Survivorship Bias - White Paper

Survivorship Bias - White Paper - A White Paper On...

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Unformatted text preview: A White Paper On Survivorship Bias 04.27.2010 The media always praises the survivors, but not the non‐survivors. We often hear about the stories of Bill Gates, Steve Jobs, Madonna and other celebrities that make a fortune. But we rarely hear about the stories of non‐survivors. Why is this the case? Are we engineered to just look at the survivors? Is it beneficial for us to only look at the survivors and not the others? Sandra Chan Kendrick Daniel Nudge Consultancy 1 Definition Survivorship bias, During a war, your a type of selection bias, is defined as the logical error of concentrating on people or things that “survived” some process and ignoring those that did not survive the process. In order words, the sample only includes those who survive the process and excludes those who do not. The survivors include anyone or anything that make it past some sort of a selection process to be considered further. The survivorship bias can lead to (1) overly optimistic beliefs since failures are ignored and (2) the false belief that successes in a group have some special property. In order to give you a better understanding of the survivorship bias, here is a brief story that illustrates the phenomenon: country sends daily bombing raids to into enemy territory. Many of the planes never return and those that do are covered in bullet holes from machine guns. Wanting to improve the odds of survival for planes, your engineers study the location of the bullet holes. The engineers reason that they should place more armor in the areas with the most bullets. After conducting an analysis of the planes, engineers notice that the bullets are clustered on the wings, tail, and rear gunner’s station. There are very few bullets found in the main cockpit or fuel tanks. Based on this information, the logical conclusion drawn by the engineers is to add more armor plating to the wings, tail, and rear gunner’s station. Believe it or not, this is the wrong thing to do. Planes with bullets in the cockpit or fuel tanks did not make it home; the bullet holes in the surviving planes where located in places that were essentially harmless. The real data of this experiment are in those planes that were shot down, not the ones that survived the process. Survivorship bias, a type of selection bias, is defined as the logical error of concentrating on people or things that “survived” some process and ignoring those that did not survive the process. 2 Survivors Should we trust the survivors? You may wonder, if I want to be a survivor, why can’t I just simply trust and imitate the survivors and ignore all the samples of non‐ survivors? The answer is absolutely NO. You should not blindly follow and trust what the survivors say or do. As human beings, survivors, just like other non‐survivors, exhibit the postcompletion error, which means once they finish their main tasks; they tend to forget things related to previous step. In other words, they cannot accurately tell you all the things they have done in order to survive. Following what survivors say or do in order to succeed by imitating them will not always lead you to the same result or outcome. Survivors may succeed simply because they are present at the right time, right place and right situation. Also, humans are influenced by a heuristic – representativeness. We often confuse random fluctuations with casual patterns. We stereotype survivors and underestimate the possibility of randomness or luck. Do we have evidence to prove that survivors are successful because of certain things such as complex decision analysis and not because of luck? If you go to the “Leadership” section of a bookstore, there are a lot of different books that talk about the most successful leaders, the survivors, who are most often used in describing what makes a good leader. These leaders are often very unique cases and do not fully represent the population. How can you compare Steve Jobs with Madonna? Leadership is a process, not simply a position. The success of a leader can be attributable to a range of things such as external factors or the characteristics of the leader. Or survivors may succeed simply because they are present at the right time, right place and right situation. 3 Why does survivorship bias exist? The survivorship bias exist because we have been trained since the beginning of time to take advantage of information that is lying directly in front of us and ignore information that we do not see. Humans have developed heuristic methods to help in problem solving, learning, and discovery. The presence of these heuristics leads to biases in everyday decision‐making. Throughout the remainder of this report, we will illustrate real word examples in which survivorship bias occurs and elaborate on the implications of this phenomenon in our society. Reasons for Existence The fundamental point of the survivorship bias is that we do not select or look at a sample that is representative of the entire population. Humans have the tendency to ignore failures and only look at those things that are most salient about the survivors. This action alone represents something that is not right because one cannot assess the population without looking at the non‐ survivors. The non‐survivors and the survivors are the complete, all‐encompassing population. The survivorship bias exist because we have been trained since the beginning of time to take advantage of information that is lying directly in front of us and ignore information that we do not see. 4 Implications ‐ Community Focusing Illusion Focusing Illusion An instance of this would be the fact that humans tend to focus on notable differences and exclude those that are less noticeable. The focusing illusion commonly arises in situations in which individual assess their well‐ being. Humans have a tendency to concentrate attention on the influence of a single factor on their well being and tend to exaggerate its importance relative to other factors that also contribute to one’s well‐ being. When one looks at the survivors, one may simply look at the salient differences Community Instincts Focusing illusion is the tendency of humans to make judgments based on attention to a subset of available information. Humans tend to place much emphasis on this information and put less emphasis on information that is not available. This is related to the survivorship bias as we have a tendency to put more emphasis on the “survivors” which in this case are those things that survive among the vast amounts of information that are present within the environment. such as the glamour of name brand clothing the survivors are wearing, the fancy restaurants they go to and forget to look at those things such as a person’s job or what that person actually does to attain the things that they currently have. Humans tend to place much emphasis on this information and put less emphasis on information that is not available. Community Instincts Social Instincts based on survivorship bias may not be the best for you. Humans are different from their primate ancestors and other animals because we do not only possess family instincts, we also possess community instincts. Community instincts allow us to identify with a larger, symbolically marked group of people and emotionally attach ourselves to this group. However, how do we know if we choose the 5 Implications ‐ Community Focusing Illusion Community Instincts right group? The survivorship bias causes us to only view those that are successful and our community instinct fosters our desire to hang out with a group of people that we want to identify with. Human beings are social creatures that want to choose and fit in with a significant group. In an attempt to be a part of a social group, we try to conform to the norms of the desired group. As a result, people who want to be successful hang out with those who are already considered successful and imitate them. However, gaining membership in the “successful” group or imitating survivors does not guarantee or change the likelihood that we are going to succeed. As the book Fooled by Randomness suggests, “All these activities can put high demands on one’s time and divert the subject from what should be the real preoccupation, namely the accumulation of nominal and (the paper) wealth. ” Eventually, we may end up broke and experience social exclusion when we no longer have the financial capability to live a luxurious life. Also, if we just hang out with survivors who are wealthy, it is difficult to assess the situation outside of our group. We will not realize how lucky or how good our living is compared to other non‐survivors. Therefore, we may be better off living or hanging out with people who are equally or less successful, so that we can recognize how lucky we are, which will allow us to be psychologically healthy and mentally satisfied. Gaining membership in the “successful” group or imitating survivors does not guarantee or change the likelihood that we are going to succeed. 6 Implications ‐ Finance Investment and Ignorance of Risk Investment and Ignorance of Risk The survivorship bias is also present in finance. The most significant example of this is present in the performance valuation of mutual funds. Mutual funds companies exclude the past returns of funds or companies that have failed or merged with other companies at some point during the year. The market assessment is solely based on the survivors – the companies or funds that still exist today. This action leads one to ignore some of the risk that is present because of the exclusion of failing companies or funds. Some of the risk (which should be represented by the failing companies) is being ignored, Some of the risk (which should be represented by the failing companies) is being ignored, intentionally from the analyst’s side and unintentionally for the intentionally from the potential investors analyst’s side and because of unintentionally for the survivorship bias. potential investors because of survivorship bias. This causes the valuation of the mutual funds to skew towards the higher end and is overly optimistic. If investors are aware of the presence of the survivorship bias involved in mutual funds, analysts will realize that non‐survivors do not show up in the data provided. They essentially become more knowledgeable and conscious about the risks involved when investing in a mutual fund. 7 Implications ‐ Recognition Recognition Heuristic Conjunction Fallacy Recognition Heuristic The survivorship bias phenomenon is also present in the recognition heuristic. The recognition heuristic states that: “If one of two objects is recognized and the other is not, then infer that the recognized object has the higher value with respect to the criterion.” Since we often emphasize the qualities of survivors, we use the information about these survivors when we make decisions. We can easily recognize and value those who have the traits of the survivors more than those who do not have those traits. The process of recognizing the traits of survivors is fast and frugal and only little time and information is needed. Conjunction Fallacy The conjunction fallacy works in tandem with the survivorship bias in certain situations. The conjunction fallacy occurs when the likelihood that two or more characteristics are simultaneous true are judged more likely than one of the characteristics being true. The media often concludes that leaders have certain set of qualities, instead of just one main quality. Conjunction fallacy frequently occurs when we assume that a successful person is more likely to have this set of characteristics than just one of the characteristics alone. We rarely think that a (potential) leader will only have one quality. For example, we may think that charisma and passion are essential for a great leader, instead of just charisma or passion alone. If one only demonstrates one characteristic, we assume that he or she will be less likely to be a good leader. We forget that there are a lot of different kinds of leaders and leaders may not have the same qualities as the media has praised or broadcasted. The process of recognizing the traits of survivors is fast and frugal and only little time and information is needed. 8 Conclusion The survivorship bias is a phenomenon that is present in many situations throughout society. The presence of the bias can lead to overly optimistic beliefs about a situation and can also lead to the false belief that survivors in a group exhibit some sort of special quality. The survivorship bias has many implications for humans with the most relevant being its effect in a social context. Learning about the survivorship bias makes one less vulnerable to the consequences of the phenomena. An individual that is aware of the bias will know what questions to ask which helps the individual put things into perspective. This will also challenge the individual to look beyond the numbers. one must realize the intelligence of the unconscious and use it to make better and more informed decisions in one’s daily life. Last but not least, the knowledge will remind you about the significance of unknown data or information. We are built to see patterns, to find causes for things, and to believe in our own rationality. These are things that we cannot help doing. In order for one to become a more knowledgeable individual, 9 References Gigerenzer, Gerd. Gut Feelings: the Intelligence of the Unconscious. New York: Viking, 2007. Print. McDonald, Ian. The Survivor Effect. Digital image. Mutual­Fund Math Puts A Sheen on Returns. Wall Street Journal, 23 July 2004. Web. 22 Apr. 2010. <http://pages.stern.nyu.edu/~adamodar/New_Home_Page/article s/mutualfundsurvbias.htm>. "Survivorship Bias." Wikipedia, the Free Encyclopedia. 23 Apr. 2010. Web. 27 Apr. 2010. <http://en.wikipedia.org/wiki/Survivorship_bias>. Thaler, Richard H., and Cass R. Sunstein. Nudge: Improving Decisions about Health, Wealth, and Happiness. New Haven: Yale UP, 2008. Print. 10 ...
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