Behavioural finance: how car journeys shed light on our brains
Behavioural finance is defined by the application of psychology to finance: it thus differs from classical financial theory by considering individuals not as purely rational beings, but as being influenced by their emotions or by reasoning biases. Just a few days before the first holidays, the long summer journeys and their inevitable traffic jams teach us a few lessons about behavioural biases: "information cascade", "correlation bias" and "memory bias".
The itinerary, the typical example of the "information cascade"...
Route selection has often been used to describe mimicry bias and in particular the "information cascade".
When leaving on holiday, motorists look for the best route to take. Everyone has their own technique to gain a few precious minutes of idleness: road maps, GPS, hearsay, observations... Despite the talents of one or the other, the classic example used is likely to happen again :
You have two roads ahead of you to get to your resort by the sea. A priori, but without certainties, the map seemed to indicate that the road on the left is shorter than the one on the right. But you left quickly and without this famous map. Luckily (or not!), you are not alone and many cars seem to be heading towards the seaside as well. You have time to see a first car take the road on the right (for reminder, the longest according to your memory). A second and then a third car also rush in. When you arrive at the fork you could rely on your memory but you decide to rely on those "who seem to know". Let's then imagine that the cars in front of you have all had the same reasoning, namely to follow the one in front... and that the first driver has chosen completely at random...
This is a typical example of an informational cascade: decisions based on observing the behaviour of others without validating it as rational or relevant. A bad initial choice then leads to a cumulation of bad decisions by the other actors. The latter do not modify their choices despite the information they have or could have.
The informational cascade is regularly mentioned to explain the phenomena of stock market bubbles or crashes. In the same way, this bias facilitates certain frauds such as the Ponzi scheme, which consists in remunerating clients' investments with funds from new entrants, or, conversely, it makes it possible to ensure certain commercial successes through word of mouth (after having convinced the first clients, the others follow more easily).
Traffic jams, a situation that leaves time to create illusory correlations
They also make it possible to illustrate certain specific biases. Who hasn't had the impression of being systematically in the slowest line on the road (like at the supermarket)? This feeling sheds light on two types of bias:
An illusory correlation bias
Murphy's Law states that "Anything that is likely to go wrong, will go wrong". But although everyone knows that this law is absolutely unscientific and therefore unproven, individuals tend to make up illusory correlations: inventing correlations that do not exist or exaggerating weak correlations. This bias obviously gives rise to false hopes of gains in investments or poor diversification of assets.
Memory bias
To carry out a study on the subject (Why cars in the next lane seem to go faster?), two Canadian researchers (Donald A. Redelmeier & Robert J. Tibshirani) showed students a video of traffic jams, filmed from inside a moving car. The researchers deliberately selected a sequence in which the car is in the fastest lane. However, 86% of the students considered the sequence to be realistic, 70% felt they were in the slowest lane and 65% would have changed lanes if they were actually driving! The very negative feeling experienced when the car is overtaken therefore has more impact than that experienced by a driver overtaking another car. This study highlights the fact that it is easier to remember an unpleasant moment than a pleasant one. Translated into finance, a disappointment linked to a capital loss will remain more lasting than good performance.
Have a good trip for those who will be travelling by car and above all... have a good holiday!
Decryption of the projection bias
Insights by our Wealth Engineering expert, Stéphane Maljevac.
Hospitality is a vibrant sector that’s always on the move and influenced by a multitude of economic, social and...
When it comes to personal finance, we’re usually advised to keep a little distance, figuratively, from our financial...
The sun is out and so are the lawnmowers. Cue the friendly banter between enthusiasts of the walk-behind mower, the...