You bought a house for a price that you think is good and in a locality that appears posh. After moving in, you realise that you paid at least 15 per cent more than the going rate. Besides, you find the neighbourhood uninteresting. What will you do?

If you prefer to take corrective action, you may even sell the house for a loss and move out. Typical behaviour indicates that you may spend more on the house to make it look better. This is because you are committed to your prior decision of buying the house. Behavioural psychologists call this escalation bias. It refers to our tendency to invest more in a seemingly losing proposition.

Bidding for the best

Consider this experiment. Subjects were asked to bid for a twenty dollar bill. The highest bidder, declared the winner of the auction, would buy the bill for the amount she bid for. The catch was that the second highest bidder would also pay the price at which she bid for but receive nothing in return.

Researchers found that two bidders typically continue till the end, one trying to outbid the other. All other bidders normally drop out half way into the auction, realising that it would be costly if they end up being the second highest bidder. On one occasion, the winner paid $212 to buy the $20 bill, determined not to be the second highest bidder. That, in essence, is escalation bias.

We often “throw good money after bad” because we want our decision to turn out well. Not surprisingly, research has shown that we tend to invest more money in a project if we receive feedback that the project is failing than if it is succeeding.

And if this sounds too familiar, it is because we display similar behaviour with our personal investments. If you buy a stock and it moves up, you are unlikely to buy more. But what if the stock declines? You will most likely feel compelled to buy more shares.

(The author is the founder of Navera Consulting. He can be reached at >enhancek@gmail.com )

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