Recency Effects in Geology & Financial Markets
Recency effects – we overweight near-term events and underweight everything else – cause havoc in financial markets. It causes us to think of the last few years as normal, whether it’s housing, technology stocks, equity multiples, or the ease with which you can raise venture capital. It generally takes a crisis to disabuse us of the idea, which is an awfully high price to pay when the alternative is simply paying slightly more attention to history.
The problem is much worse in geology, however, when it can range from thousands to millions of years between catastrophic events. Almost every major geological problem occurs rarely, at least in the sense of short human lifespans, but most still have a likelihood of 100% of one day occurring again.
To the preceding point, consider this quote from a 2001 paper about Hualalai lava flows:
Public and perhaps official understanding of specific lava flow hazards and the perceptions of risk from renewed volcanism at each volcano are proportional to the time lapsed since the most recent eruption that impacted Kona, rather than a quantitative assessment of risk that takes into account recent growth patterns.
Source: C. E Gregg et al., “Perception of Lava Flow Hazards and Risk at Mauna Loa and Hualalai Volcanoes, Kona, Hawaii,” December 2001, http://adsabs.harvard.edu/abs/2001AGUFM.V12B0972G. )
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According to a recent survey conducted by the same researchers, even residents of the west coast of Hawaii’s big island have little idea of the hazards they face.
On average less than two-thirds of residents were aware of the most recent eruptions that impacted Kona and a minority felt that Mauna Loa and Hualalai could erupt again. Furthermore, only about one-third were aware that lava flows could reach the coast in Kona in under three hours …Hazard awareness and risk perception varies between subpopulations defined by age, geography, and ethnicity. Long time intervals since damaging lava flows have occurred in Kona has contributed to lower levels of awareness and perception of the threat.
Source: C. E Gregg et al., “The Perception of Volcanic Risk in Kona Communities from Mauna Loa and Hualalai Volcanoes, Hawai`i,” December 2002, http://adsabs.harvard.edu/abs/2002AGUFM.V12B1431G.