Class 2 (Judgment under Uncertainty: Heuristics and Biases)
PART A
This survey is available on line here:
- If your last name is A to L, click here (http://faculty.chicagobooth.edu/george.wu/teaching//private/38801B/survey1/prob.xls)
- If your last name is M to Z, click here (http://faculty.chicagobooth.edu/george.wu//teaching/private/38801B/survey2/prob.xls)
The information from the survey will be used throughout the course to demonstrate certain ideas about decision making. It is very important for you to fill out the survey before Tuesday, July 7, 9:00 p.m. and return it by email to the TA account (38801ta@gmail.com).
You should not think of the survey as a test of your research skills; you will not be graded on your answers. For example, do not go out and look up the "correct" answers in the encyclopedia or ask your friends. Answer the questions honestly. We will keep your answers confidential.
PART B
Read: Amos Tversky and Daniel Kahneman (1974), "Judgment under Uncertainty: Heuristics and Biases," Science 185, 1124-1131. This article is in your course package and also available here: http://links.jstor.org/sici?sici=0036-8075%2819740927%293%3A185%3A4157%3C1124%3AJUUHAB%3E2.0.CO%3B2-M (You need to have a University IP or be using the proxy server or VPN to have access.)
Background:
Managers often make implicit or explicit probabilistic judgments about future events, such as the price of crude oil in May 2010, or the chance of being promoted to partner. The focus of this class is on how people make such judgments, and the reasons why these judgments are sometimes biased.
Tversky and Kahneman (T&K) describe three heuristics that we often use in forming such judgments: representativeness, availability, and anchoring and adjustment. These heuristics, while in general sensible, lead to systematic judgmental biases. The Science article that describes these biases is difficult, but worth the effort. The ideas are deep and important!
Pay particular attention to anchoring and availability. The section on representativeness is difficult, so don't worry so much about the names applied to the phenomena discussed in this section (e.g., illusion of validity, etc.). Instead, you should try to get a flavor for why these general findings are inconsistent with reasonable statistical principles.
Preparation Questions:
1. What is anchoring and adjustment? Try to think of an example of anchoring other than the ones described in the article.
2. What is availability? Consider an "item forecaster" at an electronic retailer such as Amazon. An item forecaster must make quarterly sales forecasts for all items or sku's (stock keeping units) that need to be stocked during that quarter. The sales forecast is then ordered. How might availability lead an item forecaster to be systematically biased in his or her forecasts?
PART C
Read: Charles T. Munger (1995), "A Lesson on Elementary, Worldly Wisdom as it relates to Investment Management & Business," Outstanding Investor Digest.
This article is available here: http://faculty.chicagobooth.edu/george.wu/teaching/private/38801B/articles/munger.pdf
Read from beginning through paragraph starting: "One approach is rationality" and ending: "many of which are wrong" and then again starting: " And, by the way, I have a name for people who went to the extreme efficient market theory" and ending: " And, as usual in human affairs, what determines the behavior are incentives for the decision maker."
The remainder is optional reading.
Background:
Charles Munger has been business partner to Warren Buffet for almost 40 years and is one of the six directors of Berkshire Hathaway. He is also the chairman of Wesco Financial, 80% owned by Berkshire Hathaway. In this article, Munger writes about his approach to investment and business.Question:
1. Why does Munger believe it is so important to have multiple models in your head? How might the use of multiple models be used as a corrective measure for the sometimes inappropriate use of the judgmental heuristics described in Tversky and Kahneman?
- George Wu (2008). “Bayes Rule Primer”
- Jacob Weisberg (1998). “Keeping the Boom from Busting”, New York Times Magazine (July 19). This article isavailable here: http://query.nytimes.com/gst/fullpage.html?res=9A0DEFD91331F93AA25754C0A96E958260&sec=&spon=&pagewanted=al