1 Yehya Chawich Anchoring: Its danger and role of the market crash Psychologists have reported that when

people make numerical estimates, their estimates may be strongly influenced by previous merits of the item. In our case, it is important to note that various heuristics such as anchoring and overconfidence origin promote under reaction. The conditions under which investors are untenable to these heuristics are dissimilar from the conditions that cause investors to be untenable to overreaction. (note that you used conditions and untenable multiple times in the same sentence; you probably want to reword) My initial hypothesis is that people rely on a limited arithmetical value of heuristic principles which reduce the total tasks of assessing probabilities and predicting numbers to simpler judgmental operations. The problem is that in some particular situations, heuristic lead to severe and systematic errors. It is worth giving special importance to the word "systematic." One of the most striking attributes was that the errors were not desultory - they could be described and even predicted. I think that nowadays people are more focused on the anchoring affect then they were before the crash. The Market crash was the high point, but even nowadays anchoring illustrates how dangerous this misleading behavior could be. This does not mean that now we foresee the future, it simply implies that we are more informed of the different courses of action then before the crash and should assess the consequences of those actions more accurately, weighted by expectations of occurrence. Nevertheless, we can see that poor information and lack of proper/costless information lay at the heart of the contemporary mess we find ourselves in. B.Bernanke wrote: During the worst phase of the financial crisis, many economic actors including investors, employers, and consumers metaphorically threw up their hands and admitted

2 that, given the extreme and, in some ways, unprecedented nature of the crisis, they did not know what they did not know. The profound uncertainty associated with the unknown unknowns during the crisis resulted in panicky selling by investors, sharp cuts in payrolls by employers, and significant increases in households' precautionary saving (Bernanke, 2010). The resulting quarrels have proved influential in many fields, including finance, where the sway stems from the effort to connect legal analysis to a practical, rather than hypothetical, understanding of how persons think and behave. If persons use identifiable heuristics, and if they make methodical anchoring errors, we might better understand why finance is as it is, and we might create better strategies for ensuring that finance actually promotes necessary goals. Good link to concepts explored during the term A comprehension of heuristics and biases should

improve our appreciation of the their legitimate role in markets. If people make anchoring errors, perhaps government has good purpose to override their choices. The affect of the anchoring also stems from its obvious connection with special problems with which policymakers are troubled. For example, the system of risk injunction has been said to show an amalgamation of delusion and neglect. The tidal wave of investment knowledge available has often complicated the issues for many of my potential clients and exaggerates the opportunity for the wise financial advisement that can help to differentiate fads from principles. People require to be reminded of basic investment principles occasionally to prevent them from making the wrong solutions. Good insight Principles have an anchoring influence. If sound investment principles are intrinsically impressed on my client, even though he may sometimes drift (out of greed) toward interest with fads like penny stocks, options, and the like, my client will return back to the reality of those principles. A comprehension of anchoring might assist in understanding how and why this is so, and give a sense of what might be done by way of answer. If the financial advisors are overconfident and also

3 anchored to their most contemporary estimate, they may be resistant to give as much weight as they should to the information in the current earnings statement and not raise their estimate. An anchor is often taking effect even when people think that it is not; that anchors operates even when people accept, and say they accept, that the anchor is uninformative; and that making people wellinformed of an anchor's result or consequence does not decrease anchoring. I agree that in the face of higher volatility, estimates are frequently made from an initial value, or "anchor, which is then adjusted to provide a final answer. Note that volatility plays a main role when markets change from a period of elation towards periods of excessive doubt. As far as market bubbles are concerned, when the bigger fool does not occur, a panic is set in motion and property prices take a nosedive. Commonly speaking, clients panicky reaction (e.g. selling property at fire-sale prices, withdrawing money from a bank or declining to rollover debt) can fundamentally result in greater deprivations than if we would just stay put. Given the volatility concerning the latter, second- guessing is a subordinate strategy to immediate action. So when clients begins selling their stocks or bonds, we are better off to instantly follow suit even if we are sure this is unwarranted given the fundamentals this is also known as the sell-first-ask-questions-later principle in the marketplace. The primary value, or starting point, may be advised by the formulation of the issue, or it may be the outcome of a partial computation. Because even the most competent investors, the math whizzes of Wall Street and financial regulators did not fully comprehend what was going on in the market place. Intelligence seemed readily available, but it was completely useless at times. Institutional investors, for instance, would require reading thousands of pages worth of information for every collateralized debt obligation purchased to be aware of whole lot that was being acquired. Since not quite no one had the time to look at and comprehend the meaning of that many pages, investors either (i)

4 uncritically accepted the ratings given by rating agencies or (ii) determined to hedge their risk. As for the former market crash, it was clear after multi-notch rating disparages during the crisis that rating agencies had been as uninformed as all other investors. I have found some researches research data that demonstrate the new reality. For example, some behavioral economists indicate that asset bubbles and financial crashes have been with humanity for centuries because we do not take actions like homo economics. For example, as P.Krugman wrote: Many real-world investors bear little resemblance to the cool calculators of efficient- market theory: they are all too subject to herd behavior, to bouts of irrational exuberance and unwarranted panic (Krugman, 2009). But given the extremely large human and financial costs related to these crashes, everyone wants to find approaches to prevent them. But that is desirable thinking at best, and threatening at worst since under such illusion we will be overly revealed to the new and unforeseen. F.Hayek informed us in advance about this semblance of knowledge syndrome by writing: To act on the belief that we possess the knowledge and the power which enable us to shape the process of society entirely to our liking, knowledge which in fact we do not possess, is likely to make us do much harm (Hayek, 1974). Some economists were not unexpected by these results. Glaser (2004) have presented that anchoring is especially susceptible to overconfidence. We usually accept that our capabilities are above average, may have a belief of control, may be more than is necessary optimistic about the future, or may think our information is more accurate than it really is. As an outcome of anchoring, we are susceptible; to underestimate the actual risks (i.e. Acknowledge historical lessons) and overestimate our abilities to overcome unpredicted problems. This was perhaps the reason why market regulators and governments thought before the market crash that there was nothing inappropriate, and if there was, they could without difficulty solve the issues. What is more,

5 market participants were overconfident in the capability of governments and regulators in taking authority of a given case (even though history has shown that this is rarely the situation). Against this backdrop, most investors resolved to have blind faith in efficient markets and comprehensive authorities instead of doing their own activities. Glaser stated that: when we are overconfident we always believe, for some reason or another, that history no longer applies to the present situation. When asset prices rise, we try to explain it by fundamentals. When banks become too large (with respect to a countrys GDP), we explain it through globalization of finance. When countries live beyond their means (i.e. run a massive current account deficit), we think the reason is higher growth potential (i.e. higher return) (Glaser, 2004). I can summarize that anchoring may play an important role in my future advisory work. Because anchoring reflects the amount to which the preliminary judgment about an event or situation forbids one from deviating from that situation regardless of new knowledge to the contrary.

Bibliography Bernanke, B. (2010). Implications of the Financial Crisis for Economics. Center for Economic Policy Studies and the Bendheim Center for Finance, Princeton University, Princeton, New Jersey. Glaser, B. (2004). Asset bubbles, financial crises and the role of human behavior. Retrieved at: http://saskatoonhousingbubble.blogspot.com/2011/12/asset-bubbles-finanicial-

crisises-and.html Hayek,F.(1974).Prize Lecture. Retrieved http://www.nobelprize.org/nobel_prizes/economics/laureates/1974/hayek-lecture.html Krugman, P. (2009). How Did Economists Get It So Wrong? NYTimes.com. Retrieved at: http://www.nytimes.com/2009/09/06/magazine/06Economic-t.html?pagewanted=all at:

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Criteria Score

Analysis and Evaluation (75 points) Focused an original, significant idea (max score 10) Coherent argument and discussion (max score 40) References to recent literature (evidence) (max score 20) Framed significance of paper, conclusion (max score 5)

10 36 19 5

Comments: Good work in researching current relevant literature and citing quotes within the body of the paper. Make sure to either provide numbers to bibliography references or footnotes. You clearly explored the concept of anchoring. I would have liked to hear more about how you will incorporate this information into your work with clients. Overall good effort.

Structure (15 points total) Proper citation, grammar, spelling (max score 10)

7 Formatting and organization (max score 5) 4 Comments: You offer an interesting writing style. As you review potential publications (see list following this table) you will need to assess the audience. Based on the tone of other articles, you will be able to assess if you want to modify some of your own work. Overall Evaluation (10 points) Originality, analysis, research, bibliography (max score 10) 10 Comments: Good effort on this project. It is clear to me that you really reflected on the subject, explore current literature and synthesized your arguments. I think the paper is publishable, although you will need to further develop your recommendations to the practitioner and fine-tune the organization so that there is a clear flow between: introduction and hypothesis, current literature, your argument and insights and conclusion/future research implications Total Score 93 Magazines you might consider when seeking publication Journal of Financial Planning Financial Planning Magazine, Financial Advisor Magazine Investment Advisor Magazine Journal of Financial Services Professionals Journal of Retirement Planning