Behavioral Finance

CHAPTER 13

Illusions

Our capacity to predict the likelihood of future events relies in part on our ability to draw inferences from past observations. Traditional economic theory assumes that individuals evaluate and learn from past occurrences in an objective fashion. Psychological studies, however, have shown that humans have persistent limitations in their ability to draw conclusions from historical data and hence often derive false conclusions from past experience.

Cognitive illusions, or biases, represent one subset of these limitations. A cognitive bias is a departure in inference or judgment from objective analysis that leads to a distortion in perception or understanding. From a set of observations on how one performs in a specific context, one may believe he or she is more capable at the given task than actually warranted. When comparing one's prediction to an actual outcome of events, one might tend to overstate the impact he or she had on the outcome. These illusions can have an acute impact on financial markets, as evaluations of investment possibilities and choices of professional managers can be affected significantly by them.

ILLUSION OF TALENT

One of the most successful franchises in video game history is Madden NFL, a series of football video games produced by EA Sports. Named after John Madden, a famous National Football League player, coach, and commentator, the label has sold more than 70 million copies across multiple gaming platforms since its inception in ...