Module XIII·Article I·~1 min read
Bounded Rationality and Heuristics
Behavioral Economics
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Bounded Rationality and Heuristics Classical microeconomics assumes a rational homo economicus. Behavioral economics demonstrates systematic deviations. Understanding these deviations is important for market analysis and decision making.
Bounded Rationality
Herbert Simon: people are rational within cognitive limitations.
Limitations:
- Time and attention
- Computational abilities
- Memory
- Information
Satisficing: instead of optimization — searching for a “good enough” solution.
Heuristics
Heuristics: simplified rules for quick decisions.
- Availability heuristic: assessment of probability based on how easily examples come to mind. Overestimation of vivid, recent events.
- Representativeness: assessment of probability based on similarity to a typical example. Ignoring base rates.
- Anchoring: dependence on initial information. The first number influences the estimate.
Systematic Errors
- Overconfidence: overestimation of one's own knowledge and abilities.
- Hindsight bias: “I knew this beforehand”—after the fact.
- Confirmation bias: seeking confirmation for one's own beliefs.
For the Investor
Personal errors: awareness of bias helps avoid them.
Market anomalies: systematic errors of others—opportunities.
Behavioral finance: a separate discipline about deviations in financial markets.
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