Behavioral Finance

Question 1

Over-weighting the recent past

Answer 1

Investor’s like patterns. The recent past represents a nice easy way to find a pattern that can become the basis for an investment decision. An assumption the recent past will repeat in the future.

Question 2

Self-Affirmation Bias

Answer 2

The belief that when something goes right it’s because you were smart and made the right decision. If it does not work out it’s someone else’s fault or bad luck.

Question 3

Spotting trends that are not there

Answer 3

Investors seek patterns that help support decisions sometimes without adequate confirming research

Question 4

Status quo bias

Answer 4

The tendency of investors to do nothing when action is actually called for

Question 5

Over-reaction

Answer 5

Investors emotionally react towards New Market information

Question 6

Outcome bias

Answer 6

The tendency to make a decision based on the desired outcome rather than on the probability of that outcome

Question 7

Overconfidence

Answer 7

The tendency to place too much emphasis on one’s own abilities.

It often works hand-in-hand with confirmation bias

Question 8

Mental accounting

Answer 8

Looking at sums of money differently, depending on their source or their intended use.

Question 9

Prospect theory

Answer 9

The different ways people evaluate losses and gains. Researchers Kahnerman & Tversky found that losses have a much greater negative impact than a gain will have positive.

Question 10

Status quo bias

Answer 10

The tendency of investors to do nothing when action is actually called for.

Question 11

Loss aversion and risk-taking

Answer 11

Investors are risk-averse when it comes to gains. They do not want to give them up, they are risk seekers when it comes to losses. They will take big risks to avoid realizing them. People often opt for the sure gain. As a result investors are biased towards in action and seriously underweight the cost of missed opportunities. Opportunity cost.

Question 12

Analysis paralysis

Answer 12

When the fear of either making an error outweighs the potential value of success in a decision made in a timely manner. The imbalance results in a suppressed decision making in an unconscious effort to preserve existing options the options can overwhelm the situation and cause paralysis rendering one unable to come to a conclusion.

Question 13

Inappropriate extrapolation

Answer 13

The tendency to look at recent events or (market performance) and presume that those events or conditions will continue indefinitely

Question 14

Hindsight bias

Answer 14

The 20/20 vision we have when looking at the past and thinking we understand it when in reality we may not.

Question 15

Herd Behavior

Answer 15

The tendency for individuals to mimic the actions of a larger group could also be described as fear of missing out. FOMO

Question 16

Gambler’s fallacy

Answer 16

An individual erroneously believes that the onset of a certain random event is likely to happen following an event or series of events.

Question 17

Fear of regret

Answer 17

The tendency to take no action rather than risk making the wrong one.

Question 18

Diversification errors

Answer 18

Investors tend to diversify evenly across whatever options are presented to them.

Question 19

Heuristics

Answer 19

Experiences and biases that can facilitate problem-solving and probability judgments. These are generalizations or rules of thumb, they often result in an irrational or inaccurate conclusion. A strategy that ignores part of the information with the goal of making decisions more quickly and accurately than more complex methods.

Question 20

Behavioral Finance

Answer 20

The study of how psychology affects Finance. Psychology is the basis for human desires, goals, and motivations. In addition, psychology is the basis for a wide variety of human errors that stem from Perpetual illusions, overconfidence, and over-reliance on rules of thumb and emotions.

Question 21

Anchoring

Answer 21

The tendency of investors to become attached to a specific price as the fair value of a holding.

Question 22

Attachment bias

Answer 22

Holding onto an investment for an emotional reason rather than considering more practical applications for the inheritance. Example: My grandfather left me this stock so I can never sell it.

Question 23

Endowment basis

Answer 23

The feeling that because you own an asset it’s more valuable and special because it is yours… in reality you may not even purchase the asset if you didn’t already own it.
Example: You inherited the family’s summer home and won’t ever sell it even though it’s become a money pit.

Question 24

Cognitive dissonance

Answer 24

The challenge of reconciling two opposing beliefs.

Example: remembering the positive part of an experience but forgetting the negative.

Question 25

Confirmation bias

Answer 25

The human tendency to accept any information that confirms our preconceived position or opinion and disregard any information that does not support that notion.