OPTIMISM BIAS [YES YOU TOO]

great-depression-blog

http://optimism.behaviouralfinance.net/
https://rpseawright.wordpress.com/2012/07/16/investors-10-most-common-behavioral-biases/

“…a well-established bias in which someone’s subjective confidence in their judgments is reliably greater than their objective accuracy. Indeed, we live in an overconfident, Lake Wobegon world (“where all the women are strong, all the men are good-looking, and all the children are above average”).  We are only correct about 80% of the time when we are “99% sure.” Fully 94% of college professors believe they have above-average teaching skills. 80% of drivers say that their driving skills are above average. While 70% of high school students claim to have above-average leadership skills, only 2% say they are below average, no doubt taught by above average math teachers. In a survey, 92% students said they were of good character and 79% said that their character was better than most people even though 27% of those same students admitted stealing from a store within the prior year and 60% said they had cheated on an exam. Venture capitalists are wildly overconfident in their estimations of how likely their potential ventures are either to succeed or fail. In a finding that pretty well sums things up, 85-90% of people think that the future will be more pleasant and less painful for them than for the average person.”

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INFLATED EARNINGS ESTIMATES
http://scienceblogs.com/cortex/2010/04/15/optimism-bias/
by Jonah Lehrer  /  April 15, 2010

“I’m pretty fascinated by this chart from the McKinsey Quarterly, which is a great demonstration of the optimism bias. The chart captures the earnings estimates of equity analysts for S&P 500 companies. The downward slope of these yellow lines is what happens when our hopeful projections meet dismal reality. Needless to say, these estimates come from highly paid professionals, with access to vast amounts of data. (They’re also making projections about the relatively near future.) Unfortunately, all that data is no match for a deep-seated bias, which leads us to accentuate the positive and downplay the prospect of potential losses. (This helps explain why earnings projections are even less accurate during economic downturns.) Interestingly, the only segment of the population that isn’t vulnerable to the optimism bias are people with major depressive disorder. Maybe Wall Street should think about hiring them.”

vs DEPRESSIVE REALISM
http://www.psychologytoday.com/articles/200802/magical-thinking

“We use ritual acts most often when there is little cost to them, when an outcome is uncertain or beyond our control, and when the stakes are high. People who truly trust in their rituals exhibit a phenomenon known as “illusion of control,” the belief that they have more influence over the world than they actually do. And it’s not a bad delusion to have—a sense of control encourages people to work harder than they might otherwise. In fact, a fully accurate assessment of your powers, a state known as “depressive realism,” haunts people with clinical depression, who in general show less magical thinking.”



Tali Sharot, a faculty member of the Department of Cognitive, Perceptual and Brain Sciences at University College London, is the author of “The Optimism Bias: A Tour of the Irrationally Positive Brain.”

MANAGING EXPECTATIONS
http://www.cnn.com/2012/06/24/opinion/sharot-optimism-bias/index.html
Why we fool ourselves into optimism
by Tali Sharot   /  Jun 24, 2012

“Close your eyes for a moment and imagine your life five years from now. What sort of scenarios pop into your mind? How do you see yourself standing professionally? What is the quality of your personal life and relationships? Though each of us may define “happiness” in different ways, it remains the case that we are inclined to see ourselves motoring happily toward professional success, fulfilling relationships, financial security and stable health. Unemployment, debt, Alzheimer’s, any number of other regrettably common misfortunes are rarely factored into our projections. According to most estimates, 80% of the population hold unrealistic, optimistic beliefs about their own future. However, ask people whether the economy is going in the right direction or how they feel about the future of their country, and you will hear: “absolutely not” and “going down the drain.” Collectively we are quite pessimistic about the direction of our nation or the ability of our leaders to improve education and reduce crime. But private optimism, about our personal future, remains incredibly resilient.

Surveys show that most people overestimate their prospects for personal achievement, expect their children to be extraordinarily gifted and hugely underestimate their likelihood of divorce and cancer. What always puzzled me was how we manage to maintain optimism in the face of reality. We experience failure and heartache, we read the newspaper — we know the economy is unstable, but still we remain optimistic about our own odds. As a neuroscientist I found this especially surprising, because according to all classic theories of learning when expectations are not met, we alter them. This should eventually lead to realism, not optimism.

By scanning the brains of people while they learned from positive and negative information about the future we uncovered a possible answer to this puzzle. Surprisingly, when people learn of what the future may hold, their brains faithfully encode desirable information that can enhance optimism, but fail at incorporating unexpectedly bad information. When we learn of Oprah Winfrey’s success story, our brain takes note and concludes that maybe, we too may become immensely rich one day. But when told the odds of divorce are almost 1 in 2 we take no notice. This means that warning signs such as those on cigarette packets may only have limited impact. “Yes, smoking kills — but mostly it kills the other guy.” But at the same when we hear the housing market is going up we think — “ohhhh the value of my house is going to double.”

In fact, economists have suggested that optimism was a root cause of the financial downfall of 2008. The optimism bias was not only blurring the vision of the private sector, but also of government officials, rating agencies and financial analysts who constantly expected the market to go up and up. The belief that we are relatively immune to future harms can also put us at physical risk. Take for example an e-mail I received from a California firefighter who read my book about the optimism bias. He says fatality investigations involving firefighters often include statements to the effect of “We didn’t think the fire was going to do that” even when all of the available information about risks was there to enable safe decisions. The British government for one has decided to try to address these problems. As a first step, it has acknowledged that the optimism bias causes individuals to underestimate the cost and duration of projects. Specific guidelines of how to correct for the optimism bias in appraisals were published in the British government’s Green Book, which provides an overall methodology for economic assessment. Adjustments for the optimism bias have since been factored into the budget of many UK government projects, including most recently the 2012 London Olympics. Despite all these potential pitfalls, the science of optimism clearly indicates that, on balance, viewing the world through rose-tinted glasses is a good thing. We now know that underestimating the pain and difficulties the future undoubtedly holds lowers stress and anxiety, consequently enhancing physical and mental health. Believing that a goal is within reach motivates us to act in a way that will help us attain it. This may, for instance, explain why optimists work longer hours and tend to earn more. Yes, the 2012 London Olympics budget had to be adjusted to account for over-optimistic prediction, but if the human spirit were not optimistic, would there be anyone around to participate in the actual Games? My guess is that the number of athletes who expect to win a medal at the Olympics significantly outnumbers the number of contestants who will mount the podium to be garlanded in due course. Most athletes subject themselves to years of intensive training because they can clearly envisage the end goal. At the end of the day, to make any kind of real progress we need to be able to imagine alternative realities — better ones, and believe them to be possible.”

BIAS REMOVAL
http://theoptimismbias.blogspot.com/p/scientific-papers.html
http://www.time.com/time/health/article/0,8599,2074067,00.html
http://www.brainpickings.org/index.php/2012/12/12/science-of-optimism-sharot/
http://www.the-scientist.com/?articles.view/articleNo/32642/title/Removing-the-Optimism-Bias-/
http://www.scientificamerican.com/article.cfm?id=unflagging-optimism

“Most of us hold unrealistically optimistic views of the future, research shows, downplaying the likelihood that we will have bad experiences. Now a study inNature Neuroscience last October has found clues to the brain’s predilection for the positive, identifying regions that may fuel this “optimism bias” by preferentially responding to rosier information. Tali Sharot, a University College London neurology researcher, and her colleagues asked 19 individuals between the ages of 19 and 27 to estimate their odds of experiencing 80 unfavorable events, such as contracting various diseases or being the victim of a crime. Participants were then told the actual average probability of each before repeating the exercise.

The participants revised most of their estimates the second time around, but 79 percent of those tested paid much more attention when their actual risk was lower than what they had initially guessed. After getting the good news, these subjects rated their risk for these events as significantly lower than they did earlier. In contrast, when they had underestimated their odds of meeting with a particular misfortune, they made less drastic revisions to their guess or none at all—clinging to their earlier belief that they would probably avoid the bad luck. Using functional MRI, the resear­chers found areas in the prefrontal cortex, where conscious reasoning takes place, that were active when participants received infor­mation that was better than anticipated. The greater the difference between the subjects’ initial guess of their risk and the true probability, the more activity appeared in these regions, hinting that they contribute to positive error correction.

Activity in another part of the brain, the right inferior frontal gyrus, changed in response to discouraging information. There, however, activity did not correspond as closely with the magnitude of error in the participants’ initial risk estimates, matching the poorer correction later. That incon­sistent neural response was ob­served most clearly or most often in individuals who scored higher on standard tests for optimism as a personality trait. This finding jibes with past studies that observed an optimism bias in about 80 percent of the population. Its absence can signal anxiety or depression. Yet being overly optimistic has consequences, too, Sharot says, preventing us from taking some precautions to avoid harm or misfortune. Realizing the brain’s partiality may be half the battle. “If you are aware of the optimism bias, you can commit to actions or rules that will help protect you,” Sharot notes.” 

LEARNING CURVE
http://blogs.wsj.com/totalreturn/2011/10/28/this-is-your-brain-on-gains/
by Jason Zweig  /  October 28, 2011

“Why is it so hard for investors to learn from their mistakes? One reason, according to new research by a team of neuroscientists in London and Berlin: We learn more when results are better than expected than when they are worse than expected. In effect, your brain perceives the world through rose-colored glasses. In a recent experiment, people were asked to estimate the odds of suffering 80 different bad outcomes—being robbed, getting cancer, developing Alzheimer’s disease and so forth. Then they were shown the actual probability of those events. Finally, in a later session, they were asked to recall the probabilities of each of the 80 events. It turned out that people’s final estimates of probabilities were much more accurate when their first round of guesses had been too pessimistic. Whenever reality had turned out to be better than they had anticipated, people’s future forecasts became significantly more accurate.

In short, humans don’t learn equally well from upside and downside mistakes. Because we have what researcher Tali Sharot calls an “optimism bias,” we pay more attention when the future turns out to be better than we expected. If you bought Apple at $60 a share thinking maybe it would double, you’ve probably spent a fair amount of time wondering why you underestimated its potential and trying to apply those lessons to find other great stocks. On the other hand, if you bought Netflix at $200 a share, never dreaming it would go down by more than half, you’re probably not doing much self-reflection at all; you’re looking for somebody to blame.

At a recent meeting of more than 100 financial advisers and wealthy investors, I asked how many thought they added value to their portfolios with their selling decisions. Almost all the hands went up. I then asked how many tracked the returns of the stocks they sold after they sold them. Two-thirds of the hands went down. But, of course, there’s no way to know whether it was a good idea to sell one stock and replace it with another unless you systematically track how both of them did after the trade. The lesson: Investors must force themselves to study their mistakes, or they will never learn from them.  Otherwise your automatically optimistic brain will keep you from confronting the truth.”

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