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Turning the heat on financial decisions: Examining the role temperature plays in the incidence of bias in a time-limited financial market

Turning the heat on financial decisions: Examining the role temperature plays in the incidence of bias in a time-limited financial market
Turning the heat on financial decisions: Examining the role temperature plays in the incidence of bias in a time-limited financial market
Many laboratory-based studies provide evidence that temperature can influence how people make decisions, by affecting their risk preferences and propensity to make cognitive errors. However, the role of temperature on the quality of decisions made in real-world settings it is not well-understood. A strand of literature in financial markets has attempted to explore this, but the results have been inconclusive: some studies suggest that temperature does not affect financial decisions, whilst others reach contrasting conclusions – some suggesting that higher, and others that lower temperatures, reduce the quality and economic value of financial decisions. We design an empirical experiment to overcome the limitations of previous studies in order to shed new light on the role of temperature in financial decisions. The study employs data from a time-limited market for state-contingent assets, namely an event-driven prediction market. We assess the extent to which prediction market participants’ subjective judgments of event probabilities deviate from the actual probability of the event occurring, as a result of temperature-induced cognitive errors and risk-taking. The results demonstrate that higher temperatures are associated with lower decision quality. We also found that temperature differentially influences the decisions of those with different decision profiles, with the largest influence observed on individuals whose decisions are based on logic, objectivity and skilful cognitive evaluations of alternatives.
Betting market, Decision bias, Forecasting, Risk taking, Weather effect
0377-2217
1142-1157
Costa Sperb, Luis Felipe
9e42a3f1-c9be-45b9-8680-eb558b52aab3
Sung, Ming-Chien
2114f823-bc7f-4306-a775-67aee413aa03
Ma, Tiejun
1f591849-f17c-4209-9f42-e6587b499bae
Johnson, Johnnie E.V.
674f4c91-b889-4566-82cd-c0a33b4beaac
Costa Sperb, Luis Felipe
9e42a3f1-c9be-45b9-8680-eb558b52aab3
Sung, Ming-Chien
2114f823-bc7f-4306-a775-67aee413aa03
Ma, Tiejun
1f591849-f17c-4209-9f42-e6587b499bae
Johnson, Johnnie E.V.
674f4c91-b889-4566-82cd-c0a33b4beaac

Costa Sperb, Luis Felipe, Sung, Ming-Chien, Ma, Tiejun and Johnson, Johnnie E.V. (2022) Turning the heat on financial decisions: Examining the role temperature plays in the incidence of bias in a time-limited financial market. European Journal of Operational Research, 299 (3), 1142-1157. (doi:10.1016/j.ejor.2021.09.048).

Record type: Article

Abstract

Many laboratory-based studies provide evidence that temperature can influence how people make decisions, by affecting their risk preferences and propensity to make cognitive errors. However, the role of temperature on the quality of decisions made in real-world settings it is not well-understood. A strand of literature in financial markets has attempted to explore this, but the results have been inconclusive: some studies suggest that temperature does not affect financial decisions, whilst others reach contrasting conclusions – some suggesting that higher, and others that lower temperatures, reduce the quality and economic value of financial decisions. We design an empirical experiment to overcome the limitations of previous studies in order to shed new light on the role of temperature in financial decisions. The study employs data from a time-limited market for state-contingent assets, namely an event-driven prediction market. We assess the extent to which prediction market participants’ subjective judgments of event probabilities deviate from the actual probability of the event occurring, as a result of temperature-induced cognitive errors and risk-taking. The results demonstrate that higher temperatures are associated with lower decision quality. We also found that temperature differentially influences the decisions of those with different decision profiles, with the largest influence observed on individuals whose decisions are based on logic, objectivity and skilful cognitive evaluations of alternatives.

Text
FLB EJOR Final Version v. 04-08-2021 - Accepted Manuscript
Restricted to Repository staff only until 9 October 2023.
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More information

Submitted date: 4 August 2021
Accepted/In Press date: 29 September 2021
e-pub ahead of print date: 9 October 2021
Published date: 16 June 2022
Additional Information: Publisher Copyright: © 2021 Elsevier B.V. Copyright: Copyright 2021 Elsevier B.V., All rights reserved.
Keywords: Betting market, Decision bias, Forecasting, Risk taking, Weather effect

Identifiers

Local EPrints ID: 451822
URI: http://eprints.soton.ac.uk/id/eprint/451822
ISSN: 0377-2217
PURE UUID: 794fa65d-be3e-4bbe-a017-ca06fdf8daf5
ORCID for Ming-Chien Sung: ORCID iD orcid.org/0000-0002-2278-6185

Catalogue record

Date deposited: 28 Oct 2021 16:36
Last modified: 29 Oct 2022 01:40

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Contributors

Author: Luis Felipe Costa Sperb
Author: Ming-Chien Sung ORCID iD
Author: Tiejun Ma
Author: Johnnie E.V. Johnson

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