This is the 2nd part of a 6 part series on how cutting-edge text analysis technology is helping investors mitigate the detrimental effects cognitive biases can have on their decision-making.
The BOE Call: Built on Bias
Markets are extremely complex, and no one outcome is the result of any one cause. Nevertheless, it seems likely that confirmation bias played a role in the incorrect forecasts of the BOE’s post-brexit policy decision. As Peter Lazaroff writes in Forbes, confirmation bias can be thought of as
…the tendency for investors to seek information that supports their decision or thesis and avoid/ignore information that contradicts it. For example, an investor gets an investment tip from a friend and decides to do some research. While doing research, investors often find all sorts of positives while glossing over the red flags in trying to “confirm” the return potential of the investment. As a result, this bias results in a poor, one-sided decision making process. This bias also occurs to many investors with investments they’ve made recently as people don’t like acknowledging devaluing evidence that might discount their claims.
In other words, confirmation bias encourages one to interpret evidence in favor of a conclusion one has already come to. And when one digs into news articles published in the weeks leading up to the July 14 monetary policy meeting, it seems clear that the Brexit vote had convinced many that the outcome was a foregone conclusion. As a MarketWatch article published on June 28 stated, “investors are expecting a rate cut at the next Bank of England meeting in two weeks after the surprise vote in the U.K. last week to leave the European Union sent shock waves through global financial markets.”
Long before Carney uttered a word, many analysts had their answer. And, when he did speak, the analysts saw his words through the lens of that answer, their minds highlighting every negative word and pessimistic passage along the way.
Beating Confirmation Bias
The reason analysts got this call wrong was not because they are bad at their jobs. Instead, the reason analysts got this call wrong was because they are people. Cognitive biases are pervasive in human thought, and the calculations of market analysts are not immune.
It is due to this universal susceptibility that financial professionals need tools to check their biases. Although written by human analysts, the correct analysis of Mark Carney’s speech and monetary policy forecast were based on a score generated by an automated text analysis system. This system uses an algorithm to assess the historical relationship between a central bank’s language and market reaction. Using this analysis as a reference, the system is then able to evaluate subsequent communications from a central bank. The resulting evaluations are unbiased, comprehensive, and quantitative scores of a particular communication’s tone.
Carney’s speech received a neutral score based on sentiment analysis, indicating the Governor’s tone was moderate instead of dovish. This, of course, contradicted the prevailing interpretation of Carney’s language. Instead of dramatically increasing the likelihood of a rate cut, this data pointed to a hold. Analysts using sentiment analysis in this case were provided with an unbiased check on their own confirmation bias.
Next week’s article focuses on the perils herd mentality poses to investment professionals.
The Prattle Team