Like the other biases in this behavioral finance deep dive series is a mental shortcut. Specifically, it is the phenomenon where people’s opinions and concerns are unduly shaped by immediate: information, mental models, and other things recently experienced. Essentially, this bias boils down to “if something can be recalled then it must be important.”

Recall that at the end of this series I am going to land with A Theory of Behavioral Finance.

A Helpful Mnemonic Device: LOCHAARM

To my mind the major behavioral biases are:

• Loss aversion
• Overconfidence
• Confirmation
• Herding
• Anchoring
• Availability
• Representativeness
• Mental accounting

A helpful mnemonic device for remembering these biases is LOC HAARM, brain lock that harms investment performance.

Availability Bias: Origins

Loren J. Chapman first described in 1967[1] an odd error in judgment noticed in his research. Namely, he presented people two sets of words and asked them to report the frequency of one word in a set being paired with a different word in the other set. The words occurred in both sets the same number of times, but when asked to recall the pairings subjects reported more occurrences for words that were paired with, for example, atypically long words or when matched up with similar words like dogs and cats. In other words, folks were overestimating the frequency of pairings when it was easier to create associations.

Like other behavioral biases a correct numerical answer was readily available by counting up the associations. But rather than doing the rational thing, stop and count, people found unusualness to be more salient. These early researches were followed up on by Tversky and Kahneman in 1973.[2] In their initial work they asked English language speakers to estimate whether or not there were more words that began with the letter K, or whether or not there were more letters where K was the third letter in a word. What they found was that people estimated that words beginning with K were much higher because words of that kind were recalled more readily from memory.

And herein there is an insight that I want you to pay attention to. Namely, the way memories are formed and how they are recalled. The more paths/contexts that lead to a particular subject, the more rapidly memories are located and recalled. However, as the example above suggest, that does not make them correct. This error turns out to have important implications for us as investors.

Availability Bias: Manifestations

When asked to think about an issue, we often focus on what is most available to us at the time or can be most easily recalled. Closely related is the result that the degree of confidence we have in our conclusion is related to how easily the facts can be recalled: the easier the recall, the more confident are we. What researchers have found is that what is available and how confident we are has little to do with the quality of our analysis.

How important is the price of gasoline as an economic issue? For some it is very important, but for most it is not, although everyone, save for an oil company, would like to see a lower price. But if we watch the news we would think it very important, since its level is reported frequently and it is often the topic of lengthy news stories.

Why is this the case? Because the price of gas is posted on many street corners and so its level is available and continuously updated. When we think about the economy or our personal financial situation, the price of gasoline is something that comes easily to mind. We might even conclude that as the price rises, the economy is worse off, as well as our own personal financial situation. But is the price of gasoline so important that it deserves such an exalted position in the pantheon of economic variables? No.

The price of gasoline is an example of the availability bias. Here is the thing, Job One of investors is to understand the world for what it is and not what you would prefer it to be. Yet, most of us are incapable of suspending our preferred mental models and preferred ways of understanding the world when encountering new information. In fact, most of us have been trained by Western education since a very early age (3? 4? 5?) to immediately judge information: Do you like cereal A or cereal B better, Susan? Is that company the type of company we typically invest in? These hair trigger responses to information are actually considered a hallmark of a DEEP thinker and someone who is intelligent.

Most of the time, availability bias expressing its effects is not damaging. Except in a very notorious case within investing: state changes. Ask almost anyone in investing about the areas that are most difficult to manage and among those listed will be anticipating and quickly adapting to state changes. To me, this is the strongest expression of availability bias in investing. There is a new situation, but because our preferred mental models are hair-trigger immediately available, we misread the situation because we use the wrong mental model.

What is needed in these moments is “beginner’s mind.” That is, recognizing that situations are all unique and that, yes, how this situation is similar to other moments is interesting; but that how this situation is different is extremely important to examine, too.

Availability Bias: Nuances

But availability bias actually goes even further, uniting the entire market in a false sense of certainty regarding events. A single reporting of an event may trigger the availability bias, while multiple reportings trigger an availability cascade.

In such cases, multiple reports have an overpowering influence on individuals, driving them to make emotional decisions. Consequently, it is extremely difficult to come to an independent judgment because everywhere we turn the event is being reported and people are overwhelmed by the event.

Natural and person made disasters are examples of cascades, with considerable media time devoted to reporting such events. There are those who believe that legislation is unduly influenced by emotionally driven cascades, with small risks taking on outsized importance in the minds of the public and, in turn, politicians.

Financial markets are obviously highly susceptible to availability cascades, being continuously dominated by one cascade after another. Think 9/11. Think Global Financial Crisis of 2009. Think COVID-19. Clearly cascades are important drivers of emotional price swings and if you can summon “beginner’s mind” in these moments then you stand a greater chance of benefiting from these market tides.

Conclusion

Availability bias is a pernicious destroyer of alpha. She who is able to insert a pause between stimulus and response wins the alpha bled by those victimized by their preferences and prejudices.

[1] Chapman, L.J (1967). “Illusory correlation in observational report”. Journal of Verbal Learning. 6: 151–155

[2] Tversky, Amos; Kahneman, Daniel (1973). “Availability: A heuristic for judging frequency and probability”. Cognitive Psychology. 5 (2): 207–232