Behavioral Finance Flashcards
Over-weighting the recent past
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.
Self-Affirmation Bias
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.
Spotting trends that are not there
Investors seek patterns that help support decisions sometimes without adequate confirming research
Status quo bias
The tendency of investors to do nothing when action is actually called for
Over-reaction
Investors emotionally react towards New Market information
Outcome bias
The tendency to make a decision based on the desired outcome rather than on the probability of that outcome
Overconfidence
The tendency to place too much emphasis on one’s own abilities.
It often works hand-in-hand with confirmation bias
Mental accounting
Looking at sums of money differently, depending on their source or their intended use.
Prospect theory
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.
Status quo bias
The tendency of investors to do nothing when action is actually called for.
Loss aversion and risk-taking
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.
Analysis paralysis
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.
Inappropriate extrapolation
The tendency to look at recent events or (market performance) and presume that those events or conditions will continue indefinitely
Hindsight bias
The 20/20 vision we have when looking at the past and thinking we understand it when in reality we may not.
Herd Behavior
The tendency for individuals to mimic the actions of a larger group could also be described as fear of missing out. FOMO
Gambler’s fallacy
An individual erroneously believes that the onset of a certain random event is likely to happen following an event or series of events.
Fear of regret
The tendency to take no action rather than risk making the wrong one.
Diversification errors
Investors tend to diversify evenly across whatever options are presented to them.
Heuristics
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.
Behavioral Finance
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.
Anchoring
The tendency of investors to become attached to a specific price as the fair value of a holding.
Attachment bias
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.
Endowment basis
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.
Cognitive dissonance
The challenge of reconciling two opposing beliefs.
Example: remembering the positive part of an experience but forgetting the negative.
Confirmation bias
The human tendency to accept any information that confirms our preconceived position or opinion and disregard any information that does not support that notion.
