Biases

[Jolie]

Reading 9. Eoc 3.

Why does home bias win over overconfidence bias?

[thinkwiseandact]

Very good question. Why should we pay more attention on home bias of the client and less on overconfidence bias?

Since no one has yet answered to this question, I will try to bring arguments for or against the stated answer, although they can be challenged.

My quick research points that home bias is easier to overcome than overconfidence of the client. According to the curriculum home bias has behavioral explanations, such as availability, confirmation, illusion of control, endowment, and status quo biases. First three are cognitive errors. Individuals are less likely to make cognitive errors if they remain vigilant to the possibility of their occurrence. So, if the client’s home bias stems from availability, confirmation or illusion of control biases, educating the client will likely bring positive outcomes. Here we have work to do, that’s why home bias is more relevant in constructing IPS.

In the contrary, overconfidence bias is an emotional bias. Drawing emotional biases to the attention of an individual making the decision is unlikely to lead to positive outcomes; the individual is likely to become defensive rather than receptive to considering alternatives. Here we don’t have much to do, that’s why overconfidence bias is less relevant in constructing IPS.

[Jolie]

@thinkwiseandact

Very good question. Why should we pay more attention on home bias of the client and less on overconfidence bias?

Since no one has yet answered to this question, I will try to bring arguments for or against the stated answer, although they can be challenged.

My quick research points that home bias is easier to overcome than overconfidence of the client. According to the curriculum home bias has behavioral explanations, such as availability, confirmation, illusion of control, endowment, and status quo biases. First three are cognitive errors. Individuals are less likely to make cognitive errors if they remain vigilant to the possibility of their occurrence. So, if the client’s home bias stems from availability, confirmation or illusion of control biases, educating the client will likely bring positive outcomes. Here we have work to do, that’s why home bias is more relevant in constructing IPS.

In the contrary, overconfidence bias is an emotional bias. Drawing emotional biases to the attention of an individual making the decision is unlikely to lead to positive outcomes; the individual is likely to become defensive rather than receptive to considering alternatives. Here we don’t have much to do, that’s why overconfidence bias is less relevant in constructing IPS.

thanks a lot.

I think the curriculum indicates that we should select the dominating bias type. (Irrespective of how easy or difficult they are to fix, cause well you can just adjust to them too, subject to their wealth level of course )

Can we conclude that home bias is more dominating than overconfidence here?

[thinkwiseandact]

The curriculum uses “most relevant” words, not “dominating”. I understand you, but I would err on the side of caution and not use “dominating” term, since it is not used in the curriculum with biases anywhere.

I guess some important concept is missing in the curriculum or, otherwise, we did not pay attention. I have googled on this topic quickly, but found no answers. We may write to CFAI or the authors directly for more clarification on how they decide which bias is more relevant in constructing investment policy statement.

At this stage I based only on certain indicators and made kind of a smart guess.