Saturday, September 7, 2019

Hick's Law Applied to Investments - Too Many Darn Choices!



There is rule used to describe the relationship between choices and reaction time called the Hick-Hyman Law or Hick's Law. An increase in the number of choices presented for a decision leads to a longer reaction time. It has been applied to marketing, product development, education and other assorted fields. The law has not been applied to investments, yet the extension seems natural.

If there are more investment choices, whether mutual funds or ETFs, there will be a longer reaction time before any choice is made. If there are too many choices, then at the extreme no decision is made. 

More importantly, for traders, if there is more information to choose from, there will be a lower decision reaction time. If there are more policy choices for what action central bankers will take, there will be a longer reaction time.


There are solutions to the Hick's Law problem.  

  • Use models to cut down the choices and speed-up reaction. In the simplest case, the choice could be based on trends in price. A more complex model choice would be to use only a limited number of fundamental information inputs. A model will cut the processing time for any decision.
  • Follow rules. This is a variation on the model idea and will increase reaction time regardless of information used. 
  • Categorize information that is similar to cut the number of choices. For example, valuation measures can be bundled or aggregated for a single decision.
These solutions come in two types: one, reducing the choice set and cutting the noise and two, increasing the reaction time through hard-wiring how a decision will be made. By thinking about the basics of Hick's Law investors can fight the current problems of increased uncertainty from too many choices.

No comments: