DS730

Reading: Hidden Traps in Decision Making

• cautious vs overconfident vs overlearning lessons of the past
• Other psychological traps: Stick with status quo, confirmation bias, throw good money after bad to admit mistake.
• Solution: reframe question in various ways.
• Bad decisions come from decision making process: Alternative not clearly defined, incomplete information, cost & benefits not accurately weighed
• Brain uses heuristics to cope with complex decisions, but heuristics aren't foolproof
• Minds get tricked, compensate for this
• Best defense is always awareness

Anchoring

• Mind gives disproportionate weight to the first information is receives: initial imporessions, estimates, or data anchor subsequent thoughts and judgments
• Can be simple as commend offered by colleague or stat in newpaper
• can be as insidious as a stereotype about a person's skin color
• In business common anchor is a past event or trend
• With rapid changes in marketplace, historical anchors can lead to poor forecasts, and misgiuded choices
• Anchors establish the terms on which a decision will be made
• counter proposal was based on initial offering terms

Solutions

• don't stick with the first line of thoght that occurs to you
• Think about the problem on your own before consulting others to avoid being anchored in their ideas
• Don't anchor your advice givers with your notions. Your preconceptions simply come back to you?
• Be wary of anchors in negotiotions, and/or use them to your advantage. Set high but defensible price as opening gambit.

Status Quo

• People find status quo comfortable. Desire to protect our egos from damage, opens ourself to criticism and regret. psychological risk
• Making a choice requires additional effort
• Mergers founder because "let's not rock the boat now", rather than seize the occasion

Solutions

• Sometimes status quo is best choice
• Answer question how objectives are best mt by status quo, are elements of current situation barriers to goals?
• Never think of status quo as only alternative
• ask would you choose the status quo alternative if it weren't the status quo?
• avoid exaggerating the effort or cost in switching
• evaluate alternatives in terms of present as well as future
• if several alternatives that are superior to status quo, don't default to status quo. Force yourself to choose

Sunk cost

• Making choices that justify past choices
• Don't want to sell a stock at a loss -- cut bait!
• improving performance of employee we shouldn't have hired int he first place
• Why? unwilling to admit mistake
• Trapped by an escalation of commitment
• Any time problem in loan arise, assign to another nbanked who can look with fresh eyes
• Are penalties for making bad decision overly severe? then failed projects drag on endlessly.
• Good decisions can lead to bad outcomes

Solutions

• seek out advice of people uninvolved in earlier decision
• don't cultivate a failure-fearing culture
• when rewarding look at quality of decision making, what was known at the time, not just quality of outcomes

Confirming-evidence trap

• we seek out evidence that supports our existing point of view while avoiding information that contradicts it
• affects where we go to collect evidence, how we interpret evidence we receive

Solutions

• examine all evidence with equal rigor
• get someone to play devil's advocate
• in seeking advice of others, don't ask leading questions, that invite confirming evidence

Framing

• How problem is framed can profoundly influence choices you make
• people more likely to accept defaults
• People are risk averse when a problem is posed in terms of gains, but risk seeking when problem is posed in terms of avoiding losses
• people tend to adopt the frame as it's presented t them rather than restating problem in their own way.
• Reference point of zero, emphasizes gains and losses, and thought of losing triggers conservative response in people's minds

Solutions

• don't automatically accept problem as initially framed
• try to fram in neutral, redundant way that embraces different reference points
• Examine way advice giver framed the problem

Forecasting: Overconfidence, Prudence, Recallability

• Rarely get feedback as to the accuracy of certain forecasts
• our minds never become calibrated for making estimates in teh face of uncertainty
• worst case analysis adds enormous costs with no practical benefit
• dramatic or traumatic event in your own life distorts experience of a thing, makes more recallable.
• Anything that distorts ability to recall events in a balanced way will distort probability assessments.

Solutions

• take disciplined approach to making forecasts and judging probabilities

Reading: Deciding How To Decide

• expand tool kit of decision support tools
• understand which tools work best for which decisions

1. How well you understand the variables that will determine success
2. How well can you predict the range of possible outcomes
3. How centralized the relevant information is

• Use case-based decision analysis
• Use qualititive scenario analysis in situations of uncertainty

1. can i understand the model
2. do I understand the model
3. can I predict outcomes

• Create a range in terms of decision makeing

Risk Management

• most likely = probability = 90% cconfident
  • interest rate 3 months from now?
    • do research what it is currently
    • historical data + trends
    • triggers like the fed
  • quantify uncertinty as a probability function
    • normal prob dist. (mean and std)
    • triangle distribution = lo/hi/most likely. Doesn't have to be symmetric
• monte carlo approach