The FINANCIAL - Why do we Make the Decisions we Make?

Why do we Make the Decisions we Make?

Why do we Make the Decisions we Make?

The FINANCIAL -- In the fields of economics and business, decision-making is key. How do consumers choose which item to purchase or which business to patronise? How do those working in the financial markets decide whether they think a given stock will go up or down in value? Sometimes our behaviour in these areas can appear irrational – perhaps a subscription trap has been sprung and caught us or we will oppose wealth redistribution despite being low on the income scale.

University of Amsterdam notes that behind most of the decisions we take in these areas there are cognitive biases at work, leading us in one direction or another. It is in this field, on the border of economics and psychology, that UvA researcher Frieder Neunhoeffer works. Neunhoeffer will defend his doctoral thesis on 20 May at the University of Amsterdam.

One of Neunhoeffer’s central findings relates to the choices consumers make when faced with subscription options of differing duration. Many subscription offers we see, whether for a gym or for access to a given app or website, will be presented with options of varying durations, often with a longer-term subscription involving a ‘discount’ compared to a shorter term one: one month for €1, but six months for €5, for example. Neunhoeffer was spurred into investigating our decision making when it comes to these offers after a personal experience with a ride-sharing site. Neunhoeffer: ‘I needed to arrange some transport to Amsterdam, and I decided to look at a ride-sharing platform I had used as a student but hadn’t been on in years. I discovered you now had to sign up to use it. It was €1.50 for a week or €2.00 for six months. Even though I knew the chances I would use it again within the next half a year were extremely slim, I still went for the six months option. But it got me wondering what I would have done if the first choice had been €1.50 for a single use.’

One-time-only, one week or half a year?

Neunhoeffer set up a lab experiment and his findings confirmed his suspicion: If you offer consumers prices for one week versus six months, a majority will opt for the six months option, but if you offer a one-off payment versus six months, a majority will choose for the single use. Neunhoeffer’s explanation for this is the way we tend to think in categories - so one week versus half a year (i.e. 26 weeks) is easily comparable, allowing you to calculate the relative value and go for the ‘better deal’. On the other hand, you can’t compare single use so easily with half a year, since they are two different categories. This splitting of categories seems to make it easier for our minds to focus on what we actually need, University of Amsterdam notes.

Neunhoeffer: ‘I spent half my time on this project doing a literature review, because I was surprised that this effect had not been documented before. I spoke to various experts and they confirmed it had not yet been reported upon. Now I’d like to expand my work on this and produce a quantitative model of the effect, which I’m calling ‘pigeonholing’, because it seems once we have pigeonholed items in different categories in our minds, it becomes very hard for us to mentally cross those boundaries.’

Income redistribution and stock forecasting

Neunhoeffer’s thesis also looks at two further examples of cognitive bias: in preferences for wealth redistribution and in forecasting prices on the stock market. With regard to the former, Neunhoeffer and his co-author Michele Bernasconi of Ca' Foscari University of Venice examined how relative position on a given income scale affects an individual’s preference for greater or lesser income redistribution. His findings, using lab-based simulations, demonstrate that individuals facing greater inequality of income distribution tend to be more accepting of inequality and have less of an appetite for redistribution. His experiments suggest that those in the least equal societies are more likely to consistently overestimate their relative position on the income scale and thus fall into an ‘inequality trap’. This happens because those who believe themselves richer in relation to others frequently have a preference for lower tax rates, meaning there is broad acceptance of lower taxes on the rich and the inequality in the society is perpetuated.

Finally, in his look at cognitive biases in the stock market, Neunhoeffer, along with his co-authors Jan Tuinstra of the UvA and Mikhail Anufriev of University of Technology Sydney, examined how the amount of time available for decision making affects future prices and market volatility. He demonstrated that putting participants under greater time pressure when they were making their trading decisions actually decreased market volatility. In his lab-based stock market, he saw that the quicker people had to make their decision, the sooner prices began to converge and markets to stabilise. Neunhoeffer describes how less time to think allows less room for the kind of trend-chasing behaviour that leads to ‘bubble-and-crash’ dynamics.

Neunhoeffer: ‘These types of cognitive biases permeate so many areas of our lives. It’s a fascinating subject for study and examining them can shed some light on so many of the decisions we make without quite knowing why.’

Author: The FINANCIAL

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