Investors’ Short Term Decision Making and Review of the Hindsight Bias Effect

Abstract

An important bias in the field of cognitive psychology describes a situation in which individuals are required, ex-post, to estimate the objective likelihood, ex-ante, for a particular event to take place. This psychological bias is called Hindsight Bias, and is the mistaken tendency to believe, after the fact, in one’s ability to foresee an event in advance. This article explores the bias for data from the capital market, and in particular, it examines the decision-making ability for short-term investment based on the paper by Fischhoff (1975). In the experiment, subjects were given a sum of money which they were asked to invest in various financial assets, after having seen their historical returns charts. In this study, I examined three principal questions: (1) Whether a difference exists in the hindsight bias effect for younger subjects than for older ones. (2) Whether subjects with higher income are affected in their decision-making process in a similar way as do lower income subjects. (3) Whether a difference exists in the effect between solid investors and speculative investors with regards to their short-term decision making. Results from the first examination show strong evidence for hindsight bias for all types of events, although the effect impacts older subjects more strongly than it does younger subjects. Results from the second test indicate that higher income investors are more influenced by the effect for positive events, but for negative events the trend changes and they are less impacted by the effect. Results from the third test show strong evidence for hindsight bias for speculative investors, but no evidence of the effect is seen for solid investors.

DOI: 10.5901/mjss.2013.v4n11p176