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the remaining 26% ranked themselves as average 18 . The so called
better than average effect is not the only form in which overconfidence
occurs, as an investor can for example wrongfully believe
that he maintains the control of his portfolio (illusion of control).
It is important to mention that the tendency of market players
to overestimate themselves concerns not only the field of their
knowledge, but also their past experiences. This is the reason why
sophisticated investors who are educated and informed about
the markets’ risks show overconfidence. The influence of their
own past success is stronger than the knowledge which they have
acquired through the years 19 . As Professor Kotter 20 explains the
main reason that led Kodak to bankruptcy was the complacency
which dominated over the need for investing initiatives. The company
settled for the success which had been observed a certain
time period and failed to keep up with the changes in the market
and the technological field.
Another form of human behaviour based on the bias of overconfidence
is as mentioned above the illusion of control. This term is
used to describe the situation when people think that they can
control often uncontrollable events by overestimating the extent
to which their decisions can lead to a certain outcome 21 . Due to
the illusion of control investors ignore relevant to their decisions
facts or choose not to seek disconfirming information that may
contradict their beliefs.
Related to overconfidence is also the optimism bias, the belief of
people that the same facts will have better results on them as they
have on others. Moreover, optimism concerns negative events as
individuals often believe that they are less likely to be exposed to
dangers 22 , a notion which leads them to risky behaviours and irrational
decisions. In investment practice, optimism makes market
players vulnerable to acquiring risky products. As Shiller explains
23 although they may have strong indications that the stock
they intend to buy is not profitable, they finally acquire it due to
their past success with other stocks, which makes them believe
that their intuition will be once again verified. Overconfidence
and optimism are very closely related and they both create to the
investors a strong belief that they will avoid the market risks, a
belief which makes them less attentive and more vulnerable to
self-victimization.
The same behaviour in which overconfidence results, and more
specifically in emphasizing the importance of certain facts and
in concomitant disregarding of others, can be also caused by the
phenomenon of anchoring and adjustment. This term describes
the tendency of people to adhere to the first piece of information
that they acquire 24 . The initial information forms the anchor
on the basis of which their thought is formulated 25 . Anchoring
constitutes only the first part of the influential for the decision
making procedure as the emphasis on certain information determines
also the way in which future events are evaluated. Once
an anchor is set, the information acquired in a subsequent point
18 Montier, in: Global Equity Strategy 2006, 1 (3).
19 As Krawiec shows the obsession on past successes makes professionals investors even more
overconfident than lay investors. This overconfidence about their abilities can find imitators in the
face of their supervisors or co-workers.
20 John Kotters, in: Forbes published on 05.02.2012.
21 Langer, Roth, in: Journal of Personality and Social Psychology 1975, 951 (953).
22 Wheinstein, in Journal of Personality and Social Psychology 1980, 807.
23 Shiller, Irrational Exuberance, 2 nd ed., page 153.
24 Tversky, Kahneman, in: Science 1974, 1124 (1128).
25 Heinzt, White, in: Auditing: A journal of Practice and Theory 1989, 24 (26).
is adjusted to it and often interpreted in a way which verifies the
initial estimation.
The anchoring and adjustment phenomenon is widely used as a
selling technique at the stage of negotiations. As several studies
have shown, anchoring can strongly affect the estimated value of
a product 26 . This is the reason why traders offer a really high initial
price, which determines the process of offer and counteroffer.
When the initial price is set high the lower prices that follow seem
more reasonable, even if they do not correspond to the quality of
the product under negotiation. Anchoring is also possible to guide
the thought of investors, as it is often used both by well educated
and unsophisticated investors as a rule from which they assess
probabilities 27 . The influence in the decision making refers not
only to the early stage of acquiring stocks, but also to the subsequent
way in which market players manage their portfolio 28 . They
tend for example to anchor the value of their investment to the value
that it initially had and they hang on losing it instead of selling
it, just because they hope it will go back to its purchased price.
This behaviour exposes them to serious dangers and to undoubtedly
high possibilities of having economic losses.
Another human behaviour that challenges the classic economic
theory is the so-called framing effect. The frame is nothing more
than the way by which a certain fact or situation is described. Although
someone could imagine that the formulation of information
has a limited influence on the process of decision making,
scientific evidences indicate the opposite conclusion. More specifically,
there are several studies, which show that people are not
able to distinct completely the line between frame and substance.
As a result, when it comes to decide they do not choose the same
statistical result just because it is presented in two different ways 29 .
The framing effect is closely related to the loss aversion, an observed
human tendency, according to which the displeasure of losing
a certain amount of money is bigger than the pleasure of winning
the same amount. As Shefrin 30 explains loss aversion, as well as
concurrent decisions and hedonic editing, leads to the framing
effect.
Investment decisions are seriously affected by the effect of framing
with financial advisers having the ability to co-formulate
the investors’ behaviour. When experts present a financial product
emphasizing on the loss prospect, investors are discouraged
to acquire it, whereas they would be willing to take the risk of
acquiring it if the analysis was focused on the gain probabilities.
This is an undoubtedly risky situation as investors’ fortune relies
on the objectivity of financial analysts.
26 Orr, Guthrie, in: Vanderbilt University Law School 2004, 595 (597).
27 Belsky, Gilovich, Why Smart People Make Big Money Mistakes-And How to Correct Them: Lessons
From The New Science of Behavioral Economics, 1 st ed., page 141. Very enlightening is also the
article of Gätcher, Orzen et al., in: Journal of Economic Behavior and Organization 2009, 443.
28 Samuelson, Zeckhauser, in: Journal of Risk and Uncertainty 1988, 7 (31).
29 McNeil et al., in: New England Journal of Medicine 1982, 1259.
30 Shefrin, Beyond Greed and Fear: Understanding Behavioral Finance and Psychology of Investing,
1 st ed., page 25.
Der zweite Teil dieses Artikels erscheint in Iurratio 4/2013.
The second part of this article will be published in Iurratio 4/2013.
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Iurratio
Ausgabe 3 / 2013