BUSINESS STATISTICS

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Mid-Baneshwor
Kathmandu

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MR. SURENDRA NEPAL REEHA NEUPANE
COURSE INSTRUCTOR MBA 2021 (Morning)
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"Judgment Under Uncertainty: Heuristics and Biases"

Amos Tversky and Daniel Kahneman
SUMMARY:

This article discussed three heuristics for making decisions in the face of uncertainty:
(i)representativeness, which is frequently used when people are asked to judge the
likelihood that an object or event A belongs to class or process B; (ii) availability of
instances or scenarios, which is frequently used when people are asked to judge the
frequency of a class or the plausibility of a particular development; and (iii) adjustment from
an anchor, which is usually used in numeracy. These heuristics are cost-efficient and
usually successful, yet they lead to predictable and systemic errors. A deeper knowledge of
these heuristics and the biases they lead to could help people make better decisions in
uncertain situations.

INTRODUCTION:

This article demonstrates that people rely on a small number of heuristic principles to
simplify the complex tasks of assessing probabilities and predicting values. In general,
these heuristics are quite useful, but they can occasionally lead to serious and systematic
errors. This essay has focused on cognitive biases caused by the use of judgmental
heuristics. These biases are not caused by motivational factors such as wishful thinking or
the skewed effects of payoffs and punishments on assessments. Indeed, despite the fact
that respondents were encouraged to be accurate and were rewarded for correct answers,
many of the serious judgment errors mentioned earlier occurred. The application of
heuristics and the occurrence of biases are not restricted to laypeople. When thinking
intuitively, experienced researchers are prone to the same biases as novices. Individuals
with extensive statistical training, for example, have been found to have a proclivity to
predict the outcome that best depicts the facts, with little regard for previous probability. In
the representativeness heuristic, approach to probability judgment leads to serious errors
because similarity, or representativeness, is not influenced by several factors that should
influence probability judgments. The prior probability, or base rate frequency, of the
outcomes is one of the characteristics that has no effect on representativeness but should
have a significant impact on probability. It's unsurprising that helpful heuristics like
representativeness is kept, despite the fact that they might sometimes lead to errors in
prediction or estimation. What may surprise people is their failure to derive basic statistical
rules from lifelong experience, such as regression toward the mean or the effect of sample
size on sampling variability. Despite the fact that everyone is exposed to innumerable
examples from which these laws could be drawn in the normal course of life, only a small
percentage of people discover the concepts of sampling and regression on their own.
Statistical principles are not learned through everyday experience because the relevant
occurrences are not classified adequately. People, for example, do not notice that the
average word length of successive lines in a text differs more than the average word length
of successive pages because they do not pay attention to individual lines or pages. As a
result, people do not learn the relationship between sample size and sampling variability,
despite the fact that the evidence for such learning is there. People rarely notice biases in
their probability estimates because of a lack of a suitable code. A person could potentially
determine whether his judgments are externally calibrated by keeping track of the
proportion of events that actually occur among those to which he gives the same probability.
However, categorizing events based on their perceived probability is not natural. Without
such grouping, it is impossible for an individual to discover, for example, that only half of the
forecasts to which he assigned a probability of.9 or higher actually came true. The empirical
study of cognitive biases has implications for both the theoretical and practical roles of
judged probabilities. Subjective probability is defined in modern decision theory as the
quantified opinion of an idealized person. The set of bets on a given event that a person is
willing to accept defines the subjective probability of that event. If bet choices satisfy certain
principles known as the theory's axioms, an internally consistent or coherent, subjective
probability measure can be derived for an individual. In the sense that different people can
have different probabilities for the same event, the derived probability is subjective. This
approach makes a significant contribution in that it provides a rigorous subjective
interpretation of probability that is applicable to unique events and is embedded in a general
theory of rational decision. While subjective probabilities can sometimes be deduced from
bet preferences, this is not how they are generally produced. A person chooses team A
over team B because he believes team A has a better chance of winning; this belief is not
derived from his betting preferences. Subjective probabilities, rather than being determined
from them, determine bet preferences, according to the axiomatic theory of rational
decision. Many students believe that coherence, or internal consistency, is the only valid
criterion for evaluating judged probabilities because probability is inherently subjective. Any
set of internally consistent probability judgments is equivalent to any other, according to the
formal theory of subjective probability. This criterion is insufficient because an internally
consistent set of subjective probabilities can be incompatible with the individual's other
beliefs. Considering the example of a person whose subjective probability for all potential
coin-tossing outcomes mirror the gambler's fallacy. That is, as the number of consecutive
heads preceding a toss grows, his estimate of the likelihood of tails on that throw increases.
Such a person's judgements could be internally consistent and hence acceptable as
appropriate subjective probability, according to the formal theory's requirement. This
probability, on the other hand, debunk the widely held belief that a coin has no memory and
so cannot generate consecutive dependencies. Internal consistency is not sufficient for
judged probabilities to be considered adequate or rational. The judgments must be
compatible with the individual's entire web of beliefs. Unfortunately, there is no simple
formal procedure for determining the compatibility of a set of probability judgments with the
judge's overall belief system. Even though internal consistency is easier to achieve and
assess, the rational judge will strive for compatibility. He will strive to make his probability
judgements compatible with his subject matter knowledge, probability laws, and his own
judgmental heuristics and biases. The unfounded confidence generated by a good fit
between the projected output and the input data is referred to as the illusion of validity.
Despite the fact that the judge is aware of the circumstances that limit the accuracy of his
forecasts, the illusion persists. Despite the extensive research demonstrating that selection
interviews are highly unreliable, psychologists who conduct selection interviews generally
have a high level of confidence in their predictions. Despite numerous examples of its
shortcomings, the clinical interview is still used for selection, demonstrating the tenacity of
this effect.

CONCLUSION:

Bias is typically thought of in terms of underlying motivations or interests, particularly in the

political realm. The underlying premise of this book is that human judgments are plagued by
far more fundamental biases. Humans are not perfectly logical beings. Even when we have
perfect information and are free of motivational biases, we make bad decisions. Humans
have an uncharitable tendency to pass judgment on others; when seeking explanations for
other people's behavior, we attribute it to characteristics of the individual rather than the
situation in which they find themselves.