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A cognitive bias known as anchoring influences how individuals make decisions and judgments based on the information they are presented with.Â
It takes place when individuals base their subsequent estimates excessively on an initial piece of information, such as a price, a forecast, or a historical value. Particularly in the context of investment and finance, anchoring might result in irrational and unfavorable decisions.
Anchoring can lead investors to keep holding onto securities that have lost value because they anchored their fair value estimate to the initial price rather than to the fundamentals. Holding the investment with the expectation that the security would increase in value leads investors to accept a higher risk. The way that investors interpret market changes and respond to new information can both be impacted by anchoring. For instance, if a stock investor bases their prediction of a stock's performance on a past high or low, they could react incorrectly to new information and overreact or underreact.
Moreover, anchoring can be deliberately employed in price and sales negotiations, where establishing a strong initial anchor might influence later negotiations in one's favor. According to the Corporate Finance Institute, research has shown that the initial establishment of an anchor can have a greater impact on the outcome of a negotiation than the subsequent negotiation process. The range of all subsequent counteroffers can be impacted by intentionally choosing a beginning point that is too high or too low. The anchoring effect must therefore be understood by negotiators in order to prevent them from being swayed by unrelated or arbitrary anchors.
Anchoring can be reduced or avoided by using different methods and techniques, such as:
Anchoring is one of the many cognitive heuristics that influence how people assess probabilities in an intuitive manner. Daniel Kahneman, an economist and psychologist, and Amos Tversky, a cognitive psychologist, are credited as being the creators of behavioral economics and having made the original hypothesis. The study of how feelings and other unrelated elements affect economic decisions is known as behavioral finance, and one component of this field is anchoring.
Anchoring can lead investors to keep holding onto securities that have lost value because they anchored their fair value estimate to the initial price rather than to the fundamentals. Holding the investment with the expectation that the security would increase in value leads investors to accept a higher risk. The way that investors interpret market changes and respond to new information can both be impacted by anchoring. For instance, if a stock investor bases their prediction of a stock's performance on a past high or low, they could react incorrectly to new information and overreact or underreact.
Moreover, anchoring can be deliberately employed in price and sales negotiations, where establishing a strong initial anchor might influence later negotiations in one's favor. According to the Corporate Finance Institute, research has shown that the initial establishment of an anchor can have a greater impact on the outcome of a negotiation than the subsequent negotiation process. The range of all subsequent counteroffers can be impacted by intentionally choosing a beginning point that is too high or too low. The anchoring effect must therefore be understood by negotiators in order to prevent them from being swayed by unrelated or arbitrary anchors.
Anchoring can be reduced or avoided by using different methods and techniques, such as:
- Seeking multiple perspectives and sources of information
- Comparing and contrasting different options and alternatives
- Using objective criteria and benchmarks
- Updating one's estimates and beliefs based on new evidence and feedback
- Being aware of one's own biases and assumptions
Anchoring is one of the many cognitive heuristics that influence how people assess probabilities in an intuitive manner. Daniel Kahneman, an economist and psychologist, and Amos Tversky, a cognitive psychologist, are credited as being the creators of behavioral economics and having made the original hypothesis. The study of how feelings and other unrelated elements affect economic decisions is known as behavioral finance, and one component of this field is anchoring.
