Don’t look back: Bridging the gap between heuristics and analysis
Academics have long tried to interpret the mechanisms that lie behind financial decisions. Within the domain of behavioural finance, there is a special emphasis on “heuristics and biases”. Heuristics, which means “to discover” in ancient Greek, is about using shortcuts to produce satisfactory decisions within a limited time-frame.
Heuristics and biases can be valuable. In some cases, sticking to some rules may be positive, for example when maintaining a specific strategy in the face of market panic. Conversely, while heuristics can expedite decisions, they also pave the way for errors. It can be really damaging when investors refuse to rebalance their portfolios when structural changes reshape the business cycle. And the danger of anchoring future decisions to historic patterns is that alternative and more valuable solutions can be easily overlooked. Does that sound vaguely familiar?
Of course, historical data can help to predict future behaviour. I had to unde