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." |
|
| "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." |
|
Summary: This source explains four cognitive biases (home bias, status quo bias, availability bias, and overconfidence bias) that cause investors to make irrational financial decisions, particularly favoring familiar domestic investments over more rational global diversification.
Understanding Source B: Text Source - Case Study
| Information from Dataset | Analysis |
|---|---|
| "In 2000, Sweden changed its social security system, in which taxpayers make mandatory payments to save for their living expenses after retirement." |
|
| "Previously, the government had placed all social security payments in a single fund, and individual taxpayers could not choose how their payments were invested." |
|
| "But the new system allowed each taxpayer to craft an individual investment portfolio from a vast array of different options." |
|
| "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." |
|
| "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." |
|
| "But soon those stock prices fell dramatically." |
|
| "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 demonstrates how the cognitive biases from Source A played out in reality - taxpayers influenced by recent domestic stock performance (availability bias) and preference for Swedish investments (home bias) made choices that underperformed the globally diversified default option.
Overall Summary
- The sources together show how theoretical cognitive biases translate into real investment mistakes
- Source A identifies four biases that lead to irrational investment decisions, especially favoring familiar domestic investments over global diversification
- Source B provides a perfect real-world example where Swedish taxpayers, influenced by these exact biases, chose domestic stocks that underperformed the rational default strategy
- Key insight: Fighting one bias (status quo/accepting defaults) can activate others (home bias, availability bias), leading to worse outcomes than simply accepting a well-designed default
Question Analysis
The question requires determining whether each of three specific biases played a significant role in causing Swedish taxpayers to make poor investment choices that underperformed the default strategy.
- Must evaluate each bias individually
- Must determine if it contributed significantly to the poor investment decisions
- Focus on the outcome: taxpayers would have done better with the default strategy
This requires a comparative evaluation determining the causal contribution of each bias to the poor investment outcome.
Connecting to Our Analysis
The analysis directly addresses each of these three biases and their role in the Swedish case study. It shows how availability bias manifested in taxpayer behavior, while home bias and status quo bias did not contribute significantly to the poor outcomes. The analysis provides clear evidence for each bias's role or lack thereof in the investment decisions.
Extracting Relevant Findings
We evaluate each bias against the evidence from the Swedish case study to determine its contribution to poor investment decisions.
Individual Statement Evaluations
Statement 1 Evaluation: Availability Bias
Did taxpayers make poor choices because they focused too much on recent information about rising Swedish stock prices?
- Evidence: Taxpayers invested heavily in Swedish stocks because reports available to taxpayers showed that Swedish stock prices had been rising rapidly
- Analysis: This exactly matches the definition of availability bias - focusing on recent and prominent information
- Causal Link: Clear connection between recent performance reports and investment decisions shows this contributed significantly as taxpayers assumed recent rises would continue
- Conclusion: Availability bias directly led to poor investment choices
Statement 2 Evaluation: Home Bias
Did taxpayers make poor choices because they favored Swedish investments over global diversification?
- Evidence: While taxpayers did invest heavily in Swedish stocks, the text explicitly states this happened as a result of seeing rising Swedish stock prices
- Analysis: The primary driver was the availability bias response to recent price information, not home bias
- Key Distinction: The fact that these were Swedish stocks was coincidental to the real cause of the investment decision
- Conclusion: Home bias was not the primary driver of poor investment decisions
Statement 3 Evaluation: Status Quo Bias
Did taxpayers make poor choices because they stuck with existing investments or accepted defaults?
- Evidence: Government advertising campaign encouraged taxpayers to make their own choices, so most did
- Analysis: Status quo bias would have led them to accept the default, which would have been better
- Counteraction: The government actively countered status quo bias, leading to worse outcomes
- Conclusion: The absence of status quo bias actually caused the poor outcomes
Systematic Checking
Verifying each bias evaluation against the case study outcome:
- Availability bias led to over-investment in recently rising Swedish stocks which then fell dramatically
- Home bias was not the primary driver - taxpayers responded to recent price information rather than preferring domestic investments
- Status quo bias was actively countered, which ironically led to worse outcomes
- Only availability bias clearly contributed to poor active choices
- Status quo bias would have helped if followed by sticking with default
Final Answer
- Statement 1: Contributed Significantly
- Statement 2: Did not contribute significantly/indeterminate
- Statement 3: Did not contribute significantly/indeterminate
Availability bias
Home Bias
Status Quo Bias