Role of Context in Investment decisions:Evidence from Psychology

An interesting study run by Shepard Siegal (1975) reveals that standard dosage of a particular drug becomes less and less effective, if administered in the same context; but the same dose administered in an entirely different and/or new context will have more of an effect.

This study hypothesized that tolerance develops because the cues associated with the context in which morphine (a derivative drug) is administered (room, cage, and surroundings) come to elicit in the mouse, as a subject under study, a learned compensatory mechanism that counteracts the effect of the drug. It is as if the mouse has learned to turn off the brain receptors through which morphine works, making the morphine less effective. As this compensatory mechanism develops over a series of trials, an animal require larger and larger doses of morphine to have the same pain-killing effect. But suppose that larger dose of morphine is given in an entirely different context. Because the context is different, the animal does not compensate for the morphine because it does not recognize that drug is coming. Without the counterbalancing effects, the animal should now experience the full effect of the larger dose of that drug.

So, the difference lies within the psychology of the subject.

Seeing this study in the context of stock market investors, it can be assumed that the same information coming to the investors in different context have their separate impact on investment decision-making. It also means that apart from other things, what is equally important is the CONTEXT in which the piece of information is administered to the subject (investors).

Investors in general and individual investors in particular, tend to behave in tandem with the piece of information relevant to their investing consideration. They process the information for their decision making in a bit hurry and that invites cognitive biases on the investors’ side. The context plays a crucial role in the processing of information by the investors. They are likely to make mistakes while considering the pool of information for their investment decisions. If they receive the same information that they received in the past, in a completely new context, there is possibility that their decisions would be influenced, more or less adversely. It is suggested to the investors not to be swept away by the piece of information being delivered to them in a different context. That may prove financially fatal for their investments.

Happy Investing in the new year 2010!!

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