Reflexivity in daily life: A theoretical perspective

 Theory of Reflexivity

Generally in finance the "Reflexivity theory states that investors don't base their decisions on reality, but rather on their perceptions of reality instead" - George Soros.

In other words, stock prices might increase or decrease the equilibrium values by a significant amount persistently over time.

This is because the process of price formation is reflexive and dominated by positive or negative feedback loops between prices and expectations. 

Reflexivity in our life

We used to adhere to the principle of reflexivity without consciousness in actual life as well. Consider the following scenario: You are the batter and you observe a field for bouncers. As a result, you prepared for a bouncer on your positive loop or a yorker or some other deliveries on your negative loop. But what drives a person to choose a positive or negative loop? 

Don't think it's just about the probability. Because it's not about probability, flipping a coin relies just on probability and it's independent of external factors. But in this case, the rewards and dependent of external factors will determine whether we are more tempted to follow a negative or positive loop. But how does it depend on the situation?  Let's go back to the example, If a batsman wants to get a run whether it comes from a yorker or a bouncer, he will aim to hit the ball in that manner. If however he doesn't want to lose a wicket, he will go defensively.

The inclined towards positive or negative loops is therefore based on rewards, but rewards are not only the case, it also require a situation.

In this case, in an early over a wicket is considered to be a more valuable reward than runs, whereas in a dead over a run is considered to be a more valuable reward than a wicket.

Why we need to understand the "Theory of Reflexivity" in our life?

Because it saves our time and efforts, as per the book "Thinking fast and slow" our brain is designed to take a quick action and this is called a system 1, it consider as a fast, instinctive and emotional. Whether the system 2 is consider as a slow, deliberative and logical.

Therefore, our system 1 brain will automatically activate whenever we are in a reflexivity circumstance, causing our decisions and actions to trigger immediately and operate in accordance with the perception of reality rather than the reality.

How to check the perception of reality and reality?

Because our sense of reality and the reality we experience are inversely correlated with the rewards we receive, it lacks any clearly defined methods of verification. Both a favorable and a negative outcome are possibilities. We grew to believe that the past circumstance is a reality or a perception of reality based on the rewards we received.

The likelihood that a scenario will play out in the future differs from the likelihood that it did in a previous incarnation.  It is solely based on the hypothesis of the butterfly effect. 

(The butterfly effect rests on the notion that the world is deeply interconnected, such that one small occurrence can influence a much larger complex system)

Why we have to know about the theory of reflexivity? 

The solution is that being aware of the circumstances will help you to lower the likelihood of failure. 

The Daniel Kahneman Theorem will assist us in lowering the probability of failure.

A) Prospect theory - "most people prefer winning $50 with certainty rather than taking a risky bet in which they can toss a coin and either win $100 or nothing"

B) Endowment effect - " It describes a circumstance in which an individual places a higher value on an object that they already own than the value they would place on that same object if they did not own it"

For example: When potential buyers take the car for a test drive, the endowment effect begins to influence. They pretend to be the real owners of the car and as a result are ready to spend more money on it because of their emotional attachment.

Therefore, it's not a good idea to entirely lean towards perception of reality rather than reality unless until we are not sure about that.  In that case, we will attempt to take partial action in this situation and depending on the success rate, we will take additional action which will prevent us from making an emotionally charged judgement and weighing the pros and cons allows us to use the System 2 brain rather than the System 1 brain. Humans in general tend to favor's decisions that our emotions associated with. When we associate strongly about something, our emotions tend to override our rationality, which causes our brain to look only for data that supports us and ignore that which does not. In order to make better decisions in a scenario, it is therefore preferable to discuss the data with someone and get their thoughts before doing an analysis of it. These things will enable us to see how reality and perception of reality are related at some extend.