Anchoring and adjustment bias describes people's tendency to rely too heavily on the first piece of information they receive on a topic and use it as a reference point or anchor for making subsequent judgments, even if that initial information is inaccurate. A study found that real estate agents provided higher appraisals for a property when they were given a higher hypothetical asking price by researchers at the outset. Maintaining awareness of anchoring bias can help investors and advisers avoid letting initial reference points irrationally influence later analysis and decisions.
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“Anchor” is a heavy object attached to a cable or
chain and used to moor a ship to the sea bottom.
“Bias” the action of supporting or opposing a particular
person or thing in an unfair way, because of allowing
personal opinions to influence your judgment.
Breakdown Bias Name
4. INTRODUCTION
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⮚ Anchoring bias describes people’s tendency to rely
too heavily on the first piece of information they
receive on a topic. Regardless of the accuracy of that
information, people use it as a reference point,
or anchor, to make subsequent judgments.
6. PRACTICAL APPLICATION -CASE STUDY
Rational Investor’s point of view:
A rational investor would examine the
company’s financial situation; make an
objective assessment of its business
fundamentals; and then decide to buy,
hold, or sell the shares.
Irrational Investor’s point of view:
An irrational investors—even after going
through the trouble of performing the
aforementioned rational analysis permit
cognitive errors to cloud their judgment.
Alice, for example, may irrationally disregard the results of her research and “anchor”
herself to the $20 figure, refusing to sell unless ABC once again achieves that price.
This type of response reflects an irrational behavioral bias and should be avoided.
7. RESEARCH REVIEW – CASE STUDY
Some excellent research into the effects of
anchoring and adjustment was performed in 1987
by University of Arizona researchers. Their study
asked a group of real estate professionals to value a
property after being given a proposed selling price
quoted by the researchers at the outset of the
experiment. Specifically, the study asked each
researcher to provide the appraised value of the
property. During the experiment, the real estate
agents were divided into two groups. The table
summarizes the results with respect to the first two
categories—appraised value and salable value
Particulars Group 1
(Prices)
Group 2
(Prices)
Given asking price $119,900 $149,900
Predicted appraisal value $144,202 $128,752
Listing price $117,745 $130,981
Purchase price $111,454 $127,316
Lowest acceptable offer $111,136 $111,136
8. Behaviors That Can Cause Investor
Mistake
Investors tend to make general market forecasts that are too close to
current levels
Investors (and securities analysts) tend to stick too closely to their
original estimates when new information is learned about a company
Investors tend to make a forecast of the percentage that a particular
asset class might rise or fall based on the current level of returns
Investors can become anchored on the economic states of certain
countries or companies
9. DIAGNOSTIC TESTING- CASE STUDY
Scenario-Suppose you have decided to
sell your house and acquire a townhouse
that you have been eyeing for several
years. Your real estate agent prices your
home at $900,000, but local real estate
prices have taken a hit of 10% across the
board due to a recent bankruptcy.
What is your likeliest course of action?
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10. Diagnostic Testing
case study(options and analysis)
Options
1.Keep your home on
the market for $900,000
3. Lower your price by
10% to $810,000
4. Lower your price to
$800,000 to ensure a
bid
2.Lower your price by
5% to $855,000
Analysis
*Keeping the house on the market
for $900,000 or lowering the price by
5% to $855,000 likely indicates
susceptibility to anchoring and
adjustment bias.
*Lowering the price by 10% to
$810,000 or to $800,000 to
ensure a bid shows adequate
adjustment and incorporation of
updated information
11. ADVICES
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It's crucial and perhaps encouraging to highlight that you can
actually use this bias to your favor before diving into particular
tactics for dealing with anchoring and adjustment.
It is advisable to begin a negotiation with a far less generous
offer than what truly represents your position.
Don't assume that a first offer made by a competitor negotiator
closely resembles a possible ultimate price.
12. ADVICES (CONTINUE)
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Considering investments, awareness is the strongest defense
against anchoring and bias adjustment.
Encourage clients to consider this question when you are giving
them advice on the sale of a security: "Am I analyzing the situation
rationally, or am I holding out to attain an anchored price?"
Ask yourself: "Is my estimate rational, or am I anchored to last
year's performance figures?" before making predictions about
the direction or size of markets, or specific stocks.
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Examine the research further before accepting a suggestion from a
financial analyst and ask yourself: "Is this analyst anchored to some
previous estimate, or is the analyst putting forth an objective rational
response to a change in a company's business fundamentals?"
13. Bonus
Discussion
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• If an analyst is anchored to an earnings estimate
and earnings are rising, this is an opportunity for
investors to win, as it is likely that the analyst is
underestimating the magnitude of the earnings
upgrades.
• Conversely, if an analyst is anchored to an
earnings estimate and earnings are falling, this is
an opportunity to lose, so it's best to sell
immediately on the first earnings downgrade, as
it is likely that the analyst is underestimating the
magnitude of the earnings downgrades.