Definition
Representativeness bias causes investors to make probability judgments based on superficial similarity rather than statistical evidence. A company with a compelling narrative that "looks like" the next Amazon gets assigned high success probability regardless of base rates. This leads to paying excessive premiums for "story stocks" and ignoring statistical realities of business failure.
lightbulb Example
A small EV startup has charismatic leadership and compelling vision—it "looks like" early Tesla. Investors assign 50% chance of massive success. Base rate reality: 90% of startups fail, and EV competition is fierce. The "representative" comparison masks poor odds.
verified_user Key Points
- Judges probability by superficial similarity
- Ignores base rates and statistical evidence
- Creates overvaluation of "story stocks"
- Small sample sizes are particularly misleading