We often pay attention to irrelevant information. This happens because we develop estimates by starting with an initial anchor that is based on whatever information is provided and adjust from the anchor (sometimes our adjustments are not sufficient). More problematic perhaps is that the existence of an anchor leads people to think of information consistent (commitment and consistency) with that anchor rather than access information that represents information that is inconsistent with that anchor.
Anchoring is commonly observed in real estate and the stock market. Many BUYERS tend to negotiate based on the listed price of a house — and many SELLERS tend to determine the list priced based on adjusting their purchase price.
Some interesting points on anchoring: (1) Experts and non-experts are affected similarly by an anchor; (2) Anchoring-adjustment may occur in any task requiring an numerical response, provided an initial estimate is available; and (3) One study of particular importance for investors was conduced by Joyce and Biddle (1981), which found support for the presence of the anchoring effect among practicing auditors of major accounting firms.
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Anchoring and adjustment was first theorized by Tversky and Kahneman. The pair demonstrated that when asked to guess the percentage of African nations which are members of the UN, people who were first asked “was it more or less than 35%” guessed lower values than those who had been asked if it was more or less than 65%. Subjects were biased by the number 45 or 65 and this had a meaningful influence on their judgment. Over time this bias has been shown in numerous experiments. Interestingly, paying participants based on their accuracy did not reduce the magnitude of the anchoring effect.
The power of anchoring can be explained by the confirmation heuristic and by the limitations of our own mind. We selectively access hypothesis consistent information without realizing. Availability may also play a role in anchoring.
There are numerous examples of anchoring in everyday life:
- Children are tracked by schools that categorize them by ability at an early age and based on this initial “anchor” teachers derive expectations. Teachers tend to expect children assigned to the lower group to achieve little and have much higher expectations of children in the top group (for more info see Darley and Gross, 1983). Malcolm Gladwell talks more about anchoring in his book outliers.
- First impressions are a form of anchoring.
- Minimum payments on credit card bills.
- Posted interest rates at Banks.
- Prices on a menu in restaurants.
- Race can also be an anchor with respect to our expectations (Duncan, 1976)
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“To examine this heuristic, Tversky and Jahneman (1974) developed a paradigm in which participants are given an irrelevant number an asked if the answer to the question is greater or less than that value. After this comparative assessment, participants provide an absolute answer. Countless experiments have shown that people’s absolute answers are influence by initial comparison with the irrelevant anchor. People estimate that Gandhi lived to be roughly 67 years old, for example, if they first decided whether he died before or after the age of 140, but only 50years old if they first decided whether he died before or after the age of 9.
Anchoring effects have traditionally been interpreted as a result of insufficient adjustment from an irrelevant value, but recent evidence casts doubt on this account. Instead, anchoring effects observed in the standard paradigm appear to be produced by the increased accessibility of anchor consistent information.
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In Judgment and Decision Making, David Hardman says:
Anchoring effects have been observed in a variety of domains including pricing, negotiation, legal judgment, lotteries and gambles, probability estimates, and general knowledge. In on of these studies, Northcraft and Neale (1987) demonstrated anchoring effects in the pricing estimates of estate agents…
Despite the robustness of the anchoring effect, there has been little agreement as to the true nature of the underlying processes. One theory that has been proposed is that of selective anchoring (Mussweilier and Strack, 1997). According tot his account, the comparative question task activates information into memory that is subsequently more accessible when making an absolute judgment….
Epley (2004) listed four findings that are consistent with the selective memory account: (1) People attend to shared features between the anchor and target more than to unique features; (2) Completion of a standard anchoring task speeds identification of words consistent with implications of an anchor value rather than words inconsistent with it; (3) The size of anchoring effects can be influenced by altering the hypothesis tested in the comparative assessment (for example, asking whether the anchor is less than a target value has a different effect to asking whether it is more than a target value); (4) People with greater domain knowledge are less susceptible to the effects of irrelevant anchors.
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In Fooled by Randomness, author Nicholas Taleb offers:
Anchoring to a number is the reason people do not react to their total wealth, but rather to differences of wealth from whatever number they are currently anchored to. This is in major conflict with economic theory, as according to economists, someone with $1 million in the bank would be more satisfied than if he had $500 thousand but this is not necessarily the case.
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Tversky and Kahneman (1974)
In many situations, people make estimates by starting from an initial value that is adjusted to yield the final answer. The initial value, or starting point, may be suggested by the formulation of the problem, or it may be the result of a partial computation. In either case, adjustments are typically insufficient (Slovic & Lichtenstein, 1971). That is, different starting points yield different estimates, which are biased toward the initial values. We call this phenomenon anchoring.
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Russell Fuller writes:
Psychologists have documented that when people make quantitative estimates, their estimates may be heavily influenced by previous values of the item. For example, it is not an accident that a used car salesman always starts negotiating with a high price and then works down. The salesman is trying to get the consumer anchored on the high price so that when he offers a lower price, the consumer will estimate that the lower price represents a good value. Anchoring can cause investors to under-react to new information.