ABSTRACT
Psychological research has shown that the brain uses shortcuts to reduce the complexity of analyzing information. Psychologists call these heuristic simplifications. These mental shortcuts allow the brain to generate an estimate of the answer before fully digesting all the available information. Two examples of shortcuts are known as representativeness and familiarity. People also make representativeness errors in financial markets. For example, investors confuse a good company with a good investment. Good companies represented by firms that generate strong earnings, have high sales growth, and have quality management. Extrapolation bias is considered to be a subset of the representativeness bias because investors believe that past returns represent what they should expect in the future. Mary Bange investigates this behavior by studying the weekly and monthly surveys conducted by the American Association of Individual Investors (AAII). AAII surveys its membership regarding their opinion about the stock market and their asset allocation.
