Behavioral economists have found that several cognitive biases can influence financial investment decisions. The home bias is investors' tendency to...
GMAT Multi Source Reasoning : (MSR) Questions
Behavioral economists have found that several cognitive biases can influence financial investment decisions.
The home bias is investors' tendency to choose a large proportion of investment products from their home nations—even though it is nearly always more financially rational to diversify and invest globally. The home bias is a type of familiarity bias, an irrational preference for the familiar.
The status quo bias leads investors to retain current investments out of inertia when it would be rational to change those investments. This bias also leads investors to passively accept any investment chosen for them by default rather than make an active choice.
The availability bias makes investors focus unduly on more recent and prominent information. When stock values have been rising or falling rapidly, investors often irrationally assume the change will continue and invest accordingly.
The overconfidence bias applies to investors who feel irrationally optimistic that, regardless of what they know to be the statistical norm, their own investments will outperform that norm.
For each of the following cognitive biases, select Contributed significantly if the information provided clearly indicates it contributed significantly to the investment decisions that led to the outcome described in the final sentence of the case study. Otherwise, select Did not contribute significantly/indeterminate.
OWNING THE DATASET
Understanding Source A: Text Source - Cognitive Biases Discussion
| Information from Dataset | Analysis |
|---|---|
| "Behavioral economists have found that several cognitive biases can influence financial investment decisions." |
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| "The home bias is investors' tendency to choose a large proportion of investment products from their home nations—even though it is nearly always more financially rational to diversify and invest globally." |
|
| "The status quo bias leads investors to retain current investments out of inertia when it would be rational to change those investments." |
|
| "The availability bias makes investors focus unduly on more recent and prominent information." |
|
| "The overconfidence bias applies to investors who feel irrationally optimistic that...their own investments will outperform that norm." |
|
Summary: This educational text explains four cognitive biases (home, status quo, availability, and overconfidence) that cause investors to make financially irrational decisions instead of optimal choices like global diversification.
Understanding Source B: Text Source - Case Study
| Information from Dataset | Analysis |
|---|---|
| "In 2000, Sweden changed its social security system...Previously, the government had placed all social security payments in a single fund...But the new system allowed each taxpayer to craft an individual investment portfolio" |
|
| "A default investment strategy involving diverse investment products worldwide was provided for taxpayers who made no active choice." |
|
| "However, a governmental advertising campaign encouraged taxpayers to make their own choices, so most did." |
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| "Reports available to taxpayers showed that Swedish stock prices had been rising rapidly, and as a result a large proportion of taxpayers invested heavily in Swedish stocks." |
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| "But soon those stock prices fell dramatically." |
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| "Overall, after three years, taxpayers who made active choices would have fared far better if they had stuck with the default strategy." |
|
Summary: This Swedish case study from 2000-2003 shows how taxpayers, when given investment freedom, exhibited multiple cognitive biases (especially home and availability bias) by choosing poorly-timed domestic investments over a superior globally-diversified default option, resulting in worse financial outcomes.
Overall Summary
- The theoretical framework of cognitive biases (Source A) is perfectly demonstrated in the Swedish social security reform (Source B)
- Swedish taxpayers exhibited home bias by heavily investing in Swedish stocks and availability bias by chasing recent performance trends
- The globally diversified default option outperformed most active choices, confirming that cognitive biases lead to poor investment decisions
- Key insight: Even when people are educated about optimal investment strategies, psychological biases still drive them toward irrational choices that harm their financial outcomes
Question Analysis
This question requires determining whether each of three cognitive biases (Availability bias, Home Bias, Status Quo Bias) significantly influenced Swedish taxpayers' investment decisions that led to poorer outcomes compared to the default strategy.
Key Constraints
- Evaluate each bias separately
- Relate bias to the outcome (active choice versus default strategy)
- Provide binary-type judgments (Contributed Significantly or Did not contribute significantly/indeterminate)
- Base conclusions on the given analysis and evidence
Answer Type Needed: Logical inference linking theoretical bias descriptions to observed investor behavior and outcomes
Connecting to Our Analysis
The provided analysis links cognitive bias definitions with the Swedish case study, explicitly addressing the role of each bias in investor behavior and outcomes. The analysis clearly connects theoretical bias descriptions with observed taxpayer behavior and investment results, allowing for definitive conclusions about each bias's contribution to poor outcomes.
Extracting Relevant Findings
Evaluations of each bias are based on their theoretical descriptions and clear evidence from the Swedish case study highlighting taxpayer behavior and investment outcomes. The central hypothesis indicates that Availability Bias significantly influenced Swedish taxpayers to make active, suboptimal investment choices, while Home Bias was secondary to availability bias and Status Quo Bias was overcome.
Individual Statement Evaluations
Statement 1 Evaluation - Availability Bias
Assessment: Availability bias caused taxpayers to focus on recent rapidly rising Swedish stock prices, influencing their active investment choices.
- Evidence: Significant evidence shows taxpayers focused on recent returns and reports of rising Swedish stock prices
- Outcome Connection: Active choices driven by this bias performed worse than the default strategy
- Conclusion: Contributed significantly to poor investment outcomes
Statement 2 Evaluation - Home Bias
Assessment: While taxpayers did invest heavily in Swedish stocks, this occurred as a result of reports about rising prices, suggesting availability bias was the primary driver rather than home bias itself.
- Evidence: Taxpayers invested domestically, but the case study explicitly states this was due to reports about rising Swedish stock prices
- Primary Cause Analysis: Availability bias was the primary cause, making home bias secondary or coincidental
- Conclusion: Did not contribute significantly as an independent factor
Statement 3 Evaluation - Status Quo Bias
Assessment: Status quo bias, which would cause passive acceptance of defaults, was largely overcome by government encouragement to make active investments.
- Evidence: Most taxpayers made active choices rather than defaulting to the superior default strategy
- Outcome Analysis: Since active choices that overcame status quo bias underperformed the default strategy, this bias did not contribute to poor outcomes
- Conclusion: Did not contribute significantly to poor outcomes
Systematic Checking
A comprehensive check of evidence confirms availability bias was the primary driver of poor outcomes, while home bias was secondary and status quo bias was countered.
Supporting Points
- Availability bias explains the focus on recent rising Swedish stock prices
- Home bias appears secondary since domestic investment resulted from availability bias
- Status quo bias was mitigated by government encouragement
- Poor outcomes align with active choices driven by availability bias
- If status quo bias had prevailed, the better default strategy would have been retained
Final Answer
- Statement 1 (Availability Bias): Contributed Significantly
- Statement 2 (Home Bias): Did not contribute significantly/indeterminate
- Statement 3 (Status Quo Bias): Did not contribute significantly/indeterminate
Availability bias
Home Bias
Status Quo Bias