Anchoring and Adjustment Heuristic in behavioral finance

Abstract

As a result of changing and evolving times, there is a growing realization that dogmatic economic theories cannot meet the practical needs of market analysis. Under such circumstances, behavioral economics came into being. This paper briefly introduces the origins of behavioral finance, highlighting the role of anchoring and adjustment effects, two psychological heuristic bias in the financial market, and analyzing the pros and cons and countermeasures. From the Nobel Prize of Richard Thaler in 2017, people began to realize the importance of behavioral finance and separating it with normal economic. To understand the way to introduce social psychology phenomenon to economic, we start from explaining anchoring bias on customers and then point out how people use adjustment behavior to correct it and the importance of this behavior. The explain of concept is followed with four familiar and detailed examples of the anchoring and adjustment heuristic in behavioral finance. The examples are all about how to use anchoring and adjustment strategy. First, we will talk about product display and marketing using this strategy. The brands set up an expensive and luxury product to give customers a high prediction of the price of the product they will actually buy. When they see the actual price of the product they are going to buy, it would be much lower that there expect. As a result, they would regard themselves as picking up a bargain and purchase it without hesitation. Similarly, in a court of law, judges are influenced by juries, proving that the anchoring effect does not change depending on the amount of knowledge base (non-experts can influence experts). Also, the anchoring effect can be applied to games. People can judge the psychological price floor of their opponents by first offer thus gaining higher returns. The emergence and popularity of the interdisciplinary discipline of behavioral economics also reflects the need for interdisciplinary connections and innovation.