Behavioral Finance

CHAPTER 10

Perception Biases

A perception bias arises when an individual has difficulty figuring out what the problem is that needs to be solved. Perception biases come in many forms. We look at several perception biases in this chapter, including saliency, framing, anchoring, and sunk-cost biases. All four of these biases have been extensively studied by Kahneman and Tversky and others and are well established. While the four perception biases that we discuss in this chapter do not exhaust the list of perception biases, these four appear to be the most important.

SALIENCY

When we have not encountered something recently, we have a tendency to ignore that thing even if it is important to an upcoming decision. No one seems interested in buying flood insurance unless there has been a recent flood. Airplane accident insurance is almost never purchased except in airports just prior to boarding a flight, though it is available to be purchased from the moment travel plans are made. When the economy has been strong and vigorous for a long time, fears of an economic slowdown recede almost to the point of being completely ignored.

Saliency works in two ways. If an event has not occurred recently, then that event tends to be perceived as having zero or negligible probability of occurring in the future. However, if the same event has occurred very recently, the perceived probability of a future occurrence becomes overstated. A dramatic example of saliency seems to take place when financial ...