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Emotions May Cloud Judgment


Emotional bias can impair financial, as well as political, decision-making.


I would do anything
To hold on to you
Just about anything
That you want me to
--Ric Ocasek

Emotions are part and parcel of the human condition. Through a philosophical lens, emotions are often viewed as contributing "spice" to life.

From a cognitive standpoint, emotions constitute a mechanism for constraining and directing attention (Matthews & Wells 1994). Because they offer capacity for "framing," or for winnowing the number of possible considerations to a manageable number for deliberation, emotions can be a useful component of rational thought.

However, we also know that emotions can impair reasoned thought process. For example, emotions can influence interpretation of past events (Kahneman 2000), recognition of temporal cause and effect relationships (Thaler & Johnson 1990), and assessment of risk and reward (Kahneman & Tversky 1979).

Under conditions of threat, emotional framing mechanisms may "overshoot," leading to an excessive narrowing of information processing that inhibits generation of well reasoned solutions for coping with the threat (Staw, Sandelands, & Dutton 1981). Individuals are often unaware of the role of emotions in shaping their decisions (Fingarette 1969).

A common expression of emotional influence on decision-making is confirmation bias. Confirmation bias involves the tendency of individuals to seek and side with information that supports their beliefs, while avoiding or dismissing information that refutes their beliefs (Lord, Ross, & Lepper 1979). Confirmation bias can impair critical thinking because it de-motivates search for informed alternatives.

In financially oriented thought processes, confirmation bias inhibits what we commonly refer to in Minyanville as "seeing both sides of the trade." If you're bullish on General Electric (GE) stock, for example, confirmation bias may prevent you from understanding the bearish argument necessary for balanced information assimilation and objective risk management.

Confirmation bias is on my mind today because of the current election context. And examples abound of confirmation bias among individuals engaged in political decision-making processes. Consider, for example, those folks who can readily recite a laundry list of defects regarding the opposition while staunchly dismissing all claims made against their preferred candidates. Processes and content of other political phenomena, such as rallies, satire, and political ads all seem consistent with exciting the reactive, emotional limbic system rather than other portions of the brain that support careful, reasoned thought.

In a democracy, one-sided bias of political thought is sometimes viewed as acceptable because aggregating biased choices during an election purportedly reflects a homogenously wise "voice of the people" that magically corrects for individual bias (Surowiecki 2004).

However, just as financial markets can misprice risk due to collective errors in judgment, it seems plausible that pervasive emotionally-driven bias among voters can lead to election outcomes grounded in ignorance rather than reason.

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No positions in stocks mentioned.

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