Biases and Errors in

Judgement and
Decision Making
By
Dr. Muhammad Abbas
 Rational Decision Making Process
 You are the director of the marketing division of a rapidly expanding
consumer company. You need to hire a product manager for a new
"secret" product that the company plans to introduce to the market in
fifteen months. How will you go about hiring the appropriate
individual?
 As the owner of a venture capital firm, you have a number of
proposals that meet your preliminary considerations but only a limited
budget with which to fund new projects. Which projects will you fund?
 You are on the corporate acquisition staff of a large conglomerate that
is interested in acquiring a small-to-moderate-sized firm in the oil
industry. What firm, if any, will you advise the company to acquire?
Define the problem
 The problem has been fairly well specified in each of the four
scenarios. However, managers often act without a thorough under­
standing of the problem to be solved, leading them to solve the
wrong prob­lem.
 Accurate judgment is required to identify and define the problem.
Managers often err by (a) defining the problem in terms of a
proposed solu­tion, (b) missing a bigger problem, or (c) diagnosing
the problem in terms of its symptoms. Your goal should be to solve
the problem, not just eliminate its temporary symptoms.
Identify the criteria.

 Most decisions require you to accomplish more than one objective.

When buying a car, you may want to maximize fuel economy,
minimize cost, maximize comfort, and so on. The rational decision
maker will identify all relevant criteria in the decision-making
process.
Weight the criteria.

 Different criteria will vary in importance to a decision maker.

Rational decision makers will know the relative value they place on
each of the criteria identified (for example, the relative
importance of fuel economy versus cost versus comfort). The value
may be specified in dollars, points, or whatever scoring system
makes sense.
Generate alternatives
 The fourth step in the decision-making process requires
identification of possible courses of action. Decision makers often
spend an inappropriate amount of search time seeking
alternatives, thus creating a barrier to effective decision making.
An optimal search continues only until the cost of the search
outweighs the value of the added information.
Rate each alternative on
each

criterion.
How well will each of the alternative solutions achieve each of the
defined criteria? This is often the most difficult stage of the
decision-making process, as it typically requires us to forecast
future events. The rational decision maker carefully assesses the
potential consequences on each of the identified criteria of
selecting each of the alterna­tive solutions.
Compute the optimal decision
 Ideally, after all of the first five steps have been completed, the
process of computing the optimal decision consists of (a)
multiplying the ratings in step 5 by the weight of each criterion,
(b) adding up the weighted ratings across all of the criteria for
each alternative, and (c) choosing the solution with the highest
sum of the weighted ratings.
Implement the Decision
Evaluate the decision
Bounded Rationality and Satisficing

 Simon's bounded-rationality framework views individuals as attempting

to make rational decisions
 But it acknowledges that they often lack important information that
would help define the problem, the relevant criteria, and so on.
 Time and cost constraints limit the quantity and quality of available
information.
 Decision makers retain only a relatively small amount of information in
their usable memory.
 Finally, intelligence limitations and perceptual errors constrain the
ability of decision makers to accurately "calculate" the optimal choice
from the universe of available alternatives.
Judgmental Traps and
Heuristics
 Judgmental traps are the systematic
and unintentional biases in our
judgement while we make
decisions.
 Heuristics are the rules of thumb or
the short-cuts used in judgment and
decision making.
ATTRIBUTION BIAS
 The tendency to underestimate or overestimate
the influence of external/internal factors when
making judgments about the behavior of others
or the self.
 We blame people first, not the situation
 We blame situation first, not ourselves
 Self-Serving Bias
 The tendency for individuals to attribute their
own successes to internal factors while putting
the blame for failures on external factors
 It is “our” success but “their” failure
The overconfidence trap.

 Believingtoo much in our own ability

to make good decisions – especially
when outside of own expertise.
 1996 Everest tragedy (Scott Fisher)
Confirmation bias
CONFORMING EVIDENCE BIAS
 People naturally tend to seek information
that confirms their expectations,
BELIEFS and hypotheses, even when
disconfirming or falsifying information is
more useful or true.

 An investor can interpret information in a biased

way. The bias is more pronounced with emotionally
charged issues and for deeply entrenched beliefs.
Contrast Effects

 Evaluation of a person’s characteristics that

are affected by comparisons with other
people recently encountered who rank
higher or lower on the same characteristics
Selective Perception

 People selectively interpret what they see

on the basis of their interests, background,
experience, and attitudes
 WE ONLY SEE WHAT WE WANT TO
SEEE
Halo Effect

Drawing a general impression about

an individual OR A SITUATION on
the basis of a single characteristic
The Availability Heuristic
 People assess the frequency, probability, or
likely causes of an event
 by the degree to which instances or occurrences of
that event are readily "available" in memory
 or how easily an example can brought to mind.
 An event that evokes emotions and is vivid, easily
imagined, and specific will be more available
than an event that is unemotional in nature,
bland, difficult to imagine, or vague.
 Applications and examples
 Rate of deaths in accidents vs suicide
 Sales forecast
 Smoking addiction
Anchoring Bias

 Anchoring bias is a cognitive bias that

causes us to rely too heavily on the first
piece of information we are given about
a topic.
 Length of Nile river
 100 km to 200 km
 200 km to 300 km

 1000 km to 2000 km
 2000 km to 3000 km
Prospect theory
 We have a tendency to take risks in loss and not to take risks in gain situations.

 Gain and loss aversion/Insurance

 A: 100% chance of winning 5000 (sure gain)

 B: 70% chance of winning 8000 (risky gain)

 (in case of gains, we go for sure gains or in case of gains, we do not take risks)

 A: 100% chance of loosing 5000 (sure loss)

 B: 70% chance of loosing 8000 (risky loss)
 (in case of losses, we take risks instead of going for
sure loss
Prospect theory
 (in case of losses, we take risks instead of going for
sure loss

 INSURANCE COMPANIES

 Insurance premium/fees. Convince us for sure losses

The Sunk-Cost Trap or Escalation of
commitment

 Making choices in a way that justifies past

choices, even when the past choices no
longer seem valid.


 We may refuse, for example, to sell a stock or a

mutual fund at a loss.
 Our past decisions become what economists term sunk
costs—old investments of time or money that are now
irrecoverable.
The Conjunction Fallacy
 Salman is 31 years old, single, outspoken, and very
bright. He majored in philosophy. As a student, he was
deeply concerned with issues of discrimination and
social justice, and also participated in anti-nuclear
demonstrations.

 Which is more probable?

A Salman is a bank teller.
B Salman is a bank teller PLUS is active in the feminist
movement (TWO QUALITY)
HINDSIGHT BIAS

 Our tendency to understand a

situation or event only after it
has happened or developed:
GAMBLER’S FALLACY

 A belief that a successful outcome is due after a run of bad luck, or

more generally, the belief that a series of independent trials with the
same outcome will soon be followed by an opposite outcome

 Coin toss…….
 A gambler who looses a bet assumes that next time he will win…..and
looses again….

 “Past performance is no guarantee of future results."

 However, despite that statement being plastered everywhere in
the financial universe, individuals consistently dismiss the
warning and focus on past returns expecting similar results in
the future.
The Hot Hand

 The Hot Hand Phenomenon occurs where people believe that

'success breeds success‘
 when a person succeeds at something, he’s more likely to believe that he will
succeed in subsequent attempts, whereas the truth is that they are still governed by
the laws of chanced.
 There may some truth in this, that a person may be particularly fit or their confidence is boosted
by an initial success

 A soccer player scores two goals. More of his team mates start
passing him the ball more often in the assumption he is 'on the
ball' and will score more.
 Succeeded in Project A makes you feel that success in Project B
is due……