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86 Cards in this Set

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Judgement
the cognitive aspects of the decision-making process
System 1 Thinking
our INTUITIVE system, which is typically fast, automatic, effortless, implicit, emotional, and COMMON
System 2 Thinking
our REASONING system which is slower, conscious, effortful, explicit, logical, LESS COMMON
Normative Decision Making
perfect (ideal) decision making where we evaluate all of the information correctly to derive the best solution
Steps in the "rational" (normative) decision making process
(1) Accurately define the Problem; (2) Identify the criteria (the qualities needed); (3) Weight the criteria in importance (required vs desired); (4) Generate alternatives (list of people); (5) Rate each alternative (applicant) on each criterion (consequences of choosing this person/action); (6) Compute the optimal decision.
Bounded Rationality
decisions that are influenced by factors not directly tied to consequences are said to be bounded - most of the time our judgments are bounded to limited to some extent
Why bounded-rationality?
(1) we lack or ignore important information; (2) we operate under time and/or cost constraints; (3) we have a limited memory system (STM); (4) we have difficulty knowing what the optimal choice is; (5) it is easier to settle for an acceptable (satisficing) solution rather than the "best" solution
Prescriptive Decision Making
goal is to give us the best methods for making optimal decisions
Descriptive Decision Making
goal is to identify our mistakes and help us understand them
Heuristic
a simplified strategy for solving problems; automatic; usually give us "good" decisions, but not always the best
Availability Heuristic
an event that evokes emotions and is vivid, easily imagined, and specific will be more available than an event that is unemotional in nature, bland, difficult to imagine, or vague (what is safer traveling by air or by car?)
Representativeness Heuristic
the tendency to look for traits an individual may have that correspond with previously formed stereotypes (gender and racial stereotypes in hiring and promotion)
Affect Heuristic
emotional influences that are automatic and maybe out of our awareness (take place before any cognitive reasoning happens) (I don't like her for some reason...)
Ease of recall
individuals judge events that are more easily recalled from memory, based on vividness or recency, to be more numerous than events of equal frequency whose instances are less easily recalled (availability heuristic)
Retrievability
individuals are biased in their assessments of the frequency of events based on how their memory structures affect the search process (availability heuristic)
Presumed associations
individuals tend to overestimate the probability of two events co-occurring based on the number of similar associations they can easily recall, whether from experience of social influence (availability heuristic)
Insensitivity to base rates
when assessing the likelihood of events, individuals tend to ignore base rates if any other descriptive information is provided - even if it is relevant (representativeness heuristic)
Insensitivity to sample size
when assessing the reliability of sample information, individuals frequently fail to appreciate the role of sample size (representativeness heuristic)
Misconceptions of chance
individuals expect that a sequence of data generated by a random process will look "random," even when the sequence is too short for those expectations to be statistically valid (representativeness heuristic)
Regression to the mean
individuals tend to ignore the fact that extreme events tend to regress to the mean on subsequent trials (representativeness heuristic)
The conjunction fallacy
individuals falsely judge that conjunctions (two events co-occurring) are more probable than a more global set of occurrences of which the conjunction is a subset (representativeness heuristic)
Anchoring
individuals make estimates for values based upon an initial value (derived from past events, random assignment, or whatever information is available) and typically make insufficient adjustments from that anchor when establishing a final value (other biases)
Conjunctive and disjunctive events bias
Individuals exhibit a bias toward overestimating the probability of conjunctive events and underestimating the probability of disjunctive events (other biases)
Overconfidence
individuals tend to be overconfident of the infallibility of their judgments when answering moderately to extremely difficult questions (other biases)
The confirmation trap
individuals tend to seek confirmatory information for what they think is true and fail to search for nonconfirmatory evidence (other biases)
Hindsight and the curse of knowledge
after finding out whether or not an event occurred, individuals tend to overestimate the degree to which they would have predicted the correct outcome; furthermore, individuals fail to ignore information they possess that others do not when predicting others' behavior (other biases)
Cognitive bias
occurs in situations in which an individual inappropriately applies a heuristic when making a decision
Framing
alternative wordings of the same objective information that significantly alter the model decision, though differences between frames should have no effect on the rational decision
Expected-Utility Theory
suggests that each level of an outcome is associated with an expected degree of pleasure or net benefit, called utility.
Prospect Theory
we judge gains and losses from a reference point; we are risk averse when the problem is framed as a sure gain; we are risk seeking when faced with a sure loss; the value function for losses is steeper then the value function for gains
Misjudging probabilities
we tend to underestimate the likelihood of high-probability events and over-estimate the probability of low-probability events
Certainty Effect
the reduction in the probability of an event has more importance to us when the final outcome is certain; we prefer to eliminate all risk rather than just reducing it; we will invest a lot to be absolutely certain than less and take a chance
Pseudocertainty Effect
we are more likely to favor options that offer apparent certainty than those that only reduce uncertainty; appearance of certainty is preferred over the POSSIBILITY of reduced certainty
Transactional Utility
we judge the quality of the deal you are getting compared to what the item should cost
Acquisition Utility
the value you place on a commodity
Price-Quality Heuristic
link price and quality but do not know how to judge quality (increased dollar amount does not mean increased quality); we use price as a substitute for quality knowledge
Endowment Effect
we demand a higher selling price for a product than we would be willing to pay for the same product because it is in our possession; the seller's price includes intrinsic worth and attachment to the item
Mental Accounting
mental accounts that are used to organize, evaluate, and keep track of a variety of financial activities, such as money for vacation, a renovation, this month's budget, etc.; we have different rules for different mental accounts
Bonus
creates the image of surplus cash
Rebate
conveys the image of money that simply returns you to the appropriate status quo
Omission Bias
when contemplating risky choices, not acting is seen as less risky than acting (do no harm); actions generate more regret in the short-term while not acting will generate more regret in the long-term
Joint vs Separate Preference Reversals
we place a higher value on one option over another when evaluated separately; we reverse our preferences when we consider the options at the same time; why - conflict with system 1 & 2 thinking, the emotional is stronger in the separate evaluations, the rational is stronger in the comparison conditions
Evaluability Hypothesis
hard to evaluate attributes will have less impact in separate evaluations than in joint evaluations
Hyperbolic discounting
the present is more vivid to us than the future; we view all gains and losses in the future as worth less than present gains and losses; ie. retirement investments (future loss) vs. credit cards (current loss)
Motivation and Affect
when what we want to do conflicts with what we should do
Positive Illusions
we have an overly positive view of ourselves, the world, and the future; positive illusions enhance self-esteem and increase persistence; it is more difficult to have optimistic illusions when we are confronted with the hard facts; we don't just think positive about ourselves, but also about the groups in which we belong
Unrealistic Positive View of Self
we see ourselves as better than others; common unrealistic traits include: honesty, cooperation rationality, driving skills, health, intelligence, and morals; we are highly accurate in predicting the behavior of others
Illusion of Control
the belief that we can control uncontrollable events and that our actions can guarantee a certain outcome; the origins of superstitious behaviors
Self-serving attributions
we are more likely to accept credit for collective successes and to accept too little responsibility for failures; allows us to protect our self-image
Positive Illusions in Groups
desirable characteristics of an ingroup are internal; undesirable characteristics are caused by external factors
Self-Serving Reasoning
we first determine the best outcome based on self-interest (decide what you want) and then seek evidence to support it based on fairness (determine reasons why we should be given "it") easier to argue for collective reasons (not just me that wants...but everyone); we tend to be more self-serving when we can attribute the benefits to our group rather than ourselves
Affective influences on the endowment effect
the value people place on a commodity is far greater if they own the commodity than if they do now; disgust triggers the desire to expel, suppressing prices for people who do and do not own the commodity; sadness triggers the goal to change one's circumstances, increasing the willingness to pay to buy and decreasing the price demanded to sell
depression and decisions
linked to greater judgment accuracy; depression = more realistic view of self than those not depressed
sadness and decisions
triggers more deliberative thought processes; sad people are more impacted by anchors (original experiences)
good moods and decisions
people in good moods are more optimistic
fear and anxiety and decisions
fear and anxiety increase risk aversion
happy people and decisions
happy individuals may be less motivated to expand cognitive effort and more likely to rely on heuristic processing (System 1 thinking)
Pessimism and decisions
pessimism = better ability to make good decisions
sunk cost
the time and money already invested in something; as sunk costs increase our level of commitment increases
sunk costs and decisions
from an economic perspective, we should ignore what we have already invested and only consider future gains and losses; sunk costs are irrelevant to future decisions; they do not rationally play a part in future decisions
nonrational escalation
the degree to which an individual escalates commitment to a previously selected course of action to a point beyond that whcih a rational model of decision making would prescribe
Self-justification
once an individual makes an initial decision, negative feedback is dissonant with the initial decision; escalating the commitment reduces this dissonance; people more likely to reinvest if their initial investment had been unsuccessful because of self-justification
escalation and groups
groups are less likely to escalate commitment, but if they do, they do so to a greater extent and individuals not in a group; easier to walk away from bad decisions if they were made in a group; groupthink may cause escalation (leader won't back down, etc.)
escalation and external factors
we are more likely to escalate when the cause is unrelated to the initial decision; if unknown reason is why loss occurred then we are more likely to stick with our initial behavior; try to justify with external factors
High and low responsibility groups and escalation
high responsibility individual = personal decision to invest initially and initial investment was unsuccessful; low responsibility individual = another individual made initial investment which was unsuccessful; high responsibility individual were more likely to reinvest than low responsibility individual
personal loss and escalation
increased likelihood to continue with initial decision to invest and will reinvest; if someone else made the bad decision we are more likely to change the behavior
competitive escalation
added competition with the other party - the desire to "win" - serves as added motivation to escalate commitment
Reasons why escalation occurs
(1) Perceptual biases, (2) judgmental biases, (3) impression managment, (4) competitive irrationality
Perceptual Biases
you notice information that supports your initial decision and ignore information that goes against it; we don't look for negative information; downplay the negative and increase the positive
Judgmental Biases
any loss will distort our judgment toward continuing the initial decision because according to prospect theory, we are more willing to take risks when facing a sure loss; losses are more aversive/painful than the joy that we receive from losing a "gain"
Impression Management
we don't like others to know we have made a mistake and we want to appear consistent; instead of admitting that you've made a mistake you constantly reinvest to put off having to face the loss; since managers are rewarded based on results they are motivated to hide or delay bad outcomes by escalating
Competitive Irrationality
two parties engage in an activity that is clearly irrational in terms of the expected outcomes to both sides (the dollar auction when the value goes above a dollar); if I do this...then you will do this...(irrational escalation); rational decision is for both parties not to "play"
Prisoner delima
one convict rats out the other convict and gets off (wins) the other loses; if the one does not rat out the other then both lose the same amount (both do time)
fairness
fairness is judged by how the situation is framed; a wage cut is perceived as unfair, while a nominal gain that does not even cover inflation is more acceptable
Norms of equity
lead us to reject offers that are unequal and lead us to accept equal split offers prematurely
Ultimatum
rationally we should except any offer that is higher than zero, but we don't (the ultimatum game)
Concern for the outcomes of others
people are concerned with how their outcomes compare to the outcomes of others; the outcomes of others act as a key reference point in interpersonal decisions
Joint-versus-separate preference reversals
individuals care far more about social comparisons ($400:$400 = equity within) when rating specific outcomes and more about absolute outcomes ($500:$700 = competitive parody) in actual choice behavior
Procedural Justice
individuals value the procedures used to create justice, as well as the justice of the outcomes obtained ($60,000/yr & high procedural justice versus $75,000/yr and low procedural justice); we care more about procedural justice when rating a specific outcome and more about absolute outcomes in a choice response; self-interest is always more important than procedural justice (greed is good)
A friend tells you that his mutual fund has beaten the benchmark averages five years in a row. Should you buy in?
past stock performance is not predictive of future performance
Overconfidence
leads people to believe in their own abilities (more active investing); individual investors buy and sell too often; men buy and sell more often than women; more frequent buying and selling results in higher fees for commissions and real time trades
Optimism
investors make overly confident decisions and maintain overly optimistic views of future success (because I can imagine it it is more likely to happen)
Denying randomness
we often believe that random events are not really random; we believe that a hot fund has done well because of the fund managers talent, not luck; we ignore regression to the mean (dogs of the dow = low performers will increase/regress to the mean and we buy when low and sell when they reach the mean)
Anchoring and Status Quo
we stick with default investment allocations; investments involve immediate expenditures (losses) for a future gain
Procrastination
Omission bias (we don't invest at all) and discounting (discount future gains relative to losses NOW)
Prospect Theory
we are risk seeking with losers and risk averse with winners; as a result we hold on to losers too long and sell winners too soon