Group 7 (Chap 4) 11

TO
OUR PRESENTATION
Course Name: Behavioral Finance Presented to
Course Code: FIN-6404 Dr. Mohammad Sogir Hossain
Department of Finance Khandoker
Chairman &Professor
Jagannath University, Dhaka.
Department of Finance
Jagannath University, Dhaka.
Presented by- Group-7
Group Members
Name ID
Khairul Islam M22020203503
Md. Shariful Islam M22020203506
Md. Zobaer Rahaman M22020203520

3
Presentatio
n on- (CHAPTER -4)
‘Cognitive Dissonance Bias ’
BIAS DESCRIPTION
Bias Name: Cognitive dissonance
Bias Type: Cognitive
Subtype: Belief perseverance
General Description
 When newly acquired information conflicts with
preexisting understandings, people often experience
mental discomfort—a psychological phenomenon known
as cognitive dissonance.
 Cognitions, in psychology, represent attitudes, emotions,
beliefs, or values; cognitive dissonance is a state of
imbalance that occurs when contradictory cognitions
intersect.
5
BIAS DESCRIPTION (Cont……)
Example of Cognitive Dissonance Bias
 A consumer might purchase a certain brand of mobile phone, initially believing that
it is the best mobile phone available. However, when a new cognition that favors a
substitute mobile phone is introduced, representing an imbalance, cognitive
dissonance occurs in an attempt to relieve the discomfort that comes with the notion
that perhaps the buyer did not purchase the right mobile phone.
 People will go to great lengths to convince themselves that the mobile phone they
actually bought is better than the one they just learned about, to avoid mental
discomfort associated with their initial purchase. They will persist in their self belief
that is a bias. 6
Technical Description
 When people modify their behaviors or
cognitions to achieve cognitive harmony,
however, the modifications that they make
are not always rational or in their self-
interest.
 Any time someone gets puzzled in taking
decisions between 2 alternatives. He/she can
make a commitment to a deal by his Figure : 1 Cognitive Dissonance Theory
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emotions that is a bias.
Technical Description
 Theorists have identified two different aspects of cognitive dissonance that related to
decision making.
Those who have selective perception, relying on
1. Selective perception this perception firmly may be inaccurate. People
miscalculate/misguide by those perceptions.
Selective Decision making rationalize to a

2. Selective decision making decision even if it is high in economic cost. They
continue to fund in a project which has no good
prospects in future.. 8
PRACTICAL APPLICATION
Example of Cognitive Dissonance
1. Smoking is a classic example of cognitive Dissonance. People know smoking causes

lung cancer and Heart disease but who smoke wants to live a long and healthy life.
According to Cognitive Dissonance theory this 2 perception is contradictory. So to
reduce this discomfort smoker then biasedly rationalizes his behavior by believing
that only few smokers become ill. So people like to rationalize his belief and action.
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Example of Cognitive Dissonance
2. Investors Rationalize decisions prior to investment which get failed. They make delay
to unloading assets that are not generating adequate returns. In both cases Cognitive
Dissonance prevents investors from acting Rationally.
3. There are some investors who want to maintain self esteem rather than taking lessons
from past mistakes. They define their failure by calling it a "Chance" rather than poor
decision making.
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Feininger's Peg Experiment
Figure: 2. Modeling Cognitive Dissonance in Festinger's Peg

Experiment
11
Md. Shariful Islam - M22020203506
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RESEARCH REVIEW
 Professor William N. Goetzmann and Navad Peles established a theory that entitled
"Cognitive Dissonance and mutual fund investors", in which they examined that
investors are most likely to stick irrationally, with struggling with mutual funds.
 The theory played a significant role in compelling investors to hold losing fund
position. The researchers theorized that people do not permit themselves to accept
new evidence that suggests it might be time to evacuate a fund, because they feel
committed on their initial decision.
 The study showed that investors are affected by the disparity in value between
security's purchase price and current price.
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RESEARCH REVIEW (cont..)
Cognitive Dissonance Bias: Behaviors That Can Cause Investment Mistakes
1. It can cause investors to hold losing securities position that they otherwise
would sell.
2. It can cause investors to continue to invest in a security that they already own
after it has gone down.
3. Due to cognitive dissonance, people avoid information that counters an earlier
decision, until so much counter information is released.
4. In can cause investors to believe “ It’s different this time” they purchase high-
flying securities, that have no excess returns. 14
RESEARCH REVIEW (Cont..)
The researchers final comment
 The researchers illustrated, that the response documented in their study appears
widespread.
 This chapter might have especially broad implications.
 If cognitive dissonance is taken successfully with understanding, detecting and
countering the behavioral biases, could help numerous individual investors.
15
DIAGNOSTIC TESTING
Example Suppose that you recently bought a new car Brand A ,

Model B.
You are very pleased with your purchase
One day, your neighbor said , "Did you know that

Brand Y, Model Z (Model Z is nearly identical to
Model B),
It was giving away a free navigation system when you
bought the car.
16
DIAGNOSTIC TESTING (cont..)
Example
a. You immediately head to your home office and page through the
various consumer magazines to determine whether you should
have purchased Model B.
b. You proceed with washing the car and think, “If I had it to do
all over again, I may have purchased Model Z. Even though
mine doesn't have a navigation system, I'm still pleased with
Model B.”
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DIAGNOSTIC TESTING (cont..)
Example
c. You contemplate doing some additional research on Model Z. However, you
decide not to follow through on the idea. The car was a big, important
purchase, and you've been so happy with it—the prospect of discovering an
error in your purchase leaves you feeling uneasy. Better to just put this thought
to rest and continue to enjoy the car.
Test Result Analysis

Answering “c” may indicate a propensity for cognitive
dissonance 18
Md. Zobaer Rahaman - M22020203520
19
ADVICE
Cognitive Dissonance: Common Coping Responses
 People can and do recognize inconsistencies

between actions and beliefs.
 When they act in ways that contradict their
own beliefs, attitudes, or opinions, some
natural “alarm” tends to alert them.
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ADVICE
(cont..)
Cognitive Dissonance: Common Coping Responses
Three ways to try to reconcile conflicting cognitions
1. Modifying Beliefs
2. Modifying Actions
3. Modifying perceptions
of relevant action(s)
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Conclusion
 The bottom line in overcoming the negative behavioral effects of cognitive
dissonance is that clients need to immediately admit that a faulty cognition has
occurred.
 Rather than adapting beliefs or actions in order to circumnavigate cognitive
dissonance, investors must address feelings of unease at their source and take an
appropriate rational action.
 If you think you may have made a bad investment decision, analyze the decision; if
your fears prove correct, confront the problem head-on and rectify the situation. In
the long run, you’ll become a better investor.
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TO

Khairul Islam M22020203503

Md. Shariful Islam M22020203506

Md. Zobaer Rahaman M22020203520

Selective Decision making rationalize to a

Example of Cognitive Dissonance

1. Smoking is a classic example of cognitive Dissonance. People know smoking causes

Example of Cognitive Dissonance

Figure: 2. Modeling Cognitive Dissonance in Festinger's Peg

Cognitive Dissonance Bias: Behaviors That Can Cause Investment Mistakes

Example Suppose that you recently bought a new car Brand A ,

You are very pleased with your purchase

One day, your neighbor said , "Did you know that

Test Result Analysis

 People can and do recognize inconsistencies

Three ways to try to reconcile conflicting cognitions

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