Behavioral Finance

Question 1

The premise of _______ is that conventional financial theory ignores how real people make decisions and that people make a difference.1

Answer 1

behavioral finance

Question 2

4 information processing errors

Answer 2

Forecasting Errors (Memory Bias)
Overconfidence
Conservatism
Representativeness Bias

Question 3

Individuals have limited time and attention and as a result may rely on rules of thumb or intuitive decision-
making procedures known as heuristics. Investors’ limited analytic processing capacity may also cause them to overreact to salient or attention-grabbing news and underreact to less salient information.

Answer 3

LIMITED ATTENTION, UNDERREACTION, AND OVERREACTION

Question 4

People tend to overestimate the precision of their beliefs or forecasts, and they tend to overestimate their abilities.

Answer 4

Overconfidence

Question 5

A ______ means that investors are too slow in updating their beliefs in response to new evidence.

Answer 5

conservatism bias

Question 6

People are too prone to believe that a small sample is representative of a broad population and infer patterns too quickly.

Answer 6

representativeness bias

Question 7

Individuals are adept at discerning patterns, sometimes even perceiving patterns that may be illusory.

Answer 7

EXTRAPOLATION AND
PATTERN RECOGNITION

Question 8

Behavioral biasis

Answer 8

Framing
Mental Accounting
Regret Avoidance
Affect and Feelings/Loss Aversion

(For Me, Run Always)

Question 9

Decisions are affected by how choices are posed, for example, as gains relative to a low baseline level or losses relative to a higher baseline.

Answer 9

framing

Question 10

is a specific form of framing in which people segregate certain decisions.
For example, an investor may take a lot of risk with one investment account but establish a very conservative position with another account that is dedicated to her child’s education. Rationally, it might be better to view both accounts as part of the investor’s overall portfolio with the risk-return profiles of each integrated into a unified framework.

Answer 10

mental accounting

Question 11

the reluctance of investors to sell shares in investments that have fallen in price (realize losses)

Answer 11

disposition effect, a part of mental accounting

Question 12

people blame themselves more for unconventional choices that turn out badly so they avoid regret by making conventional decisions

Answer 12

regret avoidance

Question 13

we behave different if we buy $1k and that falls to $995 vs increasing to $1005

Answer 13

loss aversion