Saturday 24 February 2007

Behavioural Economics - 4) Cognitive Psychology

In the final post of our mini-series of articles outlining the different behaviouralist schools and their impact upon the markets, we address Cognitive Psychology.
1) Regret Theory - People tend to avoid actions that confirm mistakes.
2) Assimilation Error - Traders misjudge information to make it appear confirmatory of historical behaviour.
3) Hindsight Bias - There is a tendency to exaggerate the probability that a past series of events could have been predicted.
4) Regret Theory - Avoidance of activities that confirm previous mistakes.
5) Disjunction - One avoids making trading decisions until some entirely irrelevant future information appears.
6) Social Comparison - Utilising external behaviourisms as an information source about disciplines that one finds difficulty in interpreting.
7) Overconfidence - Traders overestimate their ability to reach correct trading decisions.
8) Cognitive Dissonance - The avoidance of information that undermines our assumptions.
9) Touchy-Feely Syndrome - The overvaluation of things that we have personally chosen.
10) Confirmatory Bias - Decisions being biased by what one wishes to believe.
11) Selective Perception - Treating information in a manner than confirms our attitudes.
To model the psychological mechanisms that influence the dynamics of financial markets, traders are required to combine all aspects of the different behavioural schools to determine how themselves and other market operators react to real-time realities. Sophisticated modelling yields profit from market inefficiencies.