Illusion of Control

Illusion of control refers to people’s tendency to believe that they have control or at least can influence the outcome of uncontrollable events. For example, people might judge their subjective probability of personal success to be higher than the actual, objective probability.

The illusion of control bias leads to overconfidence and overoptimism, two other more well-known behavioral biases.

Examples of illustion of control

As first example, let’s consider the following set up. In an experiment, research found that when people were given the choice between paying for a lottery in which they could select their own number or being randomly assigned one, people were willing to pay more if they could choose their own number. This suggests that, although the probabilities remained exactly the same, their subjective probabilities were biased due to the illusion of control.

Another clear example is related to how people estimate the likelihood of being involved in a car accident. We present you two scenarios, and you can choose a probability ranging from -5 (less likely) to + 5 (more likely):

Compared to other drivers, how likely do you think you are of being involved in a car accident when ________?

Scenario 1: you are driving the vehicle
Scenario 2: you are a passenger

Research found that subjects assessed a likelihood of -1.41 in Situation 1, and 0.01 in Situation 2. So people think that they are less likely to be involved in a car accident when they are driving the car, i.e. when they are in control.

Consequences

Having an illusion of control could cause you to trade more and might lead to improper portfolio diversification, i.e. you put your money in things you think you have a lot of control over (e.g. your own company). Having an illusion of control will also make you less focused.

Summary

The illusion of control causes us to underdiversify and to trade too often.

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