As financial markets become ever more erratic, could we be unduly influenced by the anchoring bias?
The money markets have always been a rich source of cognitive biases. Anyone who has watched ‘The Big Short‘, the 2015 film, will know that, along with an unhealthy side order of arrogance and hubris, the 2008 financia crisis was fuelled by a range of cognitive biases (for example sunk cost fallacy and authority bias).
However, one of the principle drivers for many poor decisions was anchoring bias. Put simply, our decisions, especially where money and numerical values are common, can be dramatically swayed by reference points.
The anchoring bias is a cognitive bias that affects our decisions, based on an existing initial reference point, value or position.
The common example is the product with a current discount from the ‘normal price’. We’re often swayed by being told that we’re saying X off Y when there is little understanding of the actual authenticity of the ‘original’ price or value.
As markets become more erratic, and values fluctuate dramatically, ‘original prices’ have little or no intrinsic value. They become even more arbitrary and as such, shouldn’t be included in the calculation of the ‘new value’.
It’s important to understand that in a free financial market, inflated valuations are often as a result of scarcity and quickly settle to a more realistic value, known as a correction. As the markets move more rapidly up and down at the moment, inflated, temporary values shouldn’t be trusted and it’s likely that the true value will be arrived at. As such, valuations shoudn’t be based on inflated prices, that’s a false anchor.
In business, there is another anchoring factor, prices establishment. Often, businesses will over-inflate a price artificially, for a short period, only for them to be able to advertise a ‘Was’ price. As such we have a biased view of the perceived value of the ‘Now’ price, believing we’ve saved money, when in fact, we’re paying for a product what we ought to be paying.
