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2021 CFA Level III > Behavior Finance 7-9 > Flashcards

Behavior Finance 7-9 Flashcards

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CFA flashcards
1
Q

traditional finance

A

investors are rational, risk averse, self-interest utility maximizers
unlimited knowledge

neoclassical economics

market is efficient (EMH)

Bayer’s conditional probability

Utility theory

REM (rational economic man) use indifference.curve analysis

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2
Q

Behavior finance irrational/suboptimal

BPT
Behavioral portfolio theory:
1. constructed in layers 
2. concentrated in the low and high risk asset.
Median-risk asset tend to be ignored.

Mean variance considers correlation between assets and would be more likely to diversify across asset types.

A

psychological grounded

BFMI Micro: individual
emotional bias

BFMA Macro: market
efficiencies of markets

Bounded rationality - limitation on ability to process info
Prospect theory - loss averse, reference dependence to determine g/l leading to possible cognitive error
Satisfice
capacity limitation of knowledge

friedman - savage double inflection utility functon
很贫穷和很有钱会risk averse
在中间 risk seeking

sentiment risk

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3
Q

Risk averse

A

rational
concave
prefer certainty

pay to avoid

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4
Q

Risk seeking

A

convex
risk seeking
certainty equivalent : max(pay to participate)
max(accept to not participate)

pay to undertake

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5
Q 
Perspective analysis (effort to use behavior finance)
Prospect theory ( how g/l are evaluated)
A

based on SEU subjective expected utility

Bounded rational is adequate, satisfied 满意

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6
Q

6 editing to simplify evolution of choices

A 
codification
combination
segregation
cancellation
simplification
detection of dominance
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7
Q

weakform

A

technical cannot generate excess return

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8
Q

semi-strong

A

fundamentally cannot generate excess return

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9
Q

strong-form

A

no one can earn excess return

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10
Q

3 market anomalies

A

fundamental - P/E dividend yld
violation of both semi-strong and strong form efficiency

technical - violation of all 3 forms efficiencies
ST moving avg of price move above LT moving avg - buy signal
stock move below a support level - sell
stock move above a support level - buy

Calendar anomaly - small cap have abnormally high return in Jan last day of each month and first 4 days of each month

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11
Q

behavior portfolio construction

A

consumption and saving

Behavior portfolio theory (layer) focus on portfolio construction

Behavior asset pricing model postulates a sentiment premium should be included in asset pricing

adaptive market hypothesis (AMH) principal of evolution, success is defined as survival, markets change overtime, arbitrage opportunity get priced into the market. assumes successful market participants apply heuristics until they no longer work and then adjust them accordingly.

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12
Q

cognitive error 5

A 
HIRCC
hindsight 
illusion of control
representativeness
conservatism
confirmation
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13
Q

Processing bias 4

A 
FMAA
Framing
Mental accounting 
Anchoring
Availability
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14
Q

Emotional Bias 6

A 
LOSSER
Loss aversion
overconfident
self-control
status quo
endowment 
regret-aversion
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15
Q

Conservatism

A

underweight new info

is a belief perseverance bias in which people maintain their prior views or forecasts by inadequately incorporating new information

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16
Q

Confirmation

A

selective bias
Seeking data to support beliefs, discounting contradictory facts
ignore and undervalue what contradict their belief

a cognitive error, is a belief perseverance bias. Individuals who exhibit this bias look for confirmation of their belief and ignore any information which contradicts their belief.

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17
Q

representativeness bias

IPS

A

classifying info base on past experience

overweight most recent information

base rate neglect
- too little consideration given to the initial classification being correct

sample size neglect
-inferring too much from a small new sample of information

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18
Q

illusion of control

CAPM, mean variace framework

A

tend to believe they can control or influence outcomes

lead to excess trading

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19
Q

Hindsight bias

A

may see past events as having been p predictable and reasonable to expect

20
Q

Anchoring

A

overweight initial default number
stick to their original estimates/analysis

hold onto

21
Q

Mental Accounting

goal based

A

invest in layers
treat one sum of money differently from another equal-sized sum of money

layer/goals

22
Q

framing

provide a full range of relevant info

A

decision based on how case is presented

focus future and let go realized loss

23
Q

availability bias

start the allocation process within global market portfolio

A

Individuals exhibiting this bias will assess the likelihood of an outcome based on how easily they can recall the information.

a cognitive error, is an information-processing bias.

  1. may limit their investment opportunity set
  2. may choose an investment without doing a thorough analysis of the stock, may fail to diversify, and
  3. may not achieve an appropriate asset allocation.

overcome this bias by developing an appropriate investment policy strategy, with a focus on appropriate goals (short- and long-term), and having a disciplined approach to investment decision making.

24
Q

loss aversion bias
disposition effect

goal based

A

prospect theory, loss averse
in which people tend to strongly prefer avoiding losses as oppose to achieving gain

investor behave as the evaluation of g/l based on reference point

25
Q

disposition effect

A

holding the investment that have experienced losses too long, and selling investment that have experience gains too quickly

  • limiting upside profit
  • trade excessively and hold risker portfolio
26
Q

Myopic loss aversion (近视的）special application of loss aversion

A

explain for equity premium that describes an anomalously higher historical real returns of stocks over gov’t bond

combines time-horizon-based framing, mental accounting and loss-aversion bias

more concerned with ST losses than LT results/gains
over emphasis ST G/L and weight losses more heavily than gains
resulting a higher equity risk premium

27
Q

overconfidence

self-attribution bias

A

people demonstrate unwarranted faith in their intuitive reasoning, judgements, cognitive abilities.

attribute success
overestimated knowledge levels, ability and access to information

underestimate risk and overestimate exp(r)
trade excessively
hold poorly diversified portfolio
lower return than the market

28
Q

self control bias

A

fail to act in pursuit of long-term goal because of lack of self-discipline.

  1. hyperbolic discount
    tendency to prefer small payoffs now compare to large payoffs in the future
  2. save/spend disposable income, spend today rather than save for tomorrow
  3. st satisfaction conflict lt goal/achievement
29
Q

status quo bias

A

do nothing, stay the same
Status quo bias reflects the tendency for forecasts to recent observations and then avoid making changes.
Status quo bias can be mitigated by a disciplined effort to avoid anchoring on the status quo.

need education

30
Q

endowment bias

A

emotional attachment

people value an asset more when they hold rights to it than when they do not. Refuse to sell.

31
Q

regret aversion bias

A

avoid making decisions made out of fear that the decision will turnout poorly

error of commission - action taken
error of omission -action non-taken

need education

32
Q

behavior modified asset allocation

A

the wealthier the client, the more the practitioner should and adopt to the client’s behavioral biases

standard living risk - the likelihood of achieve outliving his/her asset if a function of the level of wealth

cognitive error should be moderated
(easier to correct by education)
emotional biases should be adapted to

33
Q

Barnewall two-way model

A

passive

active

34
Q

BB-K five way model

level of confidence & method of action

A

ACIG

Adventurer - confident and impetuous 浮躁
unwilling to take advice

Celebrity - anxious and impetuous
seeks and take advice

Individualist - confident and careful
good to work with

Guardian - anxious and careful
seek advice from someone more knowledgable

35
Q

Pompian behavior model

A

BITS
PFIA

FROM LOWEST RISK TO HIGH

PP, FF,II,AA
Passive preserver emotional
friendly follower cognitive 
independent individualist cognitive
active accumulator emotional
36
Q

Passive preserver
Pompian behavior model
primarily emotional bias

A
  • not financially sophisicated
  • low risk tolerance
  • not willing to risk own capital

display emotional biases

focus of advice should be on addressing these emotions.

Describing how the investment relationship will help to accomplish goals would seem most appropriate.

37
Q

naive diversification (framing bias)

A

1/n divide contribution equally among available funds ignoring the issue of correlation and true diversification.

consequence:

  • Maintaining an under-diversified portfolio with assets having high correlations with each other.
  • Missing long-term objectives—not achieving the required returns or capital accumulation necessary to meet long-term expenses or goals, and potentially outliving the assets.
38
Q

Social proof bias

A

individual are bias to follow the belief of a group

39
Q

bounded rationality

A

recognizes that people are not fully rational when making decisions and do not necessarily optimize but rather satisfice when arriving at their decisions

40
Q

two reason for poor decision by investment committees:
1. decisions reflect the biases of the members.
2. social proof or herding as each member seeks to follow the beliefs of other members
view

A

actions to take to avoid:
assemble a diverse group of knowlegedgable members
follow an agenda
assure all members share

41
Q

The gambler’s fallacy

A

is a cognitive behavioral bias in which an analyst wrongly projects a reversal to a long-term trend.

Misunderstands mean reversion in assuming below average rates must return to above-average rates in a specific time period.

42
Q

Limitations of classifying investors into the various behavioral investor types include:

A
  1. investor can display both emotional biases and cognitive errors, making it difficult to classify the individual according to behavioral biases.
  2. may display traits of more than one behavioral investor type, making it difficult to place the individual into a single category.
  3. As investors age, they will most likely go through behavioral changes
  4. Even though two individuals may fall into the same behavioral investor type, the individuals should not necessarily be treated the same due to their unique circumstances and psychological traits.
  5. Individuals tend to act irrationally at unpredictable times because they are subject to their own specific psychological traits and personal circumstances. In other words, people don’t all act irrationally (or rationally) at the same time.
43
Q

deviation from a rational portfolio

A

for cognitive error

high wealth low SLR
moderate 5-10%

low wealth high SLR
close to rational 0-3%

for emotional bias

high wealth low SLR 10-15%
low wealth high SLR 5-10%

44
Q

friendly follower FF

primarily cognitive bia

A

an often overestimate his or her risk tolerance,
may follow “hot” ideas and show availability bias,

follow leads from friends/colleagues, want to be in the latest/popular investment without considering LT goal

low/moderate risk tolerance
overestimate risk tolerance

45
Q

independent individualist II

primarily cognitive bias

A

overconfident, self contribution
strong skilled

moderate/high risk tolerance

strong-willed
do own research

46
Q

active accumulator AA

primarily emotional bias

A

entrepreneur background, strong skilled
confident, self-control
higher turnover rate, involved in decision making

2021 CFA Level III (12 decks)

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