What does the future hold? How can we prepare ourselves for the unexpected? We humans have developed a repertoire of unconscious mechanisms to help us cope with insecurity. While these mechanisms may assuage feelings of helplessness and paralysis, they can also cloud our judgment. Professors Manel Baucells and Martin Weber explain how three such mind traps work: hindsight bias, overconfidence and risk seeking for losses. Knowing how these psychological biases manifest themselves in your own decision making will help you to keep them in check and improve your ability to make decisions in situations of uncertainty.
Tools and Frameworks:
This article includes a simple test to reveal signs of overconfidence, which just might make you think twice the next time you are tempted to be 100 percent certain of something.
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The authors cite seven pieces of research, including some of their own studies: one involving 85 investment bankers based in London and Frankfurt, to test the effect of hindsight bias on financial performance; one involving a group of private investors that measured different facets of overconfidence on trading levels; and another involving a sample of graduates, MBA students and executives revealing that, when the situation is perceived as a loss, people prefer to take risks and see a high probability that things will turn out for the best, ignoring the possibility that things could actually end up being much worse.
About the Authors:
Manel Baucells is associate professor in the Managerial Decision Sciences Department at IESE Business School in Barcelona and is currently writing a book on happiness, blending research from economics and psychology.
Martin Weber is chair of banking and finance at the University of Mannheim and director of the university's Institute of Investment Banking.