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Overcoming Cognitive Biases: A Heuristic for Making Value Investing Decisions

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  • Eben Otuteye
  • Mohammad Siddiquee

Abstract

Investment decisions are subject to error due to cognitive biases of the decision makers. One method for preventing cognitive biases from influencing decisions is to specify the algorithm for the decision in advance and to apply it dispassionately. Heuristics are useful practical tools for simplifying decision making in a complex environment due to uncertainty, limited information and bounded rationality. We develop a simple heuristic for making value investing decisions based on profitability, financial stability, susceptibility to bankruptcy, and margin of safety. This achieves two goals. First, it simplifies the decision making process without compromising quality, and second, it enables the decision maker to avoid potential cognitive bias problems.

Suggested Citation

  • Eben Otuteye & Mohammad Siddiquee, 2015. "Overcoming Cognitive Biases: A Heuristic for Making Value Investing Decisions," Journal of Behavioral Finance, Taylor & Francis Journals, vol. 16(2), pages 140-149, April.
    • Handle: RePEc:taf:hbhfxx:v:16:y:2015:i:2:p:140-149
    DOI: 10.1080/15427560.2015.1034859
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    Cited by:

    1. Athota, Vidya S. & Pereira, Vijay & Hasan, Zahid & Vaz, Daicy & Laker, Benjamin & Reppas, Dimitrios, 2023. "Overcoming financial planners’ cognitive biases through digitalization: A qualitative study," Journal of Business Research, Elsevier, vol. 154(C).
    2. Arpita Agnihotri & Saurabh Bhattacharya, 2017. "Corporate Name Change and the Market Valuation of Firms: Evidence from an Emerging Market," International Journal of the Economics of Business, Taylor & Francis Journals, vol. 24(1), pages 73-90, January.
    3. Leković Milјan, 2020. "Cognitive Biases as an Integral Part of Behavioral Finance," Economic Themes, Sciendo, vol. 58(1), pages 75-96, March.
    4. Pysarenko, Sergiy & Alexeev, Vitali & Tapon, Francis, 2019. "Predictive blends: Fundamental Indexing meets Markowitz," Journal of Banking & Finance, Elsevier, vol. 100(C), pages 28-42.
    5. Sumiyana Sumiyana & Ainun Na’im & Firdaus Kurniawan & Albertus H. L. Nugroho, 2023. "Earnings management and financial distress or soundness determining CEOs’ future over- and under-investment decisions," Palgrave Communications, Palgrave Macmillan, vol. 10(1), pages 1-10, December.
    6. Syed Aliya Zahera & Rohit Bansal, 2018. "Do investors exhibit behavioral biases in investment decision making? A systematic review," Qualitative Research in Financial Markets, Emerald Group Publishing Limited, vol. 10(2), pages 210-251, May.
    7. M. Volkov & М. Волков, 2018. "Анализ фундаментальной индексации как эффективный подход к активному инвестированию // Analysis of Fundamental Indexation as an Efficient Approach to Active Investing," Review of Business and Economics Studies // Review of Business and Economics Studies, Финансовый Университет // Financial University, vol. 6(4), pages 41-51.

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