What is... | October 28, 2011

What is availability bias?

Say there’s been a lot in the press lately about a particular company and its shares. Does this skew the way we invest in it? The behavioural economics idea of the “availability bias” says recent or very vivid information often does influence the way we invest – but also that we can overreact to the information because it is fresh in our minds.

Depending on what the news is, the thinking trap can apply across a wide range of investment types, such as property, bonds and shares, and apply to experienced as well as new investors.

Oh my, did you hear?
Behavioural Finance lists popular research papers about the availability bias, and suggests it is particularly problematic when combined with confirmation bias (when we emphasise information that confirms the view we hold, while ignoring contrary data). It cites a passage from a 1974 paper co-authored by Nobel Prize recipient Daniel Kahneman that gives examples of how the availability bias can apply in business and in wider situations in life. In wider life, “one may assess the risk of heart attack among middle-aged people by recalling such occurrences among one's acquaintances”, perhaps overestimating the risk. Recent or high profile information can come to mind more easily so may play a greater role in decisions than is warranted.

Availability of housing
Home buyers can be greatly affected by the availability bias. Think of news articles suggesting buyers should get in quick when house prices are rising to avoid being “priced out” of the market. At the other end of the spectrum is publicity about “buying opportunities” when prices fall. Former Boston Consulting Group director and author Neil Monnery examines the common perception that house prices tend to rise over time in his 2011 book Safe as houses?. Monnery finds it is “more normal” for house prices to grow at about 1% a year above inflation (and “in some countries they appear not to have increased much at all”). He examines data going back decades (and some cases centuries) and includes house prices from the United States, the United Kingdom, Norway, Germany, France, Australia and elsewhere. By widening both the timeframe and geographic scope, he arguably reduces the effect of the availability bias because the focus is not only on readily available data.

How to avoid availability bias
A lesson for prospective home buyers could be to assess the risks involved in buying a property against a longer timeframe. This extra information could encourage questioning and examination before buying – and reduce the likelihood of availability bias playing a role. Researching widely and questioning commonly accepted views may build a wider perspective of the risks involved in various types of saving and investing. Being aware of the availability bias is a good first step – the next may be to focus and act on longer term considerations rather than short-term reactions that are more often highlighted.

InvestingSharesHouse pricesMortgageBonds

eZonomics team
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