


The classification should only be indicative, the
cursor / thermometer
is usually somewhere
between two (or more) category
"boxes".


Thus imprecision and uncertainty should be
    inserted
as a factor in any analysis, if only to leave
    room
for further exploration.

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This page last update: 26/08/15  

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