Lesson 1 of 7 · 13 min
Cognitive errors versus emotional biases
Behavioural biases come in two families: cognitive errors grow out of faulty reasoning and can usually be fixed with better information, while emotional biases grow out of feelings and usually have to be recognised and worked around.
In short
- Traditional finance assumes people use all available information and decide rationally; behavioural finance studies how people actually decide, often through mental shortcuts that lead to suboptimal results.
- Cognitive errors come from faulty reasoning: statistical, information-processing or memory mistakes. They are easier to correct through information, education and advice, so the usual response is to moderate them.
- Emotional biases come from impulse, intuition and feelings. They arise spontaneously and are hard to change, so the usual response is to adapt to them.
- Cognitive errors split into belief perseverance biases (conservatism, confirmation, representativeness, illusion of control, hindsight) and information-processing biases (anchoring and adjustment, mental accounting, framing, availability).
- The six emotional biases: loss aversion, overconfidence, self-control, status quo, endowment and regret aversion.
- One bias can have both cognitive and emotional features; it is classified by the side that dominates.
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