Lecture 8–9: Heuristics Flashcards
(13 cards)
What are heuristics?
Mental shortcuts or rules of thumb used to make decisions quickly, often under uncertainty.
What is the main downside of heuristics?
They can lead to systematic biases and judgment errors.
Name the three key heuristics discussed by Kahneman and Tversky (1974).
Representativeness, Availability, Anchoring
What is the representativeness heuristic?
Judging the probability of an event based on how similar it is to a typical case or stereotype.
What biases arise from representativeness?
Conjunction fallacy, Base rate neglect, Sample size neglect, Misconception of chance
What is base rate neglect?
Ignoring statistical base rates in favor of specific (often irrelevant) details.
What is the availability heuristic?
Estimating likelihood based on how easily examples come to mind.
What biases result from availability?
Overestimation of rare, vivid events (e.g., plane crashes), Recency bias, Media influence on risk perception
What is the anchoring heuristic?
Relying too heavily on an initial value or number when making decisions.
How is anchoring tested in experiments?
By showing how irrelevant numerical prompts (e.g., spinning a wheel) influence later estimates.
What are some financial consequences of heuristics?
Overreaction to salient news (availability), Mispricing due to representativeness (e.g., hot stocks), Anchoring to purchase prices when evaluating investments
What is the law of small numbers?
The mistaken belief that small samples must reflect the properties of the population.
How can heuristics lead to predictable mispricing in markets?
Because many investors make similar errors, their biases can collectively affect prices.
