Managing cognitive risk in real estate

Abstract

This paper explores cognition and its impact on the uncertainty and risk that surround real estate enterprises. We posit that cognition creates its own risk and affects risk from other sources in many ways, and we situate an overlay paradigm within a behavioural real estate paradigm. We develop the concept of cognitive risk, and examine it using a multidisciplinary perspective. We explore approaches to managing cognitive risk and offer a framework for further research and development of cognitive risk and its management.

Keywords:

• cognition
• risk
• cognitive risk
• risk management
• behavioural real estate
• rational choice

Acknowledgement

The authors would like to thank an anonymous referee for his/her thoughtful comments that improved this paper.

Notes

1. For discussions of bounded rationality, see Simon (1979, 1990). The 1979 paper is Simon's acceptance speech when he was awarded the Nobel Prize in Economics. For another perspective on the value of the concept of bounded rationality, see Gigerenzer and Selten (2002).

2. Cognitive psychology research on these topics is extensive. Individual articles such as Kahneman and Tversky (1979) and Lindblom (1959) provide useful insights. Interesting collections of articles and original papers are to be found in Kahneman, Slovic and Tversky (1982); Arkes and Hammond (1986); Zey (1992); and Kahneman and Tversky (2000). Evans (1989) provides a very succinct and readable discussion of bias in human reasoning. An early application of cognitive psychology to economics is Maital (1982).

3. Rational choice theory (RCT) is based on instrumental rationality that assumes that an individual has a set of objectives and assesses the rationality of a decision on the likelihood of it satisfying one or more of these objectives. This form of rationality provides the foundation for preference ordering of bundles of goods and services and the development of a utility function representing a unique monotonic transformation of preferences. Instrumental rationality provides a closed system of ordering which produces measures in units of utility even though these units are stripped of any traditional connotations of pleasure or enjoyment and are not appropriate for making interpersonal comparisons of utility. In essence, RCT posits that one can compare bundles of goods and services and make consistent rankings and preferences. This summary of RCT is based on Dawes (1988), Heap, Hollis, Lyons and Weale (1992), and Wofford (1995).

Heap et al. (1992) and Dawes (1988) provide excellent discussions of instrumental rationality in economics and business in general. For a very readable discussion of expected utility, see Von Neumann and Morgenstern (1972).

4. Kuhn (1970) realised that in his original work he had numerous definitions of paradigm (over 150 by some counts) and sought to remedy this situation in the revised edition of his classic work, The structure of scientific revolutions. While these various definitions of paradigm may create issues for philosophers of science, they have little impact on the practical application of the concept of paradigm in this paper.

5. For exhaustive listings of these papers see Grissom and Liu (1994), Clapp et al. (1994) and Jaffe (1994).

6. See Reason (1997) and Hollnagel (2004) for discussions of the errors possible in routine situations.

7. For an excellent collection of articles on fundamental issues in cognitive science see Goldman (1993).

8. For a more complete listing of error or failure types see Reason (1990).

9. See Collins (2009) and Weick and Sutcliffe (2007).

10. For discussions of planning and how rational it can be, see Lindblom (1959, 1977), Forester (1984), and Kochen and Barr (1986).

11. For a thorough discussion of unintended consequences see Tenner (1996).

12. The presentation and use of data is considered by Tufte (1990, 1997). Dashboard design, construction and implementation are considered by Few (2006).

13. See Cerulo (2006) for a discussion of problems in anticipating the worst. For an excellent discussion of the issues in learning from experience see Dawes (1988).

14. Ozdilek (2010) develops a very interesting and useful treatment of time as it relates to price, cost and value.

15. Hollnagel, Woods and Leveson (2006) identify general systems models. Preventative models, or defences, will vary depending on the type of system involved.