Behavioral Bias Bingo — The Illusion of Control

////Behavioral Bias Bingo — The Illusion of Control

Behavioral Bias Bingo — The Illusion of Control

By | 2017-01-18T13:03:30+00:00 August 18th, 2014|Behavioral Finance|5 Comments
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(Last Updated On: January 18, 2017)

The Illusion of Control

In most elevators, at least in any built or installed since the early nineties, the door-close button doesn’t work. It is there mainly to make you think it works. (It does work if, say, a fireman needs to take control. But you need a key, and a fire, to do that.) Once you know this, it can be illuminating to watch people compulsively press the door-close button. That the door eventually closes reinforces their belief in the button’s power. ”

Nick Paumgarten, the New Yorker

The “Illusion of Control” is a well-researched behavioral bias that describes the tendency of people to believe that they have control over random circumstances. The elevator’s door-close, or “placebo” button is a classic case.

Hall of Famer Richie Ashburn was an outfielder in major league baseball with a funny superstition. When Ashburn had a good hitting day, he liked to continue using the same bat to keep the streak going. Fearful of getting a “hot” bat mixed up with his others, he would bring it home and sleep with it under his bed.

Psychologists have theorized that the illusion of control may occur because people place more weight on outcomes that are consistent with their desires, and less weight on those that are undesired. As EJ Lance put it, “heads I win, tails it’s chance.”

We tend to seek out coherent narratives that have explanatory power and exaggerate their consistency in the real world. Hence, when Ashburn used the same bat, and got another hit the next day, he likely concluded that it was because he used the same bat that he succeeded. When he failed to get a hit the next day, well that was just bad luck, and time for a new bat.

Game 1: Lottery ticket

You are going to buy a lottery ticket. Which do you prefer?

  • Choice 1:  A ticket where you get to choose the numbers?
  • Choice 2: A ticket with randomly generated numbers?

 

This is an experiment designed by Richard and Ross in their book “Human Inference: Strategies and Short-comings of Human Judgment.” In their experiment, they cleverly translate the illusion of control into cash values. Experiment participants pay $1 for one lottery ticket and they were told that they have the opportunity to sell the ticket back. The results shows that those who were assigned a ticket with random numbers (Choice 2) were willing to sell their ticket for an average of $1.96. What about those who chose the numbers on their tickets (Choice 1)? They required an average payment of $8.67. This group clearly thought there was something special about the numbers, since they had picked them.

Game 2: Car Accident Possibility

Here are two scenarios, and you can choose a likelihood number from scale from -5 (much less likely) through 0 (average) to +5 (much more likely) :

Compared to other drivers, how likely do you think you are of being involved in a road accident when _______?

  • Scenario 1: you are driving
  • Scenario 2: you are a passenger

This is an experiment designed by Frank P. McKenna (1993). 99 University staff and students took part in this experiment. The result shows that subject assessed a likelihood of -1.41 in Scenario 1, and 0.01 in Scenario 2 (both statistically significant). People perceive themselves as less likely to be involved in an accident when they are in control of the car.

One danger of the Illusion of Control is that it makes us less aware of environmental cues that we may receive when things are less under our control than we believe. If you get in a car accident, and attribute it to bad luck instead of poor driving, maybe you won’t be as focused as you should be on driving more slowly and keeping your eyes on the road.

Applications in Finance:

“Studies of investor behavior tell us some surprising things about the decisions they make… 85% of sell or exchange decisions are wrong — the investor would do better by doing nothing or going the other way that 85% of the time. Simple random decision making (with no investment knowledge) would have yielded about 50% good decisions.”

—Martin Conrad, Barron’s

The illusion of control may affect traders’ behaviors. Perloff (1983) states that those who underestimate the risks they are taking may have greater difficulty in adjusting should the negative event occur. Fento-O’ Creevy, etal (2003) also found that “Traders with higher levels of illusion of control perform less well than those with lower levels.”

In this experiment, a sample of 107 traders were chosen from four investment banks in London. Of the 107 participants, 52 were traders, 40 were trader managers, and 15 were senior managers (66% were bachelor degree holders, and 36% had a higher degree).  The experiment shows a significant inverse relationship between performance and illusion of control. When the traders were more heavily influenced by the illusion of control, they earned less. Detailed experiment design and results can be found here.

Illusion of control makes us fool ourselves and keeps us from learning from our mistakes.

Reference:

  • Langer, Ellen J. (1975), “The Illusion of Control”,Journal of Personality and Social Psychology 32 (2): 311–328
  • Fento-O’Creevy, Nicholson, Soane and Willman (2003), “Trading on illusions: Unrealistic perceptions of control and trading performance”, Journal of Occupational and Organizational Psychology, 76 (1): 53-68

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About the Author:

Mr. Foulke is currently an owner/manager at Tradingfront, Inc., a white-label robo advisor platform. Previously he was a Managing Member of Alpha Architect, a quantitative asset manager. Prior to joining Alpha Architect, he was a Senior Vice President at Pardee Resources Company, a manager of natural resource assets, including investments in mineral rights, timber and renewables. He has also worked in investment banking and capital markets roles within the financial services industry, including at Houlihan Lokey, GE Capital, and Burnham Financial. He also founded two technology companies: E-lingo.com, an internet-based provider of automated translation services, and Stonelocator.com, an online wholesaler of stone and tile. Mr. Foulke received an M.B.A. from The Wharton School of the University of Pennsylvania, and an A.B. from Dartmouth College.