2017 3rd International Conference on Management Science and Innovative Education (MSIE 2017) ISBN: 978-1-60595-488-2 Availability Heuristic Will Affect Decision-making and Result in Bias SIJIA MENG ABSTRACT Heuristic is a strategy that allows us to make decision without complicate information gathering and analyzing. Availability heuristic is a type of heuristic that concentrates on retrieving information from memory. However, there are four factors that may induce bias from the use of availability heuristic. A model will be established in this paper to assess the possibility of bias occurring in decision under availability heuristic. The existence of availability heuristic is also against the traditional financial market assumption. KEYWORDS Availability Heuristic; bias; financial market. INTRODUCTION Making decisions without complex information gathering and systematic analysis is a strategy called heuristic which is unknowingly utilized by many people. Even though it may not be optimal or perfect, it is usually sufficient for the immediate goals. It could be described as mental shortcut when people assess the likelihood for an uncertain event. Tversky and Kahneman indicated that these heuristics will lead to bias and errors when people make decisions even though they are helpful in some general cases [1]. They categorized these biases into three main types, namely representative heuristic, anchoring and adjustment, and availability heuristic. Representative heuristic means that people have a tendency to make decision of an uncertain event by considering the representative of it in similar cases. Two primary bias in representative heuristic are base rate neglect and sample size neglect [1]. Base rate neglect is that people mistakenly conclude the likelihood of this event without taking account of all relevant information as they rely on the similar and salient case or process which had happened in the past. Besides, the wrong choice of sample size compared to parent population will also lead to errors in analysis and assessment of this uncertain event. Therefore, even though representative heuristic will help people to make easy computation in certain events, it will lead to unwanted biases as people are too confident with their ability to predict the possibility of an event accurately [2]. Anchoring and adjustment implies that people will anchor an information as reference and make adjustments until they reach the final estimation. The piece of information used may be obtained from certain value or past event. Therefore, the initial value of this estimation is a historical data which may not be accurate for _________________________________________ Sijia Meng, Department of Business and Economics, Monash University, Caulfield East VIC 3145, Australia, [email protected]. 267 estimation. Besides, this anchor prevents people to adjust their estimation with new information and therefore causing the forecast closely related to the original data. In addition to this, insufficient adjustments will cause errors in estimations as people will stop to make continuous adjustments since they have reached a plausible result [3]. Therefore, when people make decisions based on an anchor, they should be aware of the existence of bias in this kind of analysis and understand the possible effects. Availability heuristic describes that people tend to use instances or examples they can recall easily in a short time to evaluate the likelihood of an event. Even though availability is useful to assess the frequency of an event, it’s still affect by four main factors which are irretrievability, imaginability, illusory correlation and the effectiveness of search set [1]. As a consequence, people relying on availability heuristic will result in estimation bias. This paper will focus on analyzing of availability heuristic. Section two will show some evidence on how availability heuristic influence people’s decision making and four factors that will affect it. A simple model will be constructed in section 3 to describe the relationship between availability heuristic and possibility of errors or bias occurred under this method. Section 4 will discuss how availability heuristic challenges the tradition method of competitive market and how this model established in section three could be used in assessing decision-making in financial market. EVIDENCE AND LITERATURE REVIEW As mentioned in section 1, availability heuristic is a common type of cognitive style to assess the relative probability or frequency of an event rely on past experience and memory. Availability heuristic shows how these easily recalled examples will affect the judgement on frequency of that event. There are several evidences that supports the existence of availability heuristic. Khan, Qureshi and Ghafoor states that availability heuristic will significantly influence investor’s buying decisions as people tend to choose companies with heavy advertisements [4]. Franklin Templetion Investment indicated most investors expected market index S&P 500 will either be down or flat in the years 2009, 2010 and 2011 as financial market just suffered from Global Financial Crisis (GFC) [5]. However, S&P actually had good performance during that time period. The reason of this expectation error is that investors had deep memories of GFC and estimated the market will have relative performance in next few years. Besides, Folkes showed availability heuristic will affect consumers’ judgement of a product performance [6]. For example, if consumers cannot taste some certain food products, they will be more likely to choose a product with awards for their first time. Therefore, these evidences proved the availability heuristic’s existence and that it will lead to assessment bias by relying on this mental shortcut. There are four main reasons which would result in predictable errors. The first factor that leads to the bias is the retrievability of instances [1]. People usually think that the frequency of a certain event or instance is much higher when the similar or related past events is easily retrievable. This bias is shown in a study done by Lichtenstein where, on average, participants estimated that deaths caused by vehicle accidents are 350 times more frequent than deaths caused by diabetes while the actual statistic shows only 1.5 times more frequent [7]. This is due to the fact that vehicular accidents are far more easily retrievable comparing to deaths by diabetes because media coverage is far greater in accidents. The media bombardment of 268 accidents causes people to recall these incidents easily thus made a wrong prediction fortifies the existence of retrievability of instances bias. The biases of imaginability is a heuristic when someone needs to assess a situation based on a given rules or certain tasks instead of their memory. Tversky and Kahneman asked a number of test subjects that given 10 people to form a committee consisting k people, how many possible combinations of different groups can be formed when k=2,3,4,…,8 [1]. Without complicated calculations, the subjects can only imagine the different combinations of the committee for when k equals each numbers. This makes the number of combinations seems to be much larger when k=2 than k=8 because it is much easier to imagine different combinations of committee members when k=2. The average estimation taken from the test subjects are 70 combinations for k=2 and 20 combinations for k=8 while the actual answer is 45 in both cases. This experiment successfully shown how imaginability causes unwanted biases in heuristics. The third factor is illusory correlation which refers to the phenomenon that people could perceive a relationship between two events or variables even though there are unrelated to each other. This idea was raised by Chapman and Chapman who found people tend to overestimate the relationship if there is unusual information exist [8]. For example, according to tylervigen.com, the US spending on science, space, and technology have 99.79% correlation with the number of suicides by hanging, strangulation, and suffocation from the year 1999 to the year 2009 [9]. This information can create an illusion for some people that the two are actually related to each other. However, there are absolutely no relationship between the two events even though they maintain such a high correlation for 10 years. The final factor is called the effectiveness of search set. When asked to filter out a massive set of data or information based on a certain rule, the amount of occurrence of a certain objects or instances are linked to the effectiveness of the search. Something easy to search for makes people felt like it is much more abundance. For example, which of the following have more words, a word starting with the letter ‘r’ or a word with an ‘r’ in the third letter? According to Tversky and Hahnemann, people approach this question by recalling words in both categories to compare [1]. However, most of them judges the frequency by the ease of recalling the words instead of the actual frequencies. Because they can search for the words starting with ‘r’ much more easily, they think that words starting with ‘r’ is much more abundant when the truth is the opposite. This proves that the effectiveness of searching can cause bias in heuristic judgments. Everyone has a tendency to maximize their own benefits during decision making instances. However, due to the possibility of biases occurred under availability heuristics thinking method, their decisions usually will not be the most optimized or perfect ones. MODEL Availability heuristic is some sort of mental shortcut in certain decision making situation. Even though this may be useful in some situation, there is still a possibility that it could lead to biases. This section will be focusing on constructing a model that can determine the probability of the existence of availability heuristic bias in a particular situation. However, in order to effectively utilize the model, an assumption 269 must be made that no factors other than availability heuristic will be able to cause bias in said situation.