The Hindu Business Line : False consensus bias

Three years ago, my friend had the opportunity to buy a large tract of land outside Chennai. He decided not to. He reasoned that the land was quite far from the city and would take more than 10 years to develop. It was a saving grace that he instead chose to invest in the stock market.

His investments in the market since then have fetched him 100 per cent returns, or so he claims.

The land that he refused to buy has more than doubled in price! This could have happened to you as well.

My friend always held the opinion that one should live within city limits to commute to the office. He strongly believed that others thought the same way.

So, he reasoned that no one else would buy the land unless infrastructure developed in that area. He was wrong. There were some who thought differently. They bought the land, built houses and then the local authority provided the infrastructure. My friend suffers from what behavioural psychologists call the “False consensus bias”. What is it?

Stock market and beauty contest

It simply refers to our view that everyone thinks the way we do. It also refers to how we react when someone differs from our viewpoint — we generally call them weird! Professor Lee Ross of Stanford University conducted several experiments to document this behaviour.

False consensus bias can be related to the “Beauty contest” that Keynes talked about in “General Theory of Employment, Interest and Money”.

He drew an analogy between the stock market and the beauty contest ran by a London tabloid. The tabloid printed six beautiful faces and asked the readers to choose the most beautiful among them.

Everyone who picked the most popular face was entered into a raffle for the prize.

Keynes’ argument was that a naïve strategy would be to simply choose what you thought was the most beautiful face.

A more sophisticated strategy would be to choose what you believed others would choose! It is the same with investments. My friend learnt it the hard way.

(The author is a Chennai-based investment strategist.)

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