Describe and Explain some examples of Heuristics and their consequences in

terms of behavioural Bias?

Heuristics are a problem-solving method that uses shortcuts to produce good-enough
solutions given a limited time frame or deadline. Heuristics are a flexibility technique for
quick decisions, particularly when working with complex data. Decisions made using a
heuristic approach may not necessarily be optimal. Heuristic is derived from the Greek word
meaning “to discover”
Digital technology has disrupted all industries including finance, retail, media, and
transportation. Suddenly, once typical daily activities have become outdated. Checks are
deposited to bank accounts without visiting a local branch, products and services are
purchased online and take-out food is delivered by food service delivery apps. Technology is
creating data, which is increasingly shared across multiple industries and sectors, and a
professional in any industry may find themselves working with mounds of complex data to
solve a problem. Heuristic methods can help with data complexity given limited time and
resources.

Examples of real-life heuristics that people use as a way to solve a problem

or to learn something:
"Consistency heuristic" is a heuristic where a person responds to a situation in way that
allows them to remain consistent.
"Educated guess" is a heuristic that allows a person to reach a conclusion without
exhaustive research. With an educated guess a person considers what they have observed
in the past, and applies that history to a situation where a more definite answer has not yet
been decided.
"Absurdity heuristic" is an approach to a situation that is very atypical and unlikely - in other
words, a situation that is absurd. This particular heuristic is applied when a claim or a belief
seems silly, or seems to defy common sense.
"Common sense" is a heuristic that is applied to a problem based on an individual's
observation of a situation. It is a practical and prudent approach that is applied to a decision
where the right and wrong answers seem relatively clear cut.
"Contagion heuristic" causes an individual to avoid something that is thought to be bad or
contaminated. For example, when eggs are recalled due to a salmonella outbreak, someone
might apply this simple solution and decide to avoid eggs altogether to prevent sickness.
"Availability heuristic" allows a person to judge a situation on the basis of the examples of
similar situations that come to mind, allowing a person to extrapolate to the situation in
which they find themselves.
"Working backward" allows a person to solve a problem by assuming that they have
already solved it, and working backward in their minds to see how such a solution might
have been reached.
"Familiarity heuristic" allows someone to approach an issue or problem based on the fact
that the situation is one with which the individual is familiar, and so one should act the same
way they acted in the same situation before.
"Scarcity heuristic" is used when a particular object becomes rare or scarce. This approach
suggests that if something is scarce, then it is more desirable to obtain.
"Rule of thumb" applies a broad approach to problem solving. It is a simple heuristic that
allows an individual to make an approximation without having to do exhaustive research.
"Affect heuristic" is when you make a snap judgment based on a quick impression. These
heuristic views a situation quickly and decides without further research whether a thing is
good or bad. Naturally, this heuristic can be both helpful and hurtful when applied in the
wrong situation.
"Authority heuristic" occurs when someone believes the opinion of a person of authority on
a subject just because the individual is an authority figure. People apply this heuristic all the
time in matters such as science, politics, and education.

Consequences of Heuristics in Behaviour Finance according to research

conducted by author Zain Naqvi, Omer Farooq
https://www.researchgate.net/publication/318454967_The_impact_of_heuris
tics_on_investment_decision_and_performance_Exploring_multiple_mediatio
n_mechanisms
Hypothesis of this Research
This study presents two processes by which heuristics impact on the
investment performance of individuals: fundamental and technical anomalies.
We propose these anomalies are the direct outcome of heuristics and that
these anomalies further affect the investment decisions of investors. We
further posit that all types of heuristics induce fundamental and technical
anomalies. The heuristics components, two anomalies and outcome variable
(investment performance)
Consequences of Availability Heuristic:
 Availability heuristics, described as judging the frequency of classes or
events based on recently available information or ease of recall with
regard to a particular event and frequency of experiences with the
related events.
 By using the availability Heuristic, investors can overestimate the
probability of an event that is easily remembered for reasons unrelated
to frequency.
 Moreover, Investors buy local security than foreign security because the
information of local security is easy available. Thus, in present of
availability heuristics they only make decision because of stock price and
ignore many stock’s fundamentals and leave fundamental anomalies.
investors pick stocks that capture their attention.
 This pattern forces them to look for popular stocks rather than value
stocks. Many investors are unaware of value investing strategies
because their attention is directed toward growth investing funds; this
attention generates fundamental anomalies in the stock market.
 Popular stocks do not provide investors with average returns on their
investments over the long term. By looking to popular (growth) stocks,
investors ignore many of the underlying fundamentals of the stocks.
 Thus, availability is the most powerful heuristic to disturb the market
and leave anomalies. Moreover, stock selection depends on investor
preferences
 Most investors’ preferences are based on ease of recall of information.
Hence, when investors ignore stock fundamentals and focus on popular
stocks, they generate fundamental anomalies.

Consequences of Anchoring Heuristic:

 Anchoring heuristic refers to the tendency to estimate value by
imagining the “initial value” or default number (Pompian,2011).
Anchoring is connected to representativeness, in that investors rely on
recent experiences and are optimistic when the market is in uptrend and
pessimistic when it is in a downtrend.
 Overall, such situations grab the investors to adjust stocks’ price that are
most representative with previous stocks’ price. Investors regard
previous stock prices as anchors to estimate future stock prices. Such
thinking leads to fundamental anomalies in the stock market.

 A word of wisdom for investors could be, do not judge a stock by its
share price and do not over- or underreact to changes in stock prices.
Anchoring is the human tendency to rely too heavily on one piece of
information (e.g., news, abnormal trading volumes, extreme one-day
returns) when making investment decisions Investors focus on popular
stocks because such information captures their attention and leads them
to believe that growth stocks are valuable. When investors behave in
this fashion—associating set prices with previous stock prices and
focusing on popular stocks—they create fundamental anomalies.
Which types of Heuristics do you think are most important to everyday
decision-making: availability, representativeness or anchoring/adjustment?
Explain your answer and illustrate with examples.
I Believe all 3 are equally important for Decision making. Depending on
situation to situation and person to person different heuristics are used in our
daily Life.

Here are a few examples where Availability heuristics could play out in your
day-to-day life.
 After reading an article about lottery winners, you start to overestimate
your own likelihood of winning the jackpot. You start spending more
money than you should each week on lottery tickets.
 After seeing news reports about people losing their jobs, you might
start to believe that you are in danger of being laid-off. You start lying
awake in bed each night worrying that you are about to be fired.
 After seeing news stories about high-profile child abductions, you begin
to believe that such tragedies are quite common. You refuse to let your
child play outside by herself and never let her leave your sight.
 After seeing several television programs on shark attacks, you start to
think that such incidences are relatively common. When you go on
vacation, you refuse to swim in the ocean because you believe the
probability of a shark attack is high.

Example of Anchoring Heuristics:

 A used car salesman (or any salesmen) can offer a very high price to start
negotiations that is arguably well above the fair value. Because the high
price is an anchor, the final price will tend to be higher than if the car
salesman had offered a fair or low price to start.

 A similar technique may be applied in hiring negotiations when a hiring

manager or prospective hire proposes an initial salary. Either party may
then push the discussion to that starting point, hoping to reach an
agreeable amount that was derived from the anchor.

Example of Representativeness Heuristic:

 Consider I love to listen to New Age music and faithfully reads my
horoscope each day. In my spare time, I enjoy aromatherapy and
attending a local spirituality group.

 Based on the description above, is I am more likely to be a school

teacher or a holistic healer? Many people would identify me as a holistic
healer based on representativeness. He fits in with our existing ideas of
how a holistic healer might behave. In reality, it is far more likely that I
am actually a school teacher based purely on probability. School
teachers are far more common than holistic healers.