Why Optimism Bias Is Not Good
As the investor closed the 1 million dollar deal, he felt confident, engaged, and unbreakable. In a rising economy, he made very positive predictions about the housing market, and profits were the only thing on his mind. Then the housing bubble burst. This article is about what happened with the investor, the positive and negative sides of the optimism bias; the belief in our own superior future life which affects our perceived susceptibility to risks.
There are four distinct reasons why the optimism bias occurs. The first has to do with the desired end-states of comparative judgements. People are motivated to perceive/portray their risk as less than the risk of others because this is what they want to believe or want others to believe. This can be used for self-enhancement, self-presentation, and/or personal control. People are motivated to present themselves (and others) with a better, more in-control, world than there really is.
The second reason for the optimism bias lies in the cognitive mechanisms that guide judgement. Part of the construct is the representativeness heuristic, options that are more representative of the event/entity, from the viewpoint of the observer, are more often remembered. A singular focus on the target and estimating your personal risk lower than average are two other cognitive mechanisms that enhance the optimism bias.
Our information is not perfect and the third reason for the optimism bias is due to the difference in the amount and type of information available about the self versus the average person. The person-positive bias is the tendency to evaluate an object more favourably the more it represents a human being. Egocentric thinking causes people to consider desired outcomes and fail to consider adequately impediments that are likely to occur. At the same time, we underestimate the average person’s level of control.
The underlying affect (not to be confused with effect) is the final reason for the optimism bias. An affective state facilitates access to mood-congruent memories and cognitions. Because the ambient mood (for most people) is positive, positive memories and cognitions prompt judgements of low personal risk and focus the attention on the desired outcomes. Together all four processes turn us into ‘happy thinkers’, and that can certainly have some very positive effects.
Having introduced the optimism bias, it is time to look at the positive side. A very big positive aspect of the optimism bias is the effect on the life span it can have. Research has found that people in hospitalization will live longer if they are more optimistic about their lifespan (when other conditions are similar). The specifics about the why, and how are very debatable. What stands is that people who are more optimistic about the future, who for instance think more positive thoughts because of the underlying affect, tend to live longer.
Also in non-life threatening situations, the optimism bias has a positive effect on our perception of the world around us. People with more optimism (which in objective terms is not justifiable) have a better mood. They are less prone to depression and are more willing to face challenges. When looking at the investment banker this has resulted in a bad ending, but what about the entrepreneur who is launching an untested, new product, some optimism will help him push further. Even in the sight of backlashes and bad results, the optimism bias helps keep our emotions on the upside!
Your health and mindset can be improved by having an optimism bias. But through the same mechanics, severe damage can be inflicted. About 85% of people consider themselves to be better than average (50%) drivers, something that is quite impossible to be true. People, therefore, overestimate their skill in driving. Studies have found that people with optimism bias, especially considering their driving skills, are prone to more car accidents. The younger, and male, participants were considered to have the most optimism bias.
Because of egocentric thinking people also underestimate risks in other domains. One of these domains is smoking. People who smoke are aware of the risks and correctly estimate that they are at more risk of lung cancer than people who do not smoke. The optimism bias, especially egocentric thinking, allows people who smoke to neglect the risks for themselves and therefore underestimate the risk of lung cancer severely when compared to the risk they assign to other smokers.
Investing in stock has yielded positive results year after year. Investment bankers that were around for not too long may even have never seen a single big loss. Representative for investing was profit, not risk, nor loss. The desired end-state of investing was profits, and everyone was overestimating the profitability of the mortgage market (among others). Egocentric thinking finally eliminated any thoughts of losing money and people were creating a bubble, to large to survive. Exactly five years ago Lehman Brothers declared bankruptcy, the end of the optimism bias era, the start of the crisis. The banker from the beginning of the article now is back on the market, more cautious than before, fresh with memories of toppling banks and unsellable houses. He has temporarily been relieved of his optimism bias, but will this effect last? What will be the future of our economy and how will we prevent this from happening again? These are subjects for a later article.
Some final remarks. The optimism bias takes away some sense of reality. It is a two-sided coin. The one side allows us to be happier, and even impact our health to our benefit. On the other side is more risk-taking behaviour, worse judgement of health risks and bad investors. Enjoy the benefits, but be cautious about the downsides.
References & Further Reading:
5. Prabhakar, T., Lee, S. H. V., & Job, R. F. S. (1996). Risk-taking, optimism bias and risk utility in young drivers. In ROAD SAFETY RESEARCH AND ENFORCEMENT CONFERENCE, 1996, COOGEE BEACH, NEW SOUTH WALES, AUSTRALIA.